After reading our “Lehman Too Big To Fail?” post this morning, a high-level Lehman insider quickly reached out with two key reasons why Lehman (LEH) isn’t in the same predicament as Bear Stearns (BSC):
- The Fed’s new move–giving broker-dealers access to the discount window–changes the whole ball-game. If the Fed had made this move last Wednesday, the insider argues, Bear wouldn’t have been toast.
- Lehman’s liquidity ratio is far stronger than Bear’s was. This assertion is supported by a couple of analyst reports, which we’ve excerpted below.
We’re not experts in mid-hurricane broker-dealer balance sheet analysis, so we’ll leave the dissection of these arguments to those who are (anyone?). In the interests of balance, however, we did want to add a follow-up to our earlier note.
ANALYSTS: LEHMAN NOT BEAR
Deutsche Bank’s Mike Mayo:
Lehman is Not Bear. 1) It has more liquidity, 2) It has support among its major counterparties, evidenced by an extension on Friday of a $2B working capital line with 40 banks (one issue w/Bear Stearns [BSC] seems to be that counterparties pulled in lines). 3) Its franchise is more diversified given almost half outside the US and an asset management business that is more than twice as large relative to its size (BSC was more plain vanilla). 4) It has a seasoned and experienced CEO (Bear’s CEO was new). We maintain our Buy rating given a belief that LEH will weather this storm and our estimate of a price to adj. book value ratio of 83%.
The industry issue seems more liquidity than solvency, and LEH protected itself more fully after it’s problems similar to BSC in 1998. At year-end, it had $35B of excess liquidity combined with $63B of free collateral, implying $98B available for liquidity, or $70B more than needed for $28B of unsecured short-term debt (which includes the current portion of long-term debt). While it also has $180B of repo lines, we take comfort that 40 banks extended credit on Friday and believe that some of the repos are likely to be termed at least to some degree.
Buckingham Research’s James Mitchell and John Grassano:
Given the rapid deterioration of liquidity at BSC last week, we thought it was paramount to evaluate the liquidity positions of the other four major stand alone broker dealers. While we never thought it would come down to such a dire scenario (admittedly our mistake) – a company with $35 billion in liquidity effectively being shut down – through this analysis it seems clear that BSC was in a somewhat uniquely challenging situation when the market’s confidence in the company vanished.
For example, as noted above, total liquidity (cash, other liquid assets, and the borrowing value of unencumbered assets) at BSC was $35 billion. As a percentage of total assets, this was the lowest in the group at 9% and the only broker dealer to be below 10% – despite being the smallest firm. In contrast, the second smallest firm, Lehman Brothers (although double the size of BSC), has the highest percentage of liquidity at 25% of total assets.
Secondly, we would point out that BSC had significant “net” repo borrowing positions (repo financing minus repo lending) of $74.5 billion – more than double its liquidity position and compared to just $19 billion at LEH. In other words, as other firms refused to provide repo financing to BSC, the company didn’t have enough overnight repo loans outstanding that it could call in to repay the financing. This mismatch put a significant strain on cash in the short-term as competitors terminated repos. While BSC had a significant net lending position in its securities lending/borrowed book, securities lending agreements are typically longer than overnight (unlike most repos), and thus could not be pulled fast enough to pay down the repo lines. And even including the securities loaned/borrowed, BSC was the only broker in a “net borrower” position in terms of collateralized agreements (all other were in a net lending position).
Lastly, BSC’s sizable prime brokerage business also contributed to its downfall. And we can see that in the “net payables” data. Customer payables include, among other things, free credit balances of prime brokerage clients. With gross payables of $87 billion and net payables of $35 billion, this was a sizable liability for an institution the size of BSC. Basically, when prime brokerage and clearing clients made a “run on the bank” (i.e. demanding their cash balances back), this put an additional and sizable cash burden on BSC.
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