Debt Rattle, June 4 2008: Dishonest if he can, honest if he must

Arthur Rothstein Evicted January 1939
An evicted sharecropper among his possessions in New Madrid County, Missouri

Ilargi: The story of the hour on Wall Street for a second day in a row is Lehman. To cover the whole spectrum, we need a handful of articles. While it’s true that developments such as this can feed on themselves, for instance, Lehman lost 9% and almost 10% in the past two days, respectively, I’m still not convinced it’s the most likely bank to fall first. I look at Wachovia and Washington Mutual, and I see tons of vulnerability.

Perhaps more intriguing should be the ongoing shift in various risk assessment instruments. The damage done to the trust once held in ratings agencies and the LIBOR rate could well be so pervasive that they never can and will return to the same status they once had.

That’s the price you pay for being, let’s say, less than sincere, not surprising when trillions of dollars worth of decisions are based on your (often machine-model-made) "analyses", and untold billions have been lost because they were repeatedly found to be inaccurate. I know, billions were made because of it too, but, remember, never try to cheat a cheater.

And of course the world of finance is not some kind of parallel universe, even though it often tries to be. It does indeed register reports saying that mortgage applications are down 15%, while business bankruptcies are up 46%.

All the plans and schemes and machinations and capital injections and Fed edge-of-legal free-credit windows will turn out to be a complete waste of time and money if numbers like that don’t turn around and race back upwards, very soon. And boy, do they know it. Many executives are focused on saving their own rear ends, not their companies. Not that they would ever admit it.

Companies these days may still see their stocks go up when they report negative, but less bad than feared, numbers, but it should be, and is, obvious, that that is a very temporary game. When I read that Lehman is actively engaged in buying back its own sinking stock, while it’s clear, even though officially denied, that it’s seeking $4 billion in capital, I get nervous.

The outside capital comes at an ever rising cost to banks, and to use that to purchase your own plummeting shares, that is the very picture of desperation.


Derivatives Traders Signal Bank Woes Likely to Worsen

Interest-rate derivatives traders are betting banks' difficulties obtaining cash to fund holdings and shore up balance sheets will worsen.

The difference, or spread, between the three-month dollar London interbank offered rate, or Libor, and the overnight index swap rate, traded forward three months, is greater than similar spreads expiring this month, according to data tracked by Credit Suisse Holdings Inc.

"The movement in the forward Libor-OIS spreads is telling you that the market is concerned that things can get even worse before they get better," said Carl Lantz, an interest-rate strategist in New York at Credit Suisse. "Until all banks' balance sheets are cleaned up and they've re-capitalized, there is going to be funding pressure."

Derivatives trades are showing that while global markets have rebounded since March, the worst may not be over for banks after racking up $387 billion of losses and writedowns from mortgage-related securities since the start of last year. Lehman Brothers Holdings Inc. has tumbled 18 percent in the past two days on concern it will require outside funding to shore up its balance sheet.

The three-month Libor-OIS spread traded forward to June 16, the date the June Eurodollar futures contract expires, was 67 basis points yesterday, while the forward spread corresponding to the September Eurodollar expiration was 72 basis points.

The difference between Libor, which is an average rate based on a daily survey of 16 banks by the British Bankers' Association, and the OIS rate indirectly measures the availability of funds in the money market. Forwards give expectations for the future.

The increased difference is primarily due to traders exiting "soon-to-expire positions" earlier than usual, amid questions over Libor's reliability, according to Laurence Mutkin, London-based head of European fixed-income strategy at Morgan Stanley.

The market has grown more pessimistic since April 30, when the September spread was 6 basis points less than June, according to Credit Suisse. Eurodollar futures are priced at expiration to three-month dollar Libor and their settlement dates are typically those used to determine forward-maturity spread dates.

The spot three-month dollar Libor-OIS spread was 68 basis points today, after ranging from 24 basis points to 90 basis points this year and peaking last year at 106 basis points in December. The spread averaged 11 basis points for the 10 years prior to August, when the global credit crunch began.

Concern institutions are having difficulty accessing financing increased this week after Standard & Poor's lowered credit ratings for Morgan Stanley, Merrill Lynch & Co. and Lehman Brothers June 2, citing the possibility that the investment banks will have further writedowns on devalued assets.

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U.S. MBA's Mortgage Applications Index Fell 15.3% Last Week

Mortgage applications in the U.S. last week dropped to the lowest level in six years, reflecting less refinancing as interest rates jumped.

The Mortgage Bankers Association's index of applications to purchase a home or refinance a loan fell 15 percent to 502.3, the lowest level since April 2002, from 593.3 the prior week. The group's purchase index decreased 5.4 percent and its refinancing gauge dropped 26 percent.

The housing market faces decreasing demand as prospective buyers wait for prices to stop falling and additional foreclosures force lenders to tighten rules for mortgage applicants. The real-estate slump will probably weaken the economy for the rest of 2008.

"We continue to view the residential real-estate crash as the most important factor underlying current recessionary conditions in the U.S.," said Maury Harris, chief economist at UBS Securities LLC in Stamford, Connecticut, in an e-mail note to clients. "Home prices are falling at a faster rate, a signal of worsening supply/demand imbalance."

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Business busts boom in May, as bankrupticies rise 46%

U.S. commercial bankruptcies soared 46% in May from a year ago and many more are expected as the slowing economy chokes consumers and businesses, according to a bankruptcy management firm.

There were some 5,233 commercial bankruptcy cases last month, up from 3,589 in the year-ago period, according to AACER, a database of U.S. bankruptcy statistics. Commercial cases include bankruptcy filings from companies, as well as individuals who indicate they are running a business.

“It’s a very sizable increase year over year, no doubt about that,” said Mike Bickford, president of AACER. And there are many more bankruptcy filings to come, according to Mr. Bickford. “What we’ve seen over time using historical models is that (the filings) will stay fairly level from now through the end of August, then we’ll see another spike for September and the fall months,” said Bickford.

As many as 1.1 million bankruptcy cases, including personal filings, as well as commercial, are expected by the end of the year, he said. That is up from about 800,000 last year. There were an average 249 commercial filings every day last month. That is the highest monthly rate since new bankruptcy laws took effect in 2005, according to AACER.

