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Monday, June 16, 2008
Analysis
Lehman CEO Takes Full Responsibility for Near $3B Loss
Ken Sweet
FOXBusiness
There were no surprises on Lehman Brothers’ (LEH) earnings conference call on Monday.
Instead it was a chance for top Lehman executives to publicly address the investment bank’s mounting losses, and to buoy investor confidence in the bank's troubled balance sheet.
Lehman, the fourth-largest U.S. investment bank, reported a $2.8 billion loss, or $5.14 per share, compared to a profit of $489 million, or 81 cents a share, from a year ago--exactly the same as the preliminary figures released last week.
Lehman Chief Executive Officer Dick Fuld spoke directly with investors for the first time since the bank replaced the company’s number two and three officers and raised $10 billion in fresh capital.
“I am very disappointed with these financial results,” Fuld said. “We lost $2.8 billion, and that’s just totally unacceptable. This loss is my responsibility.”
The loss was in large part caused by the bank writing down more than $4.1 billion in mortgage-backed investments this quarter.
Investors seemed to find some solace in comments by Fuld, as well as Lehman’s newly appointed Chief Financial Officer Ian Lowitt and new Chief Operating Officer Bart McDade. The stock was up as much as 8% in mid-day trading.
The biggest issue for investors was Lehman’s ability to deleverage, or sell off, toxic parts of the bank’s balance sheet this quarter.
Fuld said the bank was able to reduce its balance sheet by $147 billion to $639 billion -- more than originally expected -- by selling off commercial and residential-mortgage backed investments, often at a loss.
The CEO said Lehman wants to reduce its exposure to all assets -- from stocks to bonds -- in order to restore the bank's balance sheet and redeploy money elsewhere.
By selling more than $147 billion-worth of assets, Lowitt said Lehman was able to reduce its leverage ratio to less than 25 times – giving the bank one of the lowest leverage ratios in the business.
Fuld also emphasized the $10 billion in new capital the bank raised last week, and said he believed the bank could survive any major market disruption, especially with the Federal Reserve's new system that came into existence after the collapse of Bear Stearns
The bank’s level three assets did not improve much, however. Lehman estimated that its level three assets, which are investments that are hard to sell or price, would decline to $38 billion this quarter, down from $42 billion in the previous quarter.
Lowitt said while the deleveraging did help reduce the bank’s exposure to the toxic level three assets, places like commercial mortgages and the residential mortgage market in Europe and the U.K. are becoming an increasing concern.
Fuld said he was “comfortable” with the bank’s current valuations on its exposure to mortgage-backed investments.
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Think telemarketer. Except, it's much worse because you can't avoid this call. Instead, when you get one, it's time to pay up, because the bet you placed with borrowed money is eating itself.
Buying stocks on margin is risky because you're essentially "playing" with someone else's money. If the shares you purchased tank, your losses will likely be more than if you had bought the shares with your own cash. This is why the New York Stock Exchange and the Nasdaq impose certain restrictions on the practice.
Initially, you¿re only allowed to borrow half of the money from your broker when buying on margin. You set up a margin account and from then on must keep a maintenance balance of at least 25% of the market value of your stocks.
If the market value of your investment falls below this minimum, you're required to make up the difference by either depositing money into your account or selling some of the stock. If your broker notifies you that you've dipped below this minimum, it's called a margin call.
If you fail to adjust your account accordingly, the broker is authorized to sell shares in your account to make up the difference. The broker can even sell other stock in your margin account to make up for the loss that selling the shares didn't cover.
As an example, say you buy $8,000 in stocks of any given company. You borrow the maximum $4,000 from your broker and pay the rest yourself. Now, if and when the total value of these shares changes, you must make sure you maintain at least $2,000 (25%) in equity. In other words, if the total value were to drop below $6,000, you¿d be in trouble since you only put in $4,000 of your own money to begin with.
