After Merrill Lynch (MER) took the hit on its CDO portfolio, selling it off to Lonestar for $0.22 $0.06 on the dollar, the market has been waiting for a similar shoe to drop at Lehman Brothers (LEH). Specifically, investors are anxious to see what kind of deal Lehman could get for the $65 billion in mortgage crap it has on its books, and whether the price would be so low as to force a big loss and a capital raise. Dan Wilchins at AP:
Brad Hintz, an analyst at Sanford C. Bernstein, wrote in a note on Monday that any loss much greater than $1.5 billion — which translates to selling $30 billion at a discount of at least a 5 per cent to their current value on Lehman’s books — would likely force Lehman to issue at least some common equity.
Selling assets at enough of a loss would force Lehman to record a quarterly charge — eating into capital for an investment bank that many investors already believe is undercapitalized. Any big reduction in Lehman’s capital could bring pressure from regulators and rating agencies to raise capital.
How much capital? Depends on how big a loss the firm takes on its mortgage junk. The 5% discount Hintz discusses above, of course, could be a dream scenario. Merrill sold its $11.1 billion of CDOs for $6.7 billion (and loaned the buyer 75% of the money to buy them). That’s a 40% discount to the value Merrill had established on its books 10 days before the sale. And even a lesser discount could leave a major hole in the balance sheet:
Depending on the price that the assets are sold for, Lehman might have to raise $4.5 billion to $7 billion in capital to offset losses, CreditSights’ Hendler said. Given that Lehman’s market capitalisation, or value in the stock market, is currently about $13 billion, such a capital raise could leave existing shareholders owning a much smaller portion of the company.
On top of dumping its battered mortgage portfolio, Lehman is said to be mulling the sale of Neuberger Berman, its asset management arm. Selling the division might prove an attractive alternative to a dilutive equity raise, but since any buyer would enter negotiations knowing that Lehman was desperate, Lehman probably wouldn’t get a great price. Lehman would also be giving up one of its most profitable and consistent assets. Once again, Lehman finds that it’s damned if it does, and damned if it doesn’t.
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