September 10, 2008 – 8:14 am

Lehman Brothers announced its third quarter results a week earlier than had been anticipated, probably out of fear that they would not be around to announce them on the date that everybody was expecting. The upshot is that there were more write-downs and losses than ever before in the bank’s 158-year history. The back-breaking $4B of losses came on $5.6B of write-downs, far worse than the expected $2.2B.

Wall Street’s fourth-largest investment bank reported a much larger-than-expected third-quarter loss of $3.93 billion, hurt by $5.6 billion of net write-downs.

The announcement was followed by an adrenaline burst and an ensuing frenzy of activity to save the firm. Most notably, Lehman said it will sell a majority stake in its prized asset-management unit Neuberger Berman, spin off commercial real-estate holdings and cut their stock dividend in an effort to shore up capital and regain investor confidence. It is even flirting with the vulture capitalists over at Black Rock.

Lehman is “formally engaged with” with BlackRock Inc., the biggest publicly traded U.S. fund manager, to sell about $4 billion of the investment bank’s U.K. residential mortgage holdings, according to today’s statement. Lehman said the transaction would help reduce the firm’s stake in home mortgages by 47 percent to $13.2 billion.

Lehman had about $65 billion in mortgage-related assets at the end of the second quarter. Most of the portfolio, about $40 billion, was tied to commercial real estate.

The firm said it plans to spin off $25 billion to $30 billion of commercial real estate investments into a separate publicly traded company, to be called Real Estate Investments Global, in the first quarter in 2009. Lehman also said it will cut its dividend to 5 cents per common share from 68 cents.

But Lehman Brothers is providing significant financing to Black Rock for the deal, and in any case it’ll take more than dividend cuts and back alley deals with Black Rock to deliver Lehman Brothers. The bank needs cash and all these tricks are simply designed to buy time to find it.

“They are saying `we are fine now,’ and that’s buying them time to negotiate for that additional capital,” Brad Hintz, an analyst at Sanford C. Bernstein in New York and former Lehman finance chief, said in a Bloomberg Television interview. “They will need capital as part of the spinoff.”

That is the real news. The death knell is that no deal exists outside of some sham with Black Rock, nor is any deal likely to exist. No deal means vulture capitalists.

Lehman will rock the markets today. With no deal in sight, Lehman’s prospects of surviving this crisis in tact are seriously in doubt.

I don’t want to start eulogizing Lehman Brothers ten minutes after the announcement, but it sounded like a head-shot to me.

Rumors were flying all night long, with some major news outfits even reviving hope in the KDB deal as others continued to call it dead.

I don’t think anyone’s intention was to propegate rumors. The lack of offcial commuique from Lehman management had left little alternative other than speculation.

We all wanted a deal for Lehman, and still do.

Watch for Lehman to be set upon by vulters after the stock goes to junk today. Keep an eye on Merrill Lynch, WAMU, National City and a few others today (see list at ML-Implode-O-Meter).

Even as is the vultures circle overhead, Lehman is busy playing the SFAS 159 game of booking losses as profits. Remember how this one works? Witness:

A company decides to designate $100 million of its subordinated bonds as subject to mark-to-market accounting. The price of the bonds drops to 80 cents on the dollar from 100 cents. So the firm books $20 million on the “presumed savings that you have on your liabilities,” Bove said.

“In the real world you didn’t save a dime,” he said. “You still owe the $100 million. It’s another one of these accounting rules that basically takes you further and further away from reality.”

According to Lehman Brothers’ press release, they earned about $1.4B losing money this way.

During the fiscal third quarter, the Firm is expected to incur negative gross mark-to-market adjustments on assets of ($7.8) billion, including gross negative mark-to-market adjustments of ($5.3) billion on residential mortgage-related positions, ($1.7) billion on commercial real estate positions, ($600) million on other asset-backed positions and ($200) million on acquisition finance positions. These mark-to-market adjustments were offset by $800 million of hedging gains during the quarter and $1.4 billion of debt valuation gains. The Firm is also expected to record losses on principal investments of approximately $760 million.
pg 5

Going broke never looked so good. But it gets even better because accounting through in a cornucopia of level 3 goodies!

Significant Reduction in Residential Mortgages, Commercial Real Estate and Other Less Liquid Assets
Residential Mortgage Exposure Reduced by 47% to $13.2 Billion, Pro Forma for Pending UK Mortgage Transaction
Commercial Real Estate Exposure Reduced by 18% from $39.8 Billion to $32.6 Billion
High Yield Acquisition Finance Exposure Reduced by 38% from $11.5 Billion to $7.1 Billion.

If you’re counting, that comes to $52.9B. Adding $1.4B of SFAS 159 funny money gets a total of $54.3B being marked to Mickey Mouse assets.

So, there you have it. Even as Lehman Brothers dissolves in boiling acid, it plays its elitist games, deluding itself into the belief that it can remain intact.

“It’s still this incrementalism that I think ultimately Wall Street’s not going to be very satisfied with,” Chuck Carlson, a portfolio manager at Horizon Investment Services in Hammond, Indiana, said in a Bloomberg Television interview. “Lehman is trying to cling to the fact that they came come out of this independent and I’m not so sure that that’s going to be the case.”

We are almost certain that it will not be the case. We are so certain that we’re willing to bet on it, any takers?


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