Lehman May Post Smallest Net Since '03 as Shares Fall (Update1)

By Yalman Onaran

March 18 (Bloomberg) -- Lehman Brothers Holdings Inc. may report its smallest quarterly profit since 2003, a day after the fourth-largest U.S. securities firm lost almost 20 percent of market value following the fire sale of Bear Stearns Cos.

Net income probably fell 58 percent in the fiscal first quarter to $480 million, or 72 cents a share, from $1.15 billion, or $1.96, a year earlier, according to the average estimate of 10 analysts surveyed by Bloomberg. Earnings were hurt by as much as $3.5 billion of asset writedowns caused by the slump in the mortgage market, analysts said.

Chief Executive Officer Richard Fuld sought to reassure shareholders yesterday, saying steps taken by the Federal Reserve to support brokerages eliminated the danger of a liquidity crisis. Bear Stearns ran out of cash as clients withdrew funds, forcing CEO Alan Schwartz to sell the fifth-largest U.S. securities firm to JPMorgan Chase & Co. for $2 a share, 90 percent less than the market value two days earlier.

``The game here is confidence,'' said James Hardesty, president of Baltimore-based Hardesty Capital Management LLC, which oversees $700 million for clients. ``The profit figures depend on how illiquid assets are marked to market, and investors don't trust those numbers.''

The collapse of Bear Stearns ranks along with Drexel Burnham Lambert Inc. as the biggest in Wall Street history. Bear Stearns was sold for about 7 percent of its market value as of March 14, when the shares closed at $30.

Fed Action

Fed officials were instrumental in pushing through the deal as part of an effort to halt the erosion of confidence in financial firms. The central bank simultaneously announced that it would allow brokers to borrow from its so-called discount window, typically open only to commercial banks, and would accept securities as collateral.

The Fed's action ``takes the liquidity issue for the entire industry off the table,'' Fuld said in yesterday's statement. Neither his comments nor the central bank policy bolstered financial stocks.

Lehman tumbled $7.51, or 19 percent, to $31.75 in New York Stock Exchange composite trading, a record one-day decline, after sinking as low as $20.25. The shares traded above $50 as recently as March 3.

Goldman Sachs Group Inc., the biggest and most profitable securities firm, fell 3.7 percent yesterday to $151.02. Morgan Stanley retreated 8 percent to $36.38. Merrill Lynch & Co., the third-largest securities firm, dropped 5.4 percent to $41.18, and Citigroup Inc., the biggest U.S. bank by assets, lost 5.9 percent to $18.62.

Equities Boost

While analysts estimate that Lehman's fixed-income revenue declined in the first quarter, mostly due to the mortgage-related writedowns, the firm may say other business grew. Equities revenue was probably 23 percent higher in the quarter, according to Wachovia Corp. analyst Doug Sipkin. Merger advisory fees may have risen 11 percent, while asset-management revenue jumped 29 percent, he predicted.

Fuld has announced plans to cut 5,300 jobs, or 19 percent of the workforce, and closed mortgage units during the past seven months, initiatives designed to help Lehman grow faster than its peers once the markets recover. He also has expanded in Europe and Asia to gain market share in stock trading.

The firm now ranks as the largest trader on the London Stock Exchange and Euronext. Lehman has risen to fourth from sixth on the New York Stock Exchange and Nasdaq. Its share of U.S. bond trading has increased by 1 percentage point to 12 percent.

``Lehman is not Bear,'' Deutsche Bank AG analyst Mike Mayo said in a report yesterday. ``It has more liquidity. It has support among its major counterparties. Its franchise is more diversified.''

Liquidity Pool

The company's stockpile of cash, money-market instruments, corporate bonds and equities available for sale is the largest among the five biggest brokers, according to Sanford C. Bernstein & Co. analyst Brad Hintz. The so-called liquidity pool amounts to $98 billion, compared with $61 billion at Goldman.

Lehman, the biggest underwriter of mortgage-backed bonds last year, owned $80 billion of the assets at the end of November. Half were tied to commercial mortgages, whose prices declined by 19 percent in the past three months. About $5.3 billion of the holdings were backed by loans to subprime borrowers at greatest risk of default. Lehman limited its writedowns to $1.5 billion last year by using financial hedges.

When the leveraged loan market recovered briefly in the fourth quarter, Lehman sold almost two-thirds of its holdings, reducing the risk of losses when prices retreated again this year.

2009 Rebound

``Lehman has had consistent management,'' Wachovia's Sipkin said in a report yesterday. ``A crisis in confidence is plaguing Lehman, not a fundamental crisis at the company.''

The firm has advised on $78 billion of U.S. mergers and acquisitions this year, second behind Goldman in the rankings with a 39 percent market share, according to data compiled by Bloomberg. That's up from 29 percent during the same period last year when it placed sixth.

Lehman may report record earnings in 2009 after this year's setback, according to analysts' estimates. By contrast, Merrill may only return to its 2005 level and Goldman probably won't match last year's earnings, analysts predict.

Investors may pay less attention to earnings prospects and focus instead on any signs customers and trading counterparties are sticking with the firm, or moving elsewhere, analysts said.

``After what happened to Bear, I don't think you can say with absolute certainty that it can't continue to happen,'' said Peter Sorrentino, a Cincinnati-based money manager at Huntington Asset Advisors, which oversees $15 billion and owns shares of JPMorgan and Goldman. ``Could Lehman go the same way as Bear? I hate to think of it.''

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

Last Updated: March 18, 2008 03:38 EDT

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