Lehman Brothers: New Plan but Same Problems

Lehman decided to have their conference call today. The massive selloff of the stock over the past two days plus the negative credit implication by S&P forced management’s hand.

You can find their conference call HERE and their press release HERE.

Highlights from the release and call:

1. Estimated net loss of ($3.9) billion or ($5.92) per common diluted share.

2. Decreased residential mortgages from $24.9 billion in 2Q08 to $13.2 billion which includes a deal with Blackrock to unload $4 billion in UK assets.

3. Decreased commercial mortgages from last quarter’s $39.8 billion to $32.6 billion.

4. Intends to spinoff the commercial assets into a new entity named REI Global. Current Lehman shareholders will receive shares in REI. The spinoff should be completed in 1Q09.

5. Spinoff will require Lehman to inject capital of 25% into new entity and then debt finance the remaining portion.

6. REI will take custody of SunCal and Archstone investments.

7. REI will be able to show assets as on a “hold-to-maturity” basis thus allowing for more prudent selling.

8. Lehman also intends to sell off 55% of their Investment Management Division (“IMD”). IMD will include Neuberger, private equity and their wealth management arm. If, and when, the sale takes place, the firm will see a positive impact of at least $3 billion towards their capital base from the goodwill associated from the NB acquisition in 2003.

9. Firm also intends to cut their dividend to $0.05 per share which will allow them to retain $450 million annually

It is apparent that Lehman is in full survival mode. And even with these actions going into effect, there are still some serious hurdles that Lehman must face. Time is not on the firm's side and deals must be done swiftly but with a great deal of prudence.

My initial thoughts of Lehman moving forward:

1. Not enough time to shore up balance sheet before S&P downgrades their credit worthiness. Of course, a downgrade would have a significant impact across various business lines – violation of debt covenants, counterparty sentiments, etc.

2. For the REI deal to work, management is counting on a good price for IMD and I am afraid that Lehman is selling from a position of weakness. Will they get their asking price? I am not so sure. To further complicate matters, they intend to use funds supplied from that sale to inject capital into REI.

3. It is possible that even after an injection of capital into the REI spinoff, approximately 75-80% of REI will be debt financed by Lehman. Again, the firm still maintains some form of credit risk even after transferring the assets.

4. I still think there will be further writedowns on the commercial assets before they are transferred over to REI (assuming the deal gets done).

5. The sale of the $4 billion in UK assets to Blackstone are requiring Lehman to seller finance.

6. The firm enjoyed much success from their ability to leverage. Unfortunately, that leverage will no longer be deployed as liberally as it once was. Thus, the earnings power that was based on higher leverage inputs will be negatively impacted.

I will continue to review conference call and the press release. At this point, the firm is still in a very dire position. I will have more later. Please stay tuned.