As expected, Lehman Brothers pre-announced its results today, reporting a $2.8 bn loss, or a loss of $5.14 a share for the second quarter ended May 31, 2008.

The stock is trending down in trading, as Wall Street's smallest investment firm has expressed its dismay at its mounting losses. We reported to you last week that the firm would not disclose its full results until the week of July 16th, which Lehman says it will now do.

So far, shares have dropped to a five-year low. Already Lehman has cut 6,400 jobs since last July, or 25% of its workforce, with headcount down by 1,900 in just this quarter alone.

At the same time, Lehman said it will raise an additional $6 bn in capital. Lehman's chief financial officer Erin Callan said on a conference call with analysts this morning that the firm asked itself, "what level of equity do we need to bolster the balance sheet, and stop the questions about our balance sheets? This capital raising has been done to end the questions and chatter about Lehman Brothers."

However, despite the assurances, the question still on the minds of traders on Wall Street is this: "Is the worst over?" From what Fox Business's Ken Sweet reports based on Lehman's conference call with analysts, the answer remains unclear. More detail is at bottom.

Lehman's $2.8 bn loss compares poorly to its first quarter net income of $489 mn, or $0.81 per share, and $1.3 bn, or $2.21 a share, for the second quarter of fiscal 2007. Analysts who track Lehman had been predicting a second quarter loss of about $300 mn.

I am updating this blog throughout the morning with the help of Fox Business reporter Sweet, who listened in on Lehman's conference call. Sweet reports that Lehman's Callan said on the call that "very importantly," the "preliminary" results are "still subject to refinement and change," with the full quarterly report due on June 16. Sweet reports that Callan added that the firm saw "no loss of counterparties or clients during the quarter."

Lehman's biggest hit came from marking down its asset-backed securities, a writedown of $4.1 bn. The largest chunk of that came from its securities backed by residential mortgages, a hit that amounted to a net $2 bn writedown. Fox Business's Sweet reports that Callan said that the writedown occurred largely because of the collapse of the $3 bn Peloton hedge fund, run by two former Goldman Sachs star traders, as well as the Bear Stearns collapse, "which caused significant capital deterioration" in Lehman's residential book of business. 

Lehman's remaining $2.1 bn writedown came from its commercial real estate, acquisition finance and other asset-backed positions. It also got a $400 mn gain from marking up its debt liabilities, legit under accounting rules. As expected, Lehman booked losses on hedges this quarter, "as gains from some hedging activity were more than offset by other hedging losses."

Chairman and chief executive officer Richard S. Fuld, Jr., who earlier this year had said that "the worst is behind us," said in a statement: "I am very disappointed in this quarter's results. Notwithstanding the solid underlying performance of our client franchise, we had our first-ever quarterly loss as a public company. However, with our strengthened balance sheet and the improvement in the financial markets since March, we are well-positioned to serve our clients and execute our strategy."

Moody's cut Lehman's rating outlook to negative, coming fast on the heels of S&P's downgrade last week on Lehman to A from A+. Lehman announced plans to raise $6 bn of fresh capital from an array of investors, which reportedly includes the New Jersey Division of Investment, a pension fund. The capital infusion comes as Lehman has already raised $6 bn, including a boost to its long-term capital through the issuance of $4 bn of convertible preferred stock in April, a stock-bond hybrid that doesn't dilute the ownership of common shareholders. That brings its total capital raise to $12 bn so far.

Fox Business's Sweet reports that Lehman's Callan said the capital raise was "substantially oversubscribed" and now "fully allocated," adding the firm is "not going to use this raise to decrease leverage," as the firm is satisfied with its leverage ratios. Callan said: "We stand extremely well-capitalized." Callan also said that "deleveraging is complete, we don't plan on reducing the balance sheet further."

This morning, the firm announced it has priced a $4 bn public offering of 143 mn shares of common at $28 per share, as well as a $2 bn offering of two million shares of convertible preferred at a sweet 8.75%. So far, no word yet of an idea raised last week, a stock rights offering for employees, where workers can buy Lehman shares at a discount.

I've previewed what to watch out for in Lehman's earnings in prior blogs, ("Questions About Lehman Brothers Continue to Mount,"and "The Fire-engine Red Flags at Lehman Brothers").

Overall, Lehman says it has bolstered its liquidity pool to an estimated $45 bn from $34 bn at the end of the prior quarter. Lehman had well more than double the cash Bear Stearns had before its sale to JPMorgan Chase and well more than three times as much as Bear's capital (Lehman is about twice the size of Bear Stearns). Still the firm has just $25 bn in shareholders equity against a huge $786 bn in assets and another $761 bn in liabilities. 

Fox Business's Sweet reports that Lehman's chief financial officer Callan said Lehman cut its gross assets by about $130 bn, to $780 bn, plus that the firm cut gross leverage to under 25.0x from 31.7x (the multiple by which its borrowings exceed equity) at the end of the first quarter. Callan said: "I want to be clear at this point that we do not intend to lower our leverage ratios from these levels."

