Lehman May Need to Find a Merger Partner if Things Get Worse
By: PARITOSH BANSAL
Reuters
June 10, 2008

The latest capital raising by Lehman Brothers will help the investment bank remain independent for now, but it may have to look for a merger partner in the longer run. Lehman on Monday raised $6 billion in capital and projected a worse-than-forecasted quarterly loss of $2.77 billion, sending its shares swooning to a new five-year low.

Experts say stand-alone U.S. investment banks such as Lehman are likely going to have to find commercial bank partners to get access to a stable source of funds. That will help them deal with future shocks and to sustain growth even if regulators restrict leverage. And once the credit crisis begins to ease, battered brokerages are likely to make for attractive pickings for commercial banks looking to expand into investment banking, setting the stage for consolidation in the industry.

“It would be harder to have a Bear Stearns kind of run on the bank at an investment bank that is affiliated with a commercial bank,” said Chip MacDonald, a partner at the law firm Jones Day. “Stable funding sources can be a real help in the time of stress.”
“The situation has to stabilize on all sides before people start thinking about M&A,” Mr. MacDonald added. He declined to comment on Lehman specifically. Fox-Pitt Kelton analyst David Trone predicted last week that a “historic” consolidation of U.S. investment banks with domestic or foreign commercial banks could be in the offing as soon as next year, as reduced risk-taking means the potential for high returns isn’t what it used to be on Wall Street.

Mr. Trone said in a report he expected a “very rapid pairing” of Goldman Sachs, Morgan Stanley, Merrill Lynch and Lehman with commercial banks. Others have pointed out the need for such mergers as well. Last month, Bank of America Chief Executive Kenneth Lewis said investment banks were likely to merge with commercial banks to better protect themselves against tough capital markets.

Mr. Lewis said the stand-alone Wall Street investment banks will become “a rarer breed” and either choose to or be forced to “combine with integrated commercial banks to gain balance sheet strength and stability through economic cycles.” Among candidates to acquire Lehman, names of banks such as Barclays, HSBC, Credit Suisse and UBS often come up, but many of these institutions are dealing with problems of their own.

Financial institutions globally have written down more than $400 billion of assets and raised more than $200 billion of capital amid the widening credit crisis. Lehman only has about $25 billion in equity to back up a balance sheet of $800 billion, said Richard Bove, an analyst with Ladenburg Thalmann, a Miami-based brokerage and investment bank.

“Any bank that took them over would immediately have problems,” Mr. Bove said at the Reuters Investment Outlook Summit in New York on Monday. Experts say a deal is unlikely in the near term unless there is a Bear Stearns kind of distress sale, and Lehman is unlikely to go down that road.

The capital infusion will likely take its toll on the stock price for a while, but leave Lehman independent, said Marshall Sonenshine, chairman of investment banking boutique Sonenshine Partners.

Lehman said it has strengthened its balance sheet since March. And with it having access to short-term funding at the Federal Reserve and having billions of dollars of assets at its disposal, a run on the bank is not seen as likely. “Certainly balance sheet is not something we need at this point from a strategic partner,” Lehman CFO Erin Callan said on a conference call.

But Lehman said it would be open to selling a block of shares for a tie-up that could help the company win business in particular products or markets. “We have talked about interest in a strategic partner,” Mr. Callan said. “So it is not to say we don’t continue to have interest if there is an appropriate partner for us.

Mr. Bove said Lehman may become attractive to a buyer at some point in the future, after it had raised capital and reduced assets. “If they do that, then Lehman probably could be bought,” Mr. Bove said.

Sonenshine Partners is a leading independent investment bank focused on providing integrated strategic, financial and corporate advisory services.  The firm was founded in 2000 and is headquartered in New York City.