A wide range of industries are struggling this year. Higher costs of food and fuel have stifled consumer spending and cut into retailers’ profits, while home builders have been slammed by falling home prices. Higher fuel costs have also hurt airlines and transportation-related companies, which have difficulty passing on their higher expenses to customers.

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"Old world" economies run into triple trouble-OECD

• Industrialised world faces triple shock
  
• U.S. GDP to shrink in second quarter
  
• European and Japanese economies to suffer more than thought
  
• Central banks advised to stay put on interest rates

U.S. economic growth will slow to a crawl, inflicting heavy collateral damage on Western Europe and Japan, because of a "triple shock" of market turmoil, high commodity prices and the end of the housing boom, the OECD said on Wednesday.

Emerging economies like China will continue to thrive although growth is likely to be at a less heady pace, the Organisation for Economic Co-operation and Development said in a twice-yearly report. Inflation may remain high for some time despite the extent of the U.S. slowdown and knock-on impact on growth in other primarily long-industrialised regions, it added.

The OECD, a public agency financed by its 30 mostly wealthy country members, highlighted problems and uncertainty caused by a shift in global economic power towards fast developing nations such as China, Brazil, India and oil-rich Russia.

It forecast a second-quarter contraction in the U.S. economy and just 1.2 percent growth for 2008 overall as a result of a housing slump and its impact on the broader economy. "The picture is of a flat U.S. economy until the end of this year and afterwards recovering only gradually," OECD chief economist Jorgen Elmeskov told Reuters, describing any suggestion that Europe or Japan could go unscathed as "a myth".

The OECD predicted a weak second quarter in the euro zone, with just 0.2 percent growth, annualised, versus the previous quarter. It forecast that the Japanese economy would expand 1.1 percent also annualised in the same period.

For this year overall, growth would slow to 1.7 percent in both the euro zone and Japan. While better than in the United States, this marks a drop from 2.6 and 2.1 percent respectively in 2007. "OECD economies face a triple adverse shock as globalisation evolves," the OECD said, adding that emerging market economic growth would continue at a healthy rate, in Eastern Europe too, even if it decelerated marginally.

The three shocks were the financial market turbulence which spilled out of the United States after the meltdown of the sub-prime mortgage market, the end of an international boom in house prices and soaring costs of food and fuel, it said. "These three shocks are inextricably linked to the growing importance of emerging markets in the global economy."

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Credit-Card Use Is Surging, Risking Another Debt Crisis

Cash-strapped Americans are ringing up more and more purchases on their credit and debit cards, and there could be a steep price to pay ahead.

Though the trend is a boon for the companies that issue the cards, analysts worry that there could be long-term problems not only for consumers but also for the anemic economy and the already-troubled banks that will be underwriting all that risky debt.

"Right now what we're seeing is the US consumer losing their disposable income as they have to spend more and more on necessities because of higher prices for gas and food," says Ron Ianieri, a market strategist and co-founder of the Options University investor education center. "Normally when you have a certain budget and you can't keep up with the budget one of the easy steps is to extend that budget using credit."

One of the main problems with that is US consumers—and their counterparts in Europe as well—already are delinquent on their credit card payments in numbers not seen in six years. The Federal Reserve last week said credit card delinquencies hit 4.86 percent in the first quarter in 2008, while revolving debt—or the type used in credit purchases—hit $957.2 billion in March, a 7.9 percent increase.

As all that risky, high-interest debt keeps accumulating, consumers will find themselves deeper in a hole that threatens to keep the economy in its sluggish state. Economists worry that the problems are being exacerbated by consumers using credit not only to buy big-screen TVs and patio furniture, but also to pay their mortgages and shop for groceries.

"There's a significant risk to people who are using credit cards to help them try to bridge the gaps that they're facing," says Sean Snaith, director of the University of Central Florida's Institute for Economic Competitiveness. "The reality is the economic picture isn't going to clear up instantaneously."

Meanwhile, the banks that underwrite the credit card debt stand to lose as the delinquencies continue to rise. Standard & Poor's on Monday issued a dour forecast for banks in 2008, in part because of their exposure to bad debt.

"It's a disaster, it's a time bomb," Ianieri says. "The credit crisis is a lot more severe than it's being made out to be.

I think the government is doing everything it can to keep the severity of this situation under wraps from the general population. I think they're just trying to bide time for these banks."

For the credit card companies, though, it's a different story. Visa and Mastercard back comparatively little of the credit actually issued through their cards, meaning they have a low level of risk for defaults and other payment issues. They get paid a fee each time someone uses their cards, and the banks that issue the cards assume responsibility for the debt.

As such, investors and analysts are fawning over the two companies in the face of consumer cash issues and the growth of emerging markets, where credit cards are only beginning to find popularity. "The reality is probably some of it is hype, but some is based on fact," Snaith says. "'Check or cash' has been replaced by 'debit or credit' and that's going to be a continuing trend not just in the US but spreading worldwide."

In a note issued last Thursday, Lehman Brothers raised its outlook on Mastercard, escalating its price target to $335 from $300. Other analysts have joined in the enthusiasm, with Stifel Nicolaus on Tuesday jacking up its price target from $312 to $367

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LIBOR on shaky ground

That LIBOR's integrity has come under scrutiny is somewhat worrying. That an unregulated body responsible for the maintenance of the most widely used benchmark in finance can't be bothered to safeguard its practices is cause for outright alarm.

One expert told Bloomberg, "LIBOR is an inherently flawed index. [It's] an unresolved problem as it's not based on actual trades and actual borrowing costs but on people's guesses. Either it will die or it will change."

But the likelihood of LIBOR going away is slim. According to The Wall Street Journal, in addition to the trillions of dollars in complex derivative investments based on the benchmark, $900 billion in subprime mortgages are tied to LIBOR.

If the myriad of failed mortgage bailouts has proved anything, it's the inability of the mortgage servicing industry to coordinate its way out of a paper bag. Servicers have the thankless job of collecting mortgage payments and chasing down borrowers if they don't send in checks.

