Euroweek
BofA ready to rescue Lehman as wildfires engulf US banks
Issue: 1071 - 12 September 2008

• $3.9bn Q3 loss racked up after Alt-A hedging failure• $30bn plan to spin-off REI comes too late• Fannie and Freddie bailout euphoria wiped out

 

Lehman Brothers was front, back and centre of events in the credit market this week and at the close in New York yesterday rumours gathered strength that Bank of America is poised to rescue the ailing investment bank.

 

The broker dealer’s credit default swaps rallied back from a previous intra-day high of 770bp to 500bp as a result of these rumours, reported dealers in New York. At the beginning of the week, it was around 350bp.

In a day of frenetic speculation, various possible suitors for Lehman popped up: Goldman Sachs, Barclays, and HSBC all had their time in the sun. But the strongest rumours concerned Bank of America.

The week had started brightly following the US Treasury’s decision to take Fannie Mae and Freddie Mac into conservatorship. But after potential Lehman suitor Korea Development Bank spurned its opportunity, the bears pounced on a new target, forcing the broker dealer to release early its third quarter results and to reveal plans to shed nearly $40bn of real estate exposure.
        

As has been common in the credit crisis, once one bushfire has been extinguished, another one or two spark up somewhere else. Fannie and Freddie might have been saved, but that has merely shifted the attention on to other US firms in trouble. The fear now is that if Lehman goes over the weekend, yet another institution will be dragged to the guillotine.

“I think the market is coming round to the conclusion that about six US firms will fail or need to be bailed out,” said a senior credit strategist in London.
        

Lehman, Merrill Lynch, Washington Mutual, AIG and Wachovia all have problems to a lesser or greater extent, but it was Lehman that dominated the airwaves.
        

This firm was at the very forefront of the volatility and bear market mood this week. It has been pursued by the credit crunch like an ailing boxer staggering from one corner to the next trying to avoid the jabs and upper cuts. But it now looks like the referee is giving the final count. “We think we’ll see a solution this weekend,” said a dealer.
        

Lehman’s share price was hovering around $5 yesterday afternoon, and the continued speculation about its fate cast a long shadow over the markets.

“The whole Lehman business is creating great uncertainty in the credit markets and this isn’t good. The Fed knows it,” said a CDS dealer.
       

If Lehman does collapse, it is possible that the Treasury will broker a deal in the same way it did for Bear Stearns. It will have to absorb the most distressed assets on its balance sheet while finding a buyer for the husk of the business.

        Goldman, Barclays,
        HSBC line up

       

Lehman rallied 125bp from the earlier wides late in the London day after rumours that Goldman Sachs is positioning itself as a buyer, though sources in New York later disputed that it is interested. Goldman deals at around 200bp in the CDS market. As London dealers left their desks Lehman was around 625bp/650bp.

“I think these huge price swings reflect the uncertainty in the market. When the rumours about Goldman surfaced, understandably some shorts decided to take profits,” said a London default dealer.
        

Barclays has also been mentioned as a possible buyer, as it has throughout the last six months. It widened about 7bp yesterday to 135bp/140bp. HSBC, another rumoured buyer, is 70bp/75bp, while Lloyds is 92bp/97bp and HBOS is 250bp/260bp.
        

But late in the New York day, Bank of America took its place at the forefront of those rumoured to be interested in buying Lehman.
       

Lehman chief executive officer Dick Fuld is believed to be touting his firm to buyers, according to several New York sources. Up until a few days ago, Fuld, a Lehman man to his fingertips, maintained that his beloved firm would stay independent at all costs.
        

The sell-off began only a day after the Fannie and Freddie news when it was rumoured that Korea Development Bank had pulled out of talks with Lehman about buying a possible stake — rumours KDB later confirmed. It said that the two parties had disagreed about the terms of an investment — which means Lehman valued itself more highly than KDB did.
 
The fall prompted Lehman to bring forward its third quarter earnings and reveal plans to shed nearly $40bn of real estate exposure and sell part of its investment management business.
 
Yet the move failed to placate the rating agencies — Moody’s announced it was putting the bank’s long and short term ratings on review with direction uncertain, warning that Lehman could fall below single-A. This in turn prompted further sell-offs as analysts said that a downgrade would lead to collateral posting, cause difficulties in rolling commercial paper and drive potential counterparties away. Standard & Poor’s also has Lehman’s A long term rating on rating watch negative.
 
Moody’s said that a “strategic transaction with a stronger financial partner” would bolster the bank’s A2/P-1 rating, but that if it was unable to secure such a partner in the “near term”, a downgrade to the Baa category was likely, with the ratings remaining on review.

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