Tuesday, June 10, 2008

Lehman's Level III stories...

Erin Callan, CFO during the conference call:

For Level 3 assets, just to make a comment, I can’t give you any specific amounts at this time as it is too early in the closing process of our books. While the valuation of all our assets is complete, our positions must now be evaluated, and that includes thousands of positions, to determine the level of price transparency and observability on May 30, in order to appropriately classify them for our 10-Q disclosure.

William Tanona – Goldman Sachs

And then obviously you’ve commented briefly on the Level 3 assets, but given the commentary that you had provided and the level of liquidations that you have done and the number of sales that were done is it safe to assume that your Level 3 assets are going to be down materially here in the quarter?

Erin Callan

Bill, that’s not safe to assume. Certainly there has been a significant portion that went out the door in the sales out of Level 3, but there is a number of other asset class reclassifications that I am expecting can happen this quarter.

So Lehman raises $12 billion this year, and takes losses of $4 billion for the quarter, yet their Level III assets don't go down?

Lehman had $40 billion of Level III assets last quarter, of which $10 billion was transferred in May 31 of last year before the proverbial fan was hit. What are those assets worth now, if they couldn't even value them when things were so materially better?

Lehman had $62 billion of assets in Level 1, $200 billion in Level 2, and $42 billion in Level 3, at the end of their last quarter. Lehman says they sold net $60 billion of assets, and if they took a $3 billion haircut on their sales, then their Level 2 assets are actually worth $20 billion less than they say. What are their Level 3 assets then worth?

Here's the math. If I want to raise $60 billion, Lehman can sell $30 billion of Level 1 assets with no haircut, and then $33 billion of level 2, of which they get $30 billion for. There is your $3 billion loss. Thus they took a 10% haircut on their level 2 assets.

Lehman will confuse you by saying mark-to-market losses, dynamic hedging, and visibility, but Lehman doesn't have any visibility on their assets; only that Erin Callan thinks that the assets are worth more than what the market says:

...reducing our gross assets by approximately $130 billion and our net assets by approximately $60 billion with a large part of the reduction, as I will talk about in detail, coming from less liquid asset categories and also providing significant price visibility for marking the remainder of our inventory....

This quarter we sold over $7 billion of commercial mortgage positions across different parts of the capital structure to over 170 different client accounts and primarily in the form of whole loans...

So haircut the $170 billion of Level 2 assets by 10%, and the $42 billion of Level 3 assets by 20%, and Lehman common ends with no equity value.

Which answers the question why they didn't come clean with Wall Street in the beginning. They couldn't.

The final questioner of Erin Callan during the conference call was Doug Sipkin of Wachovia:

Douglas Sipkin – Wachovia

I know back when you did the first offering, you had indicated that you could have raised double, triple what you did. So I am just a little curious, why you didn’t take advantage of that at a better price? Especially, knowing that you were embarking on an initiative to shrink the balance sheet and likely would be absorbing some losses along the way?

He must not of liked Erin's answers. This morning, he downgraded LEH citing the larger capital raise, poorly marked assets, and lack of confidence.