It was fantasy to assume the industry could have affected such broad change with any degree of success. Even if regulators had concluded LIBOR's flaws were serious enough to warrant a switch to another benchmark, little could have been done. Any attempt to alter such a vast quantify of mortgages would be a disaster.

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Rating Firms Seem Near Legal Deal on Reforms

Under fire for the high ratings they awarded to subprime mortgage securities, three large credit rating firms are close to announcing a broad deal with the New York attorney general to reform some of their core business practices, according to people briefed on the investigation.

Most significantly, the rating firms are considering changing how they charge fees for ratings to make it harder for investment banks to play the firms against one another to obtain a better rating, these people say, adding that negotiations are ongoing and the deal could still fall apart.

As part of the deal being discussed, the firms — Standard & Poor’s, Moody’s Investors Service and Fitch Ratings — would also aid Attorney General Andrew M. Cuomo’s broader investigation into how Wall Street packaged mortgages into securities, in exchange for immunity from prosecution. And the rating agencies will establish new standards for how investment banks review mortgage loans.

Mr. Cuomo has been investigating the once-booming and lucrative mortgage business for about a year. He is focusing on whether investment banks withheld critical information about the home loans they were packaging into bonds to be sold to investors like hedge funds, insurance companies and pension funds.

As part of that investigation, Mr. Cuomo this year secured the cooperation of Clayton Holdings, a firm that reviews loan files on behalf of investment banks. His office has not formally charged any investment banks with wrongdoing.

Regulators have struggled to assign blame for the mortgage debacle, at times pointing to everyone and no one in particular. Many institutions were involved in making loans, evaluating the debts and packaging them into securities. But rating firms played a critical role by awarding mortgage-backed securities triple-A ratings, a gold standard that allowed investors like pension funds and insurance companies to buy them.

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Foreign funders take a bank pass

Much has been made of the amount of foreign capital that may be available to rescue loss-ridden U.S. banks. But while banks succeeded in tapping that capital early on in the credit crunch, a recent filing by Washington Mutual confirms growing fears that foreign investors have become too skittish to be willing to prop up some of the nation's ailing large banks.

Before landing a $7 billion lifeline from a group led by private equity firm TPG Capital, executives at Washington Mutual played the field, scanning the globe for potential partners to help bolster the thrift's weakened capital position.

Among the financial institutions that WaMu reached out to in early March in its quest for additional funding were eight sovereign wealth funds and two international banks, as well as seven private equity players, according to a company filing in late May that sketched out the process leading up to the TPG deal.

WaMu officials also approached five U.S. and international banks about a potential sale, the filing revealed, clearly looking to keep the thrift's options open beyond the search for an equity injection.

By making multiple overtures around the world, WaMu garnered considerable and immediate interest from a number of the potential players: Of the 23 disclosed parties WaMu approached about a sale or equity investment, six of the private equity firms and four of the strategic buyers signed confidentiality agreements to talk with WaMu executives and kick the tires.

Notably absent from the mix, however, were the sovereign wealth funds and foreign banks that it had invited to the table. In fact, the WaMu filing disclosed that “none of the sovereign wealth funds or international banks indicated an interest in participating in the potential equity investment process”—a development that observers say may be a broad indicator of international institutions' interest, or lack thereof, in U.S. financials at the moment.

“With the way some of the investments sovereign wealth funds made last year are playing out, it's not surprising that they would take a pass here,” said Edwin Truman, senior fellow at the Peterson Institute for International Economics and a former assistant secretary of the Treasury for international affairs. The sovereign funds' reluctance could be a larger statement about the condition of U.S. banking institutions, rather than just a commentary on WaMu, Mr. Truman added.

With many of the largest U.S. banks' balance sheets severely wounded by the turmoil in the mortgage and credit markets that began last summer, a number of sovereign wealth funds and foreign banks jumped at the opportunity to inject cash into these financial institutions.

The growing reluctance on the part of sovereign wealth funds comes as no surprise to some observers. With many U.S. financials still reeling, sovereign wealth funds “have taken a lot of criticism in their home countries over their investments,” Mr. Truman said. “And they're not about to make another large investment in a financial institution if they believe that more bad news could unfold.”

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Losing Lehman

What is Lehman doing?Yves Smith at Naked Capitalism thinks it is one of the most irresponsible financial actions she’s seen in quite a while. “It” being the bank’s remarkable volte face: yesterday morning Lehman was mulling a $4bn rights issue, but by the afternoon - according to the WSJ - it was buying back a huge amount of stock. Smith:

For a firm which is overlevered, rumored to be on the heels of Bear Stearns, with a large short interest, to go out and buy its own shares? This is a ludicrous short-sighted use of scarce funds.

Trading yesterday wiped $1.72bn off the bank’s market capitalisation, with shares down 9.5 per cent by close at $30.61 on the NYSE. That figure could have been a lot worse were it not for the buyback. Shares were at one point down 15 per cent - before a surge in volume accompanied a strong afternoon rally.

The whole mess, of course, has been caused by two big rumours doing the rounds: first, talk of big losses in upcoming results thanks to hedges gone awry, and second, talk of borrowing from the Fed’s investment banking fund window.

The FT today reports that Lehman might have lost as much as $700m on a single hedge. In a report yesterday, the WSJ put total loss through such trades at $2bn. Felix Salmon at Market Movers wonders if this is all a case of history repeating. Bear Stearns, afterall, was stung by a similar hedging failure shortly before it hit real trouble.

Could it be that Lehman, even after seeing what happened at Bear, is making the same mistakes? That it’s trying to hedge its positions discretely, even in market which has systematically slaughtered anybody who’s tried to do that for the past year?

Actually, though, it sounds like Lehman is being hit precisely because it did what Bear did not. Bear Stearns unwound its chaos trades - broad pessimistic bets on ABX indices, short positions on mortgage brokers etc - too early. When chaos really did hit in March, Bear had no protection. Lehman, vice versa, has left them too late.

With some senior series of the ABX resurgent since March, Countrywide CDS tighter (160bp last week alone) and other indicators showing - in the run up to June at least - improvement, those chaos trades are likely earning little, if not actually, losing money.

