September 9, 2008 – 6:15 pm

The die was cast years ago, when Lehman Brothers partook of the forbidden subprime fruit and reveled in easy profits. But now the fruit has turned into an oozing black lump, the easy profits have become multi-billion-dollar losses, and Lehman’s blood is in the water. Lehman Brothers has now suffered a year’s worth of injuries and distresses in just a single day; after losing more than 90 percent of their value this year, Lehman’s shares fell by another 45 percent on capital concerns in today’s session alone. Stay tuned because more bad news is likely on its way.

Lehman Brothers Holdings Inc. fell a record 45 percent in New York trading after talks about a capital infusion from Korea Development Bank ended. The Wall Street firm is continuing to negotiate with other potential investors, a person briefed on the matter said.

Lehman is trying to raise capital and shed devalued real- estate assets after $8.2 billion in writedowns and credit losses in the past year. Korean regulators told the development bank it would be “inappropriate” to pursue a Lehman acquisition.

In other words, they don’t want Lehman Brothers’ baggage. Who could blame them? Despite the $8.2B of write-downs already taken, the company is still mired in $70B worth of junk real estate assets, and they’re expecting a third-quarter loss of more than $2B. It is clear that Lehman Brothers simply cannot generate a profit on its ow, so the lack of a deal means a lack of cash flow, and that spells death in huge Chapter 11 letters.

Lehman shares dropped 31% to $9.73 during afternoon action, leaving them down 85% so far this year. The stock was down more than 34% earlier on Tuesday.

Lehman is expected to report another big loss when the firm unveils fiscal third-quarter results on Sept. 18. It still has more than $70 billion of troubled real estate-related assets. Almost $30 billion of that is commercial real estate and a recent downturn in this market is worrying analysts, who forecast more write-downs totaling $4 billion to $5 billion.

The Street has known that Lehman Brothers sold its soul to the subprime devil long ago. The Street also knows that the write-downs, the collapsing share price, and the multi-billion-dollar losses was simply the hell it had to pay. Down on the Street, they fear no evil and the foul vulture capitalists such as Black Rock may yet spare Lehman Brothers a horrible death. Still the Street prefers the devil it knows to the one it doesn’t, so when Lehman stopped selling bonds things started to get ugly. Withness:

The slump in Lehman shares on Tuesday is not a sign that counterparties are losing confidence in Lehman, Brad Hintz, an analyst at Bernstein Research, wrote in a note to investors on Tuesday. That’s because the Federal Reserve has stepped in to lend directly to big brokerage firms this year to prevent a collapse, he explained.

Instead, the declines are related to concerns about how the company is going to raise new capital, Hintz said.

Lehman recently stopped selling bonds from a so-called shelf registration that allows companies to borrow money regularly without filing new detailed documents with regulators, Hintz noted.

“This move is a clear sign that the company has some material non-public information that the firm doesn’t want to disclose in a bond prospectus,” he wrote. “So rumors continue to swirl around the equity market about what Lehman will have to sell.”

First it was the credit default swap spreads on it’s debt:

Credit default swap spreads on Lehman debt widened by 60 basis points to 385 during midday trading, according to Credit Derivatives Research.

That’s akin to a 6 percent increase in insurance or mortgage payments by noon. But worse was to come as fear and uncertainty turned into certainty of insolvency. This is the spike in implied volatility of Lehman’s puts:

September put options that will increase in value if the stock declines, have implied volatility of about 500%, compared to 270% volatility for September 20 calls. This means Lehman’s options are infused with a massive “fear premium” that makes its options extremely expensive to buy. The Select Sector Financial SPDR (XLF), the exchange-traded fund which has become the benchmark for the financial sector, is trading at an implied volatility of 47%. Goldman Sachs’ implied volatility is 51%.

Volatility levels so high are usually associated with companies whose situations are considered critical:

To be sure, Lehman Brothers is in dire condition and management has lost the confidence of most investors. The bank reportedly needs to raise capital to shore up its finances, but so far it has not been able to find anyone to make an investment, or to buy any of its prized assets like Neuberger Berman money management unit.

With Lehman’s stock down 28% at $10.15 — the 52-week high was $67.22 — traders are essentially buying catastrophe puts. Trading volumes are extraordinarily heavy in puts that would increase if the stock fell to $7.50, $5, and even $2.50.

This type of trading indicates investors believe profoundly bad news could be in store for Lehman.

The investors are not alone. S&P has finally put Lehman Brothers on Credit Watch, and Fitch placed them on Ratings Watch Negative.

“The CreditWatch listing stems from heightened uncertainty about Lehman’s ability to raise additional capital, based on the precipitous decline in its share price in recent days,” said S&P in a report by analysts Scott Sprinzen and Tanya Azarchs.

Pay no attention to the stated similarities with Bear Stearns. Option-implied volatility spikes coincide with the death spiral of any company, regardless of whether that company is murdered or not, which will be the real difference between Lehman Brothers and Bear Stearns.

Lehman Chief Executive Richard Fuld is a sitting board member of the New York branch of the Federal Reserve. He is a privileged insider whose unbridled greed pushed his company off the wall, and now all the Fed’s men can’t give Richard his company again. 

Bear Stearns was a competitor with no sitting Federal Reserve board members in the company, and Bear Stearns was gutted. Lehman Brothers continues its elitist behavior, exercising denial while believing that it can have its cake and eat it too:

“Clearly the company does not believe that it has a serious balance sheet problem and it simply refuses to take what it believes are fire sale prices for its key assets,” he added. “Buyers seem to believe that Lehman is overvaluing its assets and refuse to hit the bid.”

Inaction like this may result in a hostile takeover of Lehman, Bove concluded.

There is one shared experience between two, however. Both have been pursued by subprime-related distresses and disasters. Both were able to fend off and initially outrun the merciless disaster. But each company found that as time wore on “that same unmerciful disaster, followed fast, then it followed faster.”


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