RealEstateFlux

A white knight in the form of Korea Development Bank (KDB) has entered the fray to possibly bail Lehman Brothers out of its write down turmoil. Earlier this week it was announced that KDB is in advanced talks to acquire a 25% stake in Lehman for as much as $5.3 billion - reportedly KDB is also pushing for an option to increase their stake to 40%. While KDB has not been a household name in the US, a dossier on the firm in The Wall Street Journal emphasizes their ambitions for growth. For KDB, a stake in Lehman may also be an investment in the institutional knowledge of global investment banking - and in the end if no deal is consummated, KDB has certainly raised their profile through this flirtation with Lehman Brothers.

The crux of the matter is that Lehman must announce quarterly earnings at the end of September, and that may include a further write down of $4.0 billion according to analyst reports. Therefore, a timely recapitalization is critical. After another big write down is announced, Lehman’s ability to maneuver will only be reduced.

Lehman is fast becoming emblematic of the Credit Crunch, and it is important for the health of financial markets for them to regain their footing. One need look no further than The Wall Street Journal’s reporting of Lehman’s SunCal investments to see how their appetite for risk grew at the height of the market. Last year when commercial lenders had pulled back and were generally looking for safe haven, Lehman essentially doubled down and kept pumping out commercial property and debt investments.

The Wall Street Journal | Michael Corkery & Susanne Craig | September 3, 2008

“Lehman made many of its real-estate investments using funds it raised from others, selling much of its debt to other investors. But the investment bank ended up keeping $2.2 billion in exposure to SunCal on its books. The firm already has written down the value to $1.6 billion — and could face further write-downs if home prices and land values keep sinking.”

Deal Journal | Heidi N. Moore | September 3, 2008

“The story of KDB is in some senses a struggle between the bank’s ambitions and the government’s needs and wishes. Most recently, Korean government officials warned KDB about making a Lehman investment, even though the bank said it may proceed.”

Forbes | Ruthie Ackerman & Lisa LaMotta | September 3, 2008

“Lehman has tough choices to make in the coming months as it decides whether to raise capital, sell off some of its assets or sell the business in its entirety. “There is no optimal solution here,” said Walter Todd, principal at Greenwood Capital Associates. “Depending on how much capital it needs to raise, utilizing several of these options would probably be the best avenue for it.”

Further credence to the possibility of a spin off of mortgage related assets has been reported by sources familiar with the matter at Lehman Brothers. The Real Estate Flux prediction market indicates a 22.27% chance that a spin off will occur as of Tuesday August 26 at 9PM, PDT.

Bloomberg | Yalman Onaran | August 26, 2008

“Investors in the new venture would also manage the holdings, which are linked to commercial real estate, the people said, declining to be identified because the proposal hasn’t been made public and no decision has been made about how to proceed. The New York-based firm had about $40 billion in commercial-mortgage assets as of May. Lehman, the largest underwriter of mortgage bonds last year, has been trying to reduce assets linked to that market as demand dried up and prices plummeted, generating more than $8 billion in writedowns and credit losses. BlackRock Inc., the largest publicly traded U.S. money manager, is considering a purchase of some of Lehman’s commercial mortgages, people familiar with those discussions said last week.”

Lehman Brothers’ distress sale of CRE assets may be billed as an opportunity for well capitalized players. NYU’s Lawrence Longua is quoted in Commercial Property News as saying that Merrill Lynch’s sale of $30 billion of CDOs to Lone Star Funds “broke the ice” and unstuck prices for this kind of portfolio sale. Mr. Longua failed to mention that Merrill was in a position to offer 75% LTV financing to Lone Star to facilitate the transaction. It is unlikely that Lehman is now in any position to offer such generous terms to bidders on its CRE portfolio.

Mid September marks the end of Lehman’s third quarter, and rather than the modest profits they had hoped to report, analysts estimate that actual losses will range from $1.8 to $2.6 billion. Losses of this magnitude may necessitate further capital raising in their race against real estate write downs.

Dealbreaker.com cites anonymous sources privy to the portfolio sale who say that there is a wide price gap between Lehman and potential buyers and that negotiations have stalled out. It has been widely reported that Blackstone and Blackrock are the two most viable buyers, but other contenders include Colony Capital, and J.E. Robert Companies.

The problem is the wide spread between Lehman’s pricing and buyer’s expected discount, in spite of the fact that FT.com has reported that “Lehman has offered to shoulder the first $5bn of any losses suffered on the portfolio’s assets following a sale”.

Reports vary as to the size of the portfolio: Lehman may be offering $14 billion of their CRE assets (Bloomberg) or $40 billion (FT.com). What is clear is that Lehman valued its CRE portfolio at $52 billion in November, and as of May it was written down to $40 billion. Since May, Lehman’s stock is down 72%. If quarterly losses continue, Lehman will be forced to raise more than the $13 billion thus far to support itself against the $8 billion of its  cumulative write downs.

FT.com | Henny Sender | August 16, 2008

“If the sale talks fail, Lehman is believed to be considering spinning off the entire commercial property division and listing it separately, people close to the discussions said. Such a move might not raise much fresh capital but could help Lehman to dispel the concerns over its balance sheet and financial health that have dogged it for the past few months.”

Bloomberg | Jonathan Keehner and Sree Vidya Bhaktavatsalam | August 13, 2008

“Bove expects Lehman to sell its entire $29.4 billion commercial mortgage portfolio. The firm also owns $10.4 billion of property. It may record a loss of $4.9 billion on the sale of the commercial mortgages, Sanford C. Bernstein & Co. analyst Brad Hintz estimated in a report last week.”

The Wall Street Journal |Randall Smith and Susanne Craig |August 18, 2008 |

“In the past few months, Lehman officials have examined an array of options to bolster the company’s financial position, ranging from selling troubled real-estate assets at a discount to divesting a piece of profitable asset-management unit Neuberger Berman, according to people familiar with the matter.”

“Another stock offering would be hard to pull off without angering existing shareholders, largely because the tidal wave of common shares floated in June has since plunged in value by 42%. Lehman shares slipped three cents, or 0.2%, to $16.17 each in New York Stock Exchange composite trading at 4 p.m. Friday.”

Dealbreaker | John Carney | August 18, 2008

“The speculation is that Lehman may simply try to spin off the assets into a separate entity, in a Good Bank-Bad Bank scenario. But that move is also being criticized. “A spin-off could meanwhile mean taking an upfront hit to capitalise the newly formed entity, without raising funds for the core business,” Lex writes in their cutie-pie British way.”