The second rumour, talk of borrowing from the Fed, was slapped down pretty sharpish by Lehman spokespeople. But it looks like Lehman is borrowing central bank money. From the ECB, [not the Fed!!]. Take the €2.17bn ($4bn) Excalibur CDO of CMBS. Single-A and priced at E+200bp it Is not for sale in the market, but does meet ECB collateral eligibility criteria.

Back though to Lehman’s overall situation: rights issue out the window, Lehman has turned to foreign shores. Private investors are now being tapped for cash - with South Koreans high on the shortlist. There is likely more pain ahead on the open market too, when trading opens in New York. Bloomberg reports that put options on the investment bank have increased to a two month high.

The Wall Street Journal offers the bluntest advice: Lehman should cut to the chase and offer itself for sale.

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Lehman hedges lose $500m to $700m

Lehman Brothers lost $500m-$700m on certain hedging positions in the second quarter, contributing to what is expected to be a larger-than-anticipated loss that may lead the bank to raise more capital by selling a stake to an outside investor. People close to the matter said Lehman had opened talks with potential investors including asset managers and Asian banks.

Analysts have suggested Lehman could look to raise as much as $4bn in new capital. The bank declined to comment.
Lehman has not made a decision on whether to raise more capital, people familiar with the matter said. If it does, the bank is more likely to sell a strategic stake rather than issue common shares. However, all options remain under consideration.

Among those interested in providing capital to Lehman is CV Starr, the investment vehicle of Hank Greenberg, former chairman and chief executive officer of AIG, the world’s biggest insurer, according to people familiar with the matter. Lehman has also reached out to other US financial institutions, including institutional investors and several Chinese entities. The most likely Chinese investor would be the State Administration of Foreign Exchange.

Executives at private equity firms say they have not been approached by Lehman Brothers. The founder of one major firm noted that if his firm took a major stake in Lehman ”we’d be penalized. Other investment banks wouldn’t show you deals and give you competitive financing.”

In the last round of rescue financing, TPG considered putting up to $3bn in Merrill Lynch but its terms were far more onerous than those on offer from sovereign wealth funds. Many sovereign wealth funds meanwhile remain on the sidelines, partly because their earlier investments remain under water and partly because they have been stung by a political backlash in the U.S.

The roughly $500m-$700m loss on trades that make up one of its hedging positions would be in addition to setbacks on previously successful hedges on its big exposures to commercial and residential mortgages, discussed by Erin Callan, chief financial officer, at a recent investor conference.

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Lehman Options Show Investors Bet on Further Drop

Investors in the options and debt- derivatives markets are betting Lehman Brothers Holdings Inc. has further to fall amid concern the fourth-largest U.S. securities firm may need a capital injection.

Options traders increased their bearish positions to a two- month high yesterday, after analysts said Lehman may report its first quarterly loss since going public in 1994. Credit-default swaps on the New York-based firm jumped 19 basis points to 275 today, according to CMA Datavision prices. The contracts rise when investors' perceptions of credit quality decline.

Lehman, which dropped to an almost five-year low on the New York Stock Exchange yesterday, declined 6 percent in early New York trading to $28.80. They are down 53 percent this year, the worst performance on the 11-company Amex Securities Broker/Dealer Index. Lehman may seek funds from overseas investors, including at least one in South Korea, the Wall Street Journal reported today without citing sources.

"Lehman may need to raise equity capital," said Bank of America Corp. analyst Michael Hecht in a report to clients. He estimates the company will report a second-quarter loss of about 50 cents a share during the week of June 16.

Trading of Lehman put options rose to 283,676 contracts, or quadruple the 20-day average, and bearish bets on the company exceeded bullish ones by 1.6-to-1. The most-active contracts were June $30 puts, which gained 68 percent to $3.35. Trading in put options that give investors the right to sell the stock at $17.50 by June 21 rose to almost 14,000 contracts yesterday.

"If there is a risk, and we do not think so, it is for shareholders and not bondholders," Andrea Crepaz, a Munich- based credit analyst at UniCredit, wrote in a note to investors today.

Lehman shares fell yesterday by the most since March 17, the day after Bear Stearns Cos. agreed to be acquired by JPMorgan Chase & Co. in order to stave off potential bankruptcy. The decline occurred even after Lehman denied borrowing from the Federal Reserve and said the firm's cash holdings have increased.

The company had more than $40 billion of liquid assets at the end of the quarter, up from $34 billion three months earlier, Treasurer Paolo Tonucci said in an e-mailed statement. The last time Lehman borrowed from the Fed was on April 16, he said.

Lehman was the most actively traded stock on U.S. exchanges yesterday, with more than 136 million shares changing hands. The firm lost $500 million to $700 million on hedging positions in the second quarter, which may prompt it to seek more capital by selling a stake to an outside investor, the Financial Times reported, citing unidentified people familiar with the matter.

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Lehman buying back its shares

Lehman Brothers Holdings Inc began using its capital to buy back its shares in the wake of its falling stock, the Wall Street Journal reported on Tuesday, citing a person familiar with the matter.

It was unclear how much stock Lehman bought, the Journal said. Lehman may also look to sell a stake to a group of investors and has held talks in recent days with at least one foreign entity, the Journal reported, citing a source.

Lehman's stock closed Tuesday's session down 9.5 percent, or $3.22, at $30.61 on the New York Stock Exchange.

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Lehman Takes a Licking

One day after investors in Lehman Brothers had to weather a sell-off in shares of the brokerage firm, the stock tanked again. On June 3, Lehman shares fell nearly 10% on press reports that the company intended to raise $4 billion in fresh capital, stirring market worries that the credit crunch could come back with a vengeance.

For some, the plunge stirred up memories of Bear Stearns' March collapse, and financial-market rumormongers wasted no time spreading the idea that the selling in Lehman shares was a prelude to a Bear-like final act for the 158-year-old firm. The bad buzz forced Lehman treasurer Paolo Tonucci to deny that the bank had to borrow funds from the Federal Reserve's discount window lending facility on June 3.

But are things really that bad for Lehman? The bond market didn't appear to think so. If the firm were truly on the verge of extinction, its debt should have seen a sharp sell-off—but that didn't happen on June 3. "The equity investor is acting first and asking questions later," said Sanford C. Bernstein analyst Brad Hintz. "Fixed-income investors were much more sanguine."

