FYI | Apr 01 2008
By Greg Peel
Since the collapse of Bear Stearns the US market has targeted Lehman Bros as the next investment bank most likely, given its similar business model. Lehman is the fourth biggest US investment bank (Goldman Sachs, Morgan Stanley, Merrill Lynch) and Bear was the fifth. When the Fed completed its emergency deal with JP Morgan on the weekend following Bear’s collapse, it passed the word around to the larger banks to please not try to badmouth Lehman or solicit its customers, lest another run be triggered.
That the Fed should make such phone calls just goes to show how concerned Bernanke was, and just how possible he thought it might be that Lehman should become the next victim. The Fed could not afford a succession of ever-larger falling dominos.
Rumours have dogged Lehman ever since. Two weeks ago the company announced a first quarter profit expectation that was a substantial loss, but nevertheless a loss that proved not as bad as Wall Street was expecting. Lehman shares jumped 46% (from the low base they had sunk to in panic). But rumours have continued nevertheless, although now suspicions are that these are probably fraudulent in intent – propagated by hedge funds setting themselves short and trying to orchestrate a kill.
Fraud aside, at least one respected bank analyst has since spooked the market with further significant profit downgrades across the sector, and expectations of more write-downs, dividend cuts and capital raisings – an eventuality that could still see Lehman under solvency pressure from the market.
[To read the case against Lehman, see “Lehman’s Demise: True or False” (FYI; 28/03/08)]
Citigroup analysts, however, cannot see the Fall of Lehman. After a couple of years “on the sidelines” (ie, a Hold rating), Citi last week upgraded Lehman to Buy. This move once again pulled Lehman shares up from what might have been a slippery slope set in place by a sharp jump in put option buying.
The basis of Citi’s argument is that neither the Fed, nor the US Treasury, will let Lehman go. Or more precisely, given what the Fed and Treasury have done to “backstop” the investment banking sector ensures there is no way Lehman can hit a liquidity crisis. The firm has US$34bn of its own liquidity in the parent company, and the Fed is offering a further US$200bn in six month swaps and direct access to short term funding via the discount window. No investment bank could go under given these facilities, Citi implies. The analysts also note Lehman has not yet even used the available facilities, other than for US$2bn “test run”.
If you ignore write-downs for a moment, the Citi analysts suggest Lehman has had its second best trading quarter in fixed interest ever, and overall generated a 20% return on equity. Citi also believes Lehman exhibits “excellent risk management”.
(A cynic might suggest (a) ignoring write-downs is a bit convenient, (b) ROE is being measured from an E that is much diminished, and (c) “excellent risk management”? Why are we even having this conversation?)
Citi sees 70% potential upside in Lehman’s share price. “Valuation,” say the analysts, “is compelling on virtually any historical metric”
We can only wait and see.
