Dick Fuld, the embattled chief executive of Lehman Brothers, has done well to keep his job for this long. Merrill Lynch and Citigroup ditched their bosses at the start of the global credit crunch while Bear Stearns boss Jimmy Cayne was forced out in January, shortly before his bank was bailed out by the US Federal Reserve and JP Morgan.
Since that rescue, the smart money has been betting that Lehman and Fuld will be the next victims of the financial crisis but, six months on, both the bank and its boss are still standing, albeit that they seem more rickety by the day.
Their foundations will get another knock this month, when Fuld is expected to unveil further massive write-downs along with third-quarter figures — forecasts range from US$3 billion to US$4 billion — which will push its losses for the six months to the end of this month close to US$5 billion, or more than the US$4.2 billion net income it earned last year. Lehman’s shareholders will be hoping he can accompany that with some good news to help shore up the bank’s plunging share price — they have lost more than three-quarters of their value over the last year.
The question is what good news? While there have been rumors that it is keen to sell its fund management business, Neuberger Berman, in order to shore up its balance sheet, analysts are not convinced this is a serious option. For a start, its predictable earnings — one of the attractions for Fuld when Lehman’s bought the business for US$2.6 billion five years ago — are even more welcome when mortgage trading and other investment banking markets are crumbling: in the first six months of the year, Neuberger accounted for almost 40 percent of its net revenues.
Fuld is believed to be trying to sell just a part of the business, or to take warrants allowing him to buy it back should the business climate, and Lehman’s balance sheet, improve. But with write-offs and trading losses eating into the bank’s already thin capital, its scope to negotiate that kind of deal is limited.
So, too, is the potential for selling a stake to the Korean Development Bank, another hot rumor of the last month. Even before the South Korean authorities started pouring cold water on the likelihood of such a high-risk venture, Fuld’s price expectations were already rather ambitious: One analyst says he was holding out for a price of between 20 percent and 50 percent above the bank’s book value of around US$40 a share, or as much as four times its current share price.
Such optimism is understandable: Fuld was instrumental in creating the investment bank in its current form and, with Cayne’s departure, holds the record as the longest-serving CEO in the business, having taken on that role in 1993. Much of his wealth is tied up in the business — his 11 million shares represent 2.4 percent of the business and he was paid US$35 million last year. This will make him uncomfortably aware of the losses suffered by the many employees who also hold shares through bonus and incentive plans as the share price has collapsed. It has also slashed the value of his own pay-off arrangements. At the end of last year, he would have collected US$241 million, based on a share price of around US$63; at US$15, that has sunk to US$57 million.
But Dick Bove, banking analyst with Ladenburg Thalmann, thinks a takeover of Lehman is inevitable, regardless of Fuld’s reluctance to sell on the cheap. He said Lehman’s value is only around US$8 billion, little more than private-equity firms have injected into much smaller banks like Washington Mutual.
“There is an opportunity to take the company and break it up and make much, much more by selling off the parts,” Bove said.
And he does not rule out trade buyers: while he thinks a bid from an investment banking rival such as Goldman Sachs or JP Morgan, busy dealing with their own problems from the global financial crisis, is unlikely, Japanese or Canadian banks could well be interested. Britain’s HSBC could also be keen, as could a break-up specialist such as Lazard or Greenhill, which could orchestrate a consortium bid.
There is unlikely to be such an easy exit for two of the other biggest casualties of the housing slump and credit crunch: Fannie Mae and Freddie Mac, the giants that back around half of all US mortgages. While they cannot survive in their current form, deciding what to do about them is one of the biggest headaches facing US Treasury Secretary Hank Paulson.
Bove said their combined debts, including off-balance sheet borrowings and conduits, are around US$9 trillion — almost twice the US$5.5 trillion of US public debt.
It is, he says, an “‘outrage” that they were allowed to get this big. He thinks their accounting failures — Freddie Mac admits that its accounts for the past two years cannot be relied on — make it as big a scandal as Enron.
Ken Murray, chief executive of fund manager Blue Planet, a specialist in financial services funds, thinks that Fannie Mae may be able to trade its way out of the crisis provided signs of a bottoming in the housing market prove sustainable. Freddie Mac’s survival is “more tenuous as it has less capital.”
Citigroup analyst Bradley Ball is even more optimistic.
“Our analysis... shows that both [Fannie] and [Freddie] should have sufficient capital through [at least] year-end 2008 ... under a variety of negative credit scenarios... all parties could wait it out until market conditions calm,” he said.
That may also be Paulson’s hope — and there was encouraging news last week when Freddie Mac managed to raise new finance through a bond issue, albeit that it had to pay a punitive interest rate to do so. Their size means that unraveling them will not be easy: the market has been waiting for Paulson’s decision for weeks.
Until then, says Andrew Milligan, head of global strategy at Standard Life, it is hard to know how it will affect the market.
“Many questions can be asked about the implications of a Fannie and Freddie bailout for equity markets in general, and financial stocks in particular, or how it would affect US growth, inflation, the budget deficit, bond yields and currency.” Milligan said.
Among the options are an effective nationalization, refinancing the debt or encouraging the companies to work through their problems.
But, “Under few of [the possible] scenarios, though, do Fannie and Freddie return to their former clout within the marketplace,” he said.
Murray thinks we are entering the third stage of the credit crunch — that of write-downs of the loan book — having got through the first two phases of liquidity crisis and suffering losses on the financial instruments.
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