Although Lehman will most likely be here for some time to come, its problems are many—and big. Start with the June 2 downgrade of Lehman's credit rating by Standard & Poor's, which reduced Lehman's debt to A from A+. The downgrade had little real immediate impact—"Lehman's debt was already trading as if the downgrade had already occurred," Gimme Credit analyst Kathleen Shanley said in a June 3 report.

The fact that Lehman's rating was left on negative watch by S&P raised fears of more downgrades to come. The June 3 sell-off also could be chalked up to the fact that a capital infusion involving the sale of a big chunk of new Lehman common stock could dilute shareholder equity. Lehman has already raised $7.9 billion in debt via the sale of preferred shares and will have to turn to the equity markets if, as is expected, they seek additional cash.

"They've reached the limit as directed by ratings agency of how much hybrid debt and preferreds they can have," says Lauren Smith, an analyst at Keefe, Bruyette & Woods. The number could be as high as $4 billion in common equity, The Wall Street Journal recently reported, equal to nearly one-quarter of Lehman's current market cap.

Investors should expect Lehman to be in for a long, tough slog. In lowering Lehman's debt rating, Standard & Poor's said it expects a "meaningful deterioration in Lehman's second-quarter performance." The equity analyst community appears to agree, having recently reduced estimates for the company's second-quarter earnings, expected June 16. Analysts now expect the firm to post a quarterly profit of 12¢ a share, down 9¢ from their consensus forecast of early May.

Lehman's profitable equity and international businesses should create a buffer that didn't exist for Bear, analysts say, but with the asset-backed securities market at a standstill (except in low-margin mortgages from Fannie Mae and Freddie Mac), and a slowing U.S. economy doing its domestic business no favors, it will take Lehman a while to recover. "The environment remains dicey [for a recovery]," Keefe, Bruyette & Woods' Smith said.

Then of course, there's the credit crunch. If nothing else, Lehman's nosedive is proof that the problems facing U.S. investment banks are far from over. Analysts expect Lehman to post more writedowns—though not necessarily of the magnitude of those in the first quarter—amid lingering credit problems. "We thought all along this situation will take longer to fix," says Thomas Atteberry, co-manager of First Pacific Advisors. "If I were Lehman, I would raise the capital while I can."

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Lehman has little choice but to raise capital

Despite its best efforts to shrink its balance sheet and soothe an anxious market, Lehman Brothers has little choice but to raise new capital. Lehman shares have lost more than half of their value in the past year amid concern its primary mortgage and credit businesses are struggling.

On Monday the stock sank after Standard & Poor's downgraded Lehman to single-A and warned the credit rating could be lowered if Lehman incurred big losses. Now there is growing consensus the bank needs to raise new equity capital, fueled in part by losses incurred as Lehman tries to shrink its balance sheet.

"They're a big trading house that is reducing leverage, a big fixed-income underwriter amid a credit crunch and the largest surviving player in a mortgage business that has been damaged for years to come," said Bernstein Research analyst Brad Hintz, a former Lehman finance chief.

The fourth-largest U.S. investment bank saw its shares sink as low as 13 percent Tuesday amid renewed questions about its financial health. The Wall Street Journal reported the bank needed to raise as much as $4 billion in capital to offset second-quarter losses that exceeded forecasts.

Lehman is considering raising capital, a person familiar with the situation said, though this source denied Lehman needed to raise capital. Lehman declined to comment. Late Tuesday afternoon, Lehman said it finished the second quarter with more than $40 billion in liquidity and has not accessed the Federal Reserve's discount window since April. Its shares retraced its losses.

The bank has been under scrutiny in recent weeks as David Einhorn, whose $6 billion hedge fund Greenlight Capital is shorting Lehman shares, accused the bank of low-balling write-downs. Last month he argued it needed to raise capital. 

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Lehman May Turn to South Korean Investors for Funds

Lehman Brothers Holdings Inc. may turn to South Korean investors such as Korea Development Bank and Woori Financial Group for fresh capital, the Wall Street Journal reported, without saying where it got the information.

The U.S. securities firm is turning to South Korea because of the company's history in the country and its "well- connected" Vice Chairman Kunho Cho, the newspaper said. Lehman is seeking investors overseas after raising capital from existing U.S. shareholders, the report said.

Korean Investment Corp., which owns shares in Merrill Lynch & Co., is unlikely to invest in Lehman, the newspaper said, citing a person familiar with the situation. Lehman is seeking to raise about $4 billion, the newspaper said, citing analysts and Wall Street executives it didn't identify.

Lehman also bought back shares, which limit declines in its share price yesterday, the report said, citing unidentified people.

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Wrecking ball hits UK housing market

Jeepers. What a way to start a week. Any remaining doubt that the housing market is in freefall was blown away by figures showing a collapse in mortgage approvals, an unprecedented rights issue repricing and profits warning from Bradford & Bingley - and an increase in the Nationwide's fixed-rate mortgages.

With house prices falling, there is a full-scale retreat from the mortgage market. Would-be homebuyers don't want to buy something they might get much cheaper next year, while lenders won't lend on assets that might soon be under water. None of the Nationwide's fixes are available below 6%, more than a full point above base rates. The squeeze is on.

In the early stages of a housing market slump, activity indicators are often more relevant than price data, which tends to lag. So when mortgage approvals fall by half and net new home reservations are down by three-quarters there is a problem. Right now the data is telling us just one thing, that the housing market is in meltdown.

Bradford & Bingley, meanwhile, is a corporate disaster area. Seven weeks ago it reckoned it didn't need a rights issue. Two weeks ago it asked for £300m at a hugely discounted 82p. Investors, however, were assured that trading was fine. Yesterday B&B's chairman, Rod Kent, admitted trading was anything but fine. Arrears are mounting, margins are being eroded, the company is about to plunge into the red and there is no sign of improvement. Private equity group TPG has been lured in to take a 23% stake and the rights price slashed to 55p.

Kent acknowledged B&B had much to do to rebuild its management's credibility with the City. But he started to do that in a very odd way. A key issue is exactly why the rights price has been slashed. OK, so the business has taken a turn for the worse since the rights issue was announced. But the original 82p price was at a near-50% discount to ensure B&B got its cash, regardless of any problems that arose. That risk was accepted by the investment banks, UBS and Citi, which underwrote the cash call and guaranteed B&B got its money. It is a risk they took in return for large fees.