Watch out for Lehman's calculation of gross leverage ratio--the ratio is a figure that divides net assets by tangible equity capital. As I warned in a prior blog, Lehman is making this metriclook better by including junior subordinated notes, which are debt instruments, in its tangible equity capital, as it considers them "long-term" and thus "equity-like" in nature.

Also, keep in mind that a lower leverage ratio doesn't mean bad assets won't remain, or that firms won't still make lousy bets. Bear Stearns' seemingly had solid capital levels due to what it thought were still decent asset bets right before it nearly collapsed. 

Back to the $130 bn reduction in its gross assets. Lehman said it delevered its exposure to residential mortgages, commercial mortgages and real estate investments by an estimated 15% to 20% in each asset class, and cut its acquisition finance exposures by an estimated 35%. Check out this exchange on the conference call between Lehman's Callan and an analyst:

Analyst: "Listen, just to make sure, interpreting the $130 bn in asset reduction was mainly in the residential and commerical finance category?"

Callan: "Leverage finance is a more meaningful and a bigger number," adding that much of what was sold were whole loans, not securities, with a big chunk coming from subprime and non-performing assets.

Analyst: "The $130 bn must be the absolute easiest to sell."

Callan: "Just to give some anecdotal evidence, the vast majority of what we sold was whole loans, not securities. The whole loans had more transparency. The commercial side was very similar. We were selling the risk component of those assets."

With these moves, Lehman is dumping much of the assets that had let it report soaring profit growth, better on average than many of its rivals. The cut still leaves about $100 bn of difficult-to-sell assets, including leveraged loans, on the balance sheet.

Next up are the illiquid assets Lehman can't get a mark on, much like the rest of the firms on Wall Street, because the markets for them are still largely in a black-out.

Lehman's total stockholders' equity was an estimated $26 bn, and total long-term capital was approximately $156 bn. Lehman has not reported the amount of frozen solid, illiquid securities, called 'level 3' assets, which stood at about $39 bn at last quarter end, or two and a half times its shareholder equity. Watch to see whether this number will increase next week when Lehman reports. Why? Check out this exchange that just now took place on the analysts' conference call with Lehman's Callan:

Analyst: "Comment on the level 3, and the liquidation you have done, level 3 will be down materially?"

Callan: "It's not safe to assume, certainly a significant portion went out to the door, and we did have some asset reclassification. The UK residential market lost its transparency, so that might go into level 3. It may not go down."

That response then led to the question on Wall Street's mind, which was posed on the conference call by Michael Mayo, a top bank analyst at Deutsche Bank. "How do we know that you've taken enough writedowns?" he asked.

Callan didn't offer a percentage, but instead replied that the "aggregate number is very large," and that Lehman was the "most active seller of assets this quarter," adding that "unquestionably the price discovery we got was tremendous. We sold risky mortgages, not just the [triple] AAA assets."

Callan added later that the "deleveraging did not create a meaningful P&L [profit and loss] event. We weren't just selling assets at significant losses."

Lehman said on the call that it took a write-down on its exposure to Suncal Cos., a California property developer as well as to Archstone-Smith, an apartment building real estate investment trust. David Einhorn, who runs Greenlight Capital and is short Lehman's shares, has already raised questions whether Lehman is not taking sufficient writedowns to these exposures.

For now, Lehman is saying it is not accessing the Federal Reserve window, a window historically only open to deposit takers like banks. Even if the Fed shuts that window in September as planned (though many still think it will keep it open if needed), Lehman says it won't run out of short-term funds. FBN's Sweet reports that Callan said on the conference call that the firm had "tested the primary dealer facility, April 16 was when it was used, on an overnight basis."

Meanwhile, the Fed and the Securities and Exchange Commission are checking Lehman's books more closely, as well as other top firms on Wall Street. The extra scrutiny comes as Sheila Bair, head of the Federal Deposit Insurance Corp., and Federal Reserve chairman Ben Bernanke are said to be leaning towards tighter oversight of capital and risk management. Congress is expected to debate legislation that would overhaul financial regulation next year.

Footnote: Fox Business's sister publication, The Wall Street Journal, reports that the stunning $2.8 bn second-quarter loss Lehman Brothers Holdings announced Monday stemmed in part from two big real-estate investments made at high prices near the top of the market that are coming back to bite the investment bank. Lehman joined with Tishman Speyer Properties last year to pay $22 billion for real-estate investment trust Archstone-Smith in the largest apartment-building deal ever, the Journal says. And in a series of projects, it teamed up with Irvine, Calif.-based land developer SunCal Cos. to develop and sell thousands of house lots to builders across Southern California. Some $1.6 billion worth of assets from those deals remain on Lehman's books, the paper reported.