Now the fees have gone up, from 3% to 8.5%, divvied up among the lawyers, bankers and accountants, and the banks are taking less risk. Kent insists the rights issue price was slashed in the interests of B&B's near 1 million small shareholders, who were mostly unlikely to take up their rights but have the proceeds from selling those rights to look forward to in return for their stake being diluted. If the rights price went under water, they wouldn't even have that to look forward to - hence the reprice.

On that basis can we presume there will be another cut if more bad news, or short sellers, force the price below 55p? However, reliable sources close to the underwriting banks provide an altogether more plausible explanation. The banks, they say, simply got cold feet. Spooked by the unprecedented profit warning during a rights issue, they demanded an unprecedented cut in the price. There is also the fact that TPG had a price at which it was willing to invest, and that forced the rethink.

Either way, two things are clear: a) B&B has much work to do to rebuild its management credibility and b) the investment banks are being bailed out at the expense of the shareholders.

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Shareholders will carry the can for B&B fiasco

There is still much gnashing of teeth about Bradford & Bingley's bungled rights issue. Representatives of small shareholders and at least one high-profile City banking analyst are calling on investors to vote against the restructured 55p deal and force the underwriters at UBS and Citi to take on the shares they previously guaranteed to buy at 82p.

The big loss they would face is their problem. They made a deal and if they didn't find out enough about the horrors lurking inside B&B before signing on the dotted line, then tough. Some would also like to see the back of the private equity group TPG, lured in to provide £179m in return for a 23% stake, arguing that it has in effect been handed control for little more than pocket money.

TPG gets to put two non-executives on to the board and will undoubtedly have a big say in who becomes the next chief executive (and probably finance director too, because the incumbent, Chris Willford, must be calculating the size of his payoff)
There are, however, big holes in the case for turfing out the new rights issue: not least that the previous 82p issue, like Monty Python's dead parrot, is no more. It is extinct.

If shareholders give the new plan the thumbs-down, chaos will surely ensue. There would be no underwriting at the higher price, so B&B would not get its much-needed cash. TPG would disappear. Its involvement is dependent on the 55p rights issue going ahead. The shares would tank (even further) and the Financial Services Authority would have to organise a rescue takeover.

Some shareholders believe the FSA has already been there and failed to drum up any interest, because the TPG deal looks like a second-best solution. Shareholders certainly cannot expect any support from the FSA. Far from beating the underwriters at UBS and Citi with a stick for reneging on their deal, it seems the watchdog had more than a little sympathy with the predicament faced by the investment banks.

Fearful of a Northern Rock-style debacle, FSA personnel have evidently been sitting alongside the B&B management in recent weeks and tearing their hair out when requests for fairly straightforward business information were met by blank looks. The Treasury has been "monitoring" the situation and the Bank of England has been saying for months that shareholders would have to stump up and feel a little pain.

It is all very well for B&B's chairman, Rod Kent, to promise he is going to hire a "shit-hot new chief executive" and haul the bank's processes into the information age, but it is not apparent why he did not notice the shortcomings over the five years he has been in the job. The business information vacuum also reflects poorly on the FSA. How can it let a bank it has been monitoring rely on out-of-date information?

But then the watchdog's report on Northern Rock demonstrated the utter inadequacy of the FSA's monitoring procedures. Nevertheless, the watchdog's view - based on first-hand experience of the internal workings of B&B - now seems to be that the bank's shareholders should consider themselves lucky that their bank is worth 55p a share and TPG should be welcomed with open arms.

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Private equity funds look to snap up cheap UK bank shares

Texas Pacific Group plans to use its investment in Bradford & Bingley as a springboard for stake-building in other banks. Such a move could trigger a wave of private equity investments in the UK's distressed financial services sector.

Paragon, which specialises in buy-to-let mortgages for professional landlords, is being stalked by at least one private equity firm. With the shares trading at just over a third of book value, Paragon could attract more suitors, sources said.

Besides TPG, other private equity firms - including Blackstone, Kohlberg Kravis Roberts and JC Flowers - are seeking to take advantage of banks' need for capital to shore up their balance sheets. They are looking to snap up bank shares cheaply.

Paragon and Alliance & Leicester are seen as the most obvious targets, while there could be interest in buying Northern Rock, currently nationalised, from the Government. Bank of Ireland, another significant buy-to-let player, could also be vulnerable and a bidder for the whole of B&B could emerge, sources said.

Several private equity firms yesterday expressed their annoyance that B&B did not hold an auction to sell a stake. One financier said: "TPG were prepared to pay 55p. Who's to say whether Blackstone or another would have paid more?"

TPG, which is paying £179m for 23pc, is expected to take a highly interventionist approach in trying to knock B&B into shape and will put two people on the board. They could be the TPG heavy-hitters who negotiated the deal, Matthias Calice and Dag Skattum, a former joint head of M&A at JP Morgan. Or TPG may choose to ask a financial services expert it has worked with in the past to join the board.

The planned sale of the stake to TPG - at a price just a third of B&B's shares when it unveiled its original rights issue - may cause friction with other investors. One said: "We don't believe in representational directors. Directors are there to serve all shareholders. TPG will have two. We don't like that."

Alex Potter, an analyst at Collins Stewart, pointed out that shareholders angry with B&B for slashing the rights issue price, issuing a profit warning and striking a deal with TPG could vote against the sale of the stake at an extraordinary general meeting in July.

Tim Sykes, an analyst at Execution, said: "It was not just a failure of the rights process, but of treasury, risk, systems and oversight. "It was a systemic failure of the organisation."

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Europe LBO loan standards loosen despite crisis

Despite the credit crunch, standards for European leveraged loans -- used to fund private equity buyouts -- loosened in the first quarter of 2008, Standard & Poor's said.

While the number of deals plummeted to just 14 in the first quarter -- compared with 315 buyouts for the whole of 2007 -- cash coverage ratios fell, leverage in smaller buyouts hit a record, and purchase price multiples continued to rise in January-March 2008, S&P said.

"Just because investors are demanding more conservative structures does not mean they are getting them," the ratings agency wrote. "What should be a real concern for investors is the fall in cash coverage ratios, which are lower than in 2007, when they were already at record thin levels."

The average ratio of earnings before interest, tax, depreciation and amortisation (EBITDA) to cash interest was 2.2 times in the first quarter, versus 2.5 times in 2007, it said. "Thin credit metrics mean that companies have less of a cash cushion if market conditions change or additional capital needs to be invested in the business, resulting in a greater risk of default," the agency warned.

Meanwhile, "leverage has not fallen as much as would be expected in a market plagued by lack of liquidity."
The average debt-to-EBITDA multiple in the first quarter was 5.8 times, versus 5.9 times in 2007. For deals between 250 million and 500 million euros, leverage actually rose -- to 6.95 times from 5.8 times in 2007.

"This is possibly because regional banks often lend to the smaller local companies and are willing to lend large amounts of debt to issuers with which they have a relationship," S&P said.

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Merrill Lynch cuts BofA earnings view, target

Bank of America Corp will face earnings pressure through 2010 due to its broad exposure to the U.S. consumer and to mortgage-related loans, said an analyst at Merrill Lynch, who also cut his earnings outlook and price target for the second-largest U.S. bank.

Analyst Edward Najarian estimates losses on Countrywide Financial Corp's pay option adjustable-rate mortgages, first lien mortgage and home equity portfolios to be in the 13 percent range. This could result in mark-to-market write-downs of $10 billion to $12 billion on Countrywide's portfolio, he added.

Bank of America agreed in January to buy Countrywide, the ailing mortgage lender, for $4 billion, swapping 0.1822 of a share for each Countrywide share. That valued Countrywide at the time at about $7.16 per share. The value of the all-stock transaction has now fallen to about $3.5 billion because Bank of America's stock has fallen.

Najarian, who rates the stock "underperform," cut his price target by $1 to $28. He cuts his earnings estimates by 20 cents a share to $2.25 a share in 2008, and $3.05 in 2009. The estimates do not include potential gains on the sale of China Construction Bank shares, he added.

"Longer-term we think BAC's collection of businesses have considerable value, but the sheer magnitude of credit losses that we expect BAC to absorb (especially in 2008 and 2009) should continue to weigh on the stock this year," Najarian wrote in a note to clients.

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Massachusetts sues H & R Block over its mortgage unit's lending practices

Massachusetts authorities sued H&R Block Inc. on Tuesday, alleging that its mortgage unit discriminated against black and Latino borrowers and escalated a foreclosure crisis in the state. The lawsuit is the first by a state in the current crisis to accuse a sub-prime-mortgage lender of civil rights violations.

The complaint, filed in Suffolk Superior Court, accuses H&R's Option One Mortgage Corp. of engaging "in unfair and deceptive conduct on a broad scale." Martha Coakley, the state's attorney general, who filed the suit, said H&R Block, the country's biggest tax preparer, and its mortgage unit marketed "extremely risky loan products" and helped escalate the foreclosure crisis in Massachusetts.

The complaint says that Option One charged black and Latino borrowers higher points and fees to close their loans than similarly situated white borrowers and that it targeted black and Latino consumers with marketing "that pushed the sale of predatory loan products."

H&R Block recently said it was refocusing on tax preparation after incurring about $1 billion of losses at Option One, which made home loans to people with poor credit. It no longer offers mortgages.

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Canada home ownership at record levels ... so is mortgage debt

Never before have so many Canadians owned homes. And never before have they owed so much for the privilege. Interest rates at or near historical lows combined with low unemployment and recent changes that allow people to buy houses with less money down and pay off mortgages over longer periods resulted in 68.4 per cent of Canadians in the housing market in 2006.

That's up from 65.8 per cent in 2001 and 60 per cent in 1971, according to the latest Statistics Canada data.
The increase comes despite the fact that the cost of housing in many cities across the country has gone through the roof, outstripping inflation by far, while median incomes have essentially flatlined.

“Low mortgage rates have helped offset much, but not all, of the impact of rising house prices in recent years on mortgage debt-service costs,” said Bertrand Recher, a senior economist with Canada Housing and Mortgage Corp.

The overall result has been a small increase in the percentage of Canadian homeowners who spend more than 30 per cent of their gross income on shelter costs, according to Statistics Canada census data. But latest CMHC figures show a sharper spike in mortgage-carrying costs in terms of after-tax income. In 2007, average household spending on monthly mortgage payments had reached 37 per cent of after-tax income, up from 32 per cent in 2006.

“That's significant — mortgage carrying costs are increasing,” said Mr. Recher. “This burden is heavier on the shoulders of first-time buyers because they don't have the equity.” Most analysts, however, see little comparison between the Canadian housing market and its American counterpart, where hundreds of thousands of homeowners suddenly found themselves in way over their heads, creating a financial meltdown.

Canadian financial institutions jealously guard the number of mortgage defaults they endure. But among the country's big banks, only about 0.27 per cent of homeowners were three months or more in arrears on their payments. “Anecdotally, we are not seeing any rise in arrears or defaults across the country,” said Jim Murphy, president of the Canadian Association of Accredited Mortgage Professionals, an organization that speaks for mortgage lenders.

“Canadian underwriting standards by lenders and mortgage insurers are much more thorough than they are in the United States. Canadian lenders are much more conservative.” One key factor in the rise of home ownership is the relatively new option of mortgages amortized over 40 years.

Paying off loans for homes over a longer period means much higher total interest costs, but lower ongoing monthly payments. The effect is increased affordability. Growth in such long-term mortgages has been nothing short of dramatic, figures show. Between the fall of 2006 and fall 2007, 37 per cent of all mortgages carried amortizations longer than 25 years, up from nine per cent in the preceding period.

“Clearly they're very popular,” said Mr. Murphy, adding that not only first-time buyers are opting for the new choice.
One real estate investor-analyst who disagrees with the rosy assessment of the Canadian market is Liberal MP Garth Turner, who argues too many people, especially younger buyers, are taking on too much debt to buy into the housing game.

Low interest rates coupled with 40-year amortizations and negligible down payments might make it easier to buy higher priced homes, but it's also leaving buyers vulnerable, Mr. Turner says. “The inevitable conclusion is that the current Canadian real estate market is floating on a sea of unrepayable, and perhaps unserviceable, debt,” Mr. Turner maintains in his book, “Greater Fool.”

Collectively, it is a lot of debt. In total, Canadians owe an amount fast approaching $850-billion on their homes, more than double what it was a decade ago, with percentage growth in double digits in recent years. If trends continue as expected, the value of all outstanding mortgages will surpass the $1-trillion mark some time toward the end of next year.

The federal government is keeping a close eye on the developments, according to Finance Minister Jim Flaherty. “We have been monitoring the mortgage market, as we do, and we've seen a trend toward longer amortizations and smaller down payments, and that is a matter of some concern,” Mr. Flaherty said recently. “We're continuing to watch that.”
Mortgage insurers, who take care of defaults, have also tightened their criteria.

Still, any concerns over the situation appear, at least for the moment, to be outweighed by more positive views. Overall economic conditions remain healthy in Canada, with unemployment close to historical lows, Mr. Recher noted. In addition, the forecast is for the rapid growth in house prices to moderate substantially while interest rates are expected to remain relatively stable, at least over the next year or two.

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In business, there are lies, damned lies and the art of misspeaking

"What is the chief end of man? - to get rich. In what way? - dishonestly if he can; honestly if he must."
Mark Twain.

If they had handed out prizes for cynicism, Twain would surely have picked up a gold medal. This comment, first published in the New York Tribune in 1871, was typical of a writer who believed that truth was the most valuable thing, so therefore we should "economize it".

Were Twain to be reborn today, he would almost certainly be in the school of journalism that is accused by politicians and business champions of poisoning public debate, ie, his premise would be that too many of them habitually utter falsehoods. Unfortunately, he would be right.

In politics, we have become inured to Double Whoppers with sleaze. From John Profumo's denial of impropriety with Christine Keeler to Bill Clinton's definition of sex with Monica Lewinsky, the lies of elected leaders can travel halfway round the world before ministers have pulled up their pants.

More recently, Tony Blair plumbed the depths of dishonesty with words of mass deception over Iraq. The "pretty straight kinda guy" routine turned out to be as bent and twisted as Jonathan Aitken's "simple sword of truth".

Though business has thrown up some notorious cases of institutionalised deceit - Big Tobacco and cancer, Ford and the Pinto - I used to believe that general standards of integrity and clarity in commerce compared favourably with those in government. I no longer do so.

Increasingly, it seems, there is a trend among heavy hitters at the top of corporate life to embrace what Winston Churchill called "terminological inexactitudes". The crime is not to tell a lie, but to be found out. Even then, there are brazen attempts to pass off pork pies as slips of the tongue.

When Hillary Clinton was caught having made up a story about evading sniper fire in Bosnia (complete tosh), her response was: "I say a lot of things - millions of words a day - so if I misspoke, that was just a misstatement." Brilliant, eh? No remorse, no apology, no shame - just a little mishap.

This method of coping with inconvenient mistruths, I fear, is becoming an acceptable modus operandi for some British bosses. Those in financial services seem particularly vulnerable to the mistakes of mispredicting.

Now, I agree, that there is an important line between an incorrect forecast made in good faith and an outright lie. Business, even at the best of times, is capricious, that's why there is money to be made: the upside of uncertainty is opportunity. But miscalculating is not the same as dissembling.

Let's consider three examples from the past 12 months. On September 17 last year, Northern Rock's then chief executive, Adam Applegarth, denied that his bank was "bleeding to death" despite customers having withdrawn £2bn. He insisted that the Rock was "well run, solvent and has a viable future". It was nothing of the sort and by February, having sucked up more than £25bn of taxpayers' cash, it collapsed into the arms of a reluctant government.

Did Applegarth lie, or was his optimism merely a misjudgment? A generous interpretation is that he was guilty of insulting our intelligence. Twain, I suspect, would have accused him of ill-starred bluffing to rescue a bad hand. In the same month that Northern Rock was nationalised, Sir Fred Goodwin, Royal Bank of Scotland's chief executive, steadfastly denied that his company would need a rights issue to shore up its finances. No cash, please, we're Scottish. Then, just eight weeks later, RBS asked shareholders for £12bn.

That's right, twelve billion, which is a lot more than zero. His explanation was that the market had deteriorated so quickly, the bank's internal forecasts were shot to ribbons. Looking back to RBS's confident rejection of funding needs, Goodwin said: "It feels like a lifetime ago… and a very uneasy lifetime at that." True or false? I'll give him the benefit of the doubt, in that I don't believe he set out to misguide investors.

He and his consortium were, however, responsible for paying £49bn in old-fashioned money for ABN Amro last October, a deal that now looks hopelessly over-priced and is inflicting severe growth pains on RBS. Which brings us to the hapless Bradford & Bingley. Oh dear, this is where it becomes very messy. On April 13, The Sunday Telegraph reported that B&B, assisted by Citigroup, was preparing a rights issue "to bolster its ailing balance sheet". The next day, B&B issued an angry denial; no fudge, no mudge, an unequivocal rejection of our sister paper's story.

Then, one month later, B&B announced - you guessed - a rights issue for £300m. Better still, it was a botched rights issue, priced at an unsustainable level that would force the bank into a humiliating withdrawal, followed by a fresh appeal for capital, but this time on emergency terms.

Did Steven Crawshaw, B&B's chief executive, know what he was doing? Either he did - and deliberately misled the market - or he didn't, which is even more worrying. Medical problems have forced his departure, but it is inconceivable that he could have stayed, even if his health had held up. Crawshaw was a misfit. The financial authorities' message is, "B&B is "no Northern Rock". But Northern Rock wasn't a Northern Rock - until it collapsed.

B&B was once a safe-as-houses building society. Today, it's a company where investors feel they are gambling, and losing, rather than investing. Perhaps the business should be rebranded as Bradford & Bingo.

Twain said: "Never tell the truth to people who are not worthy of it." B&B's army of small shareholders is not only worthy of the truth, but entitled to it.

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