Lehman Brothers-Sinking or Swimming?

Lehman Brothers Holdings Inc shares tumbled to an eight-year low on Thursday as the investment bank was battered by rumors -- later discredited -- that some key counterparties had pulled business away from it.

Pimco, the world's biggest bond fund, said it continued to trade normally with Lehman as did giant hedge fund SAC Capital, but the bank's shares still slumped 12 percent, their biggest percentage drop in a month. Lehman bonds also weakened.

Lehman Brothers has battled investors who say the investment bank is undercapitalized given its large mortgage exposure. The U.S. Securities and Exchange Commission is probing whether investors betting on Lehman's decline are spreading rumors about the company, a person familiar with the matter told Reuters in March.

At some point, Lehman's shares, which closed at $17.30 and are down more than 75 percent over the last year, could raise questions for customers considering trading with the company, said Ralph Cole, portfolio manager at Ferguson Wellman Capital Management in Portland, Oregon.

"But as long as they can borrow from the Federal Reserve, Lehman should be OK," Cole added.

Still, Lehman rumors abounded on Thursday. Jon Najarian, a founder of website optionmonster.com, said: "We are hearing a rumor that Pimco is pulling money out of Lehman."

Reuters spoke with at least three other traders who cited the Pimco rumor on Thursday as the main reason for the drop in Lehman's shares -- to as low as $15.73 -- but the three requested anonymity.

Pimco's Chief Investment Officer Bill Gross, speaking on cable network CNBC, said: "We're not reducing our risk to Lehman." The world's largest bond fund is not reducing the length of trades it will enter with Lehman, nor is it reducing the dollar size of trades, he added.
Earlier in the day, Mark Porterfield, a Pimco spokesman, told Reuters: "Pimco continues to trade with Lehman."

A Lehman spokesman declined to comment.

The cost of insuring Lehman's debt against default for five years rose 0.40 percentage point to 3.25 percent, or $323,000 per year for every $10 million of debt insured. Separately, Jonathan Gasthalter, a spokesman for SAC Capital, said: "SAC is continuing to do business with Lehman Brothers as usual."

Lehman, the fourth-largest U.S. investment bank, has repeatedly said it has enough liquidity to meet its needs. It raised $6 billion of capital in June, and $4 billion at the beginning of April.

Lehman's holding company has over $100 billion of assets it could easily sell or finance.
Rumors of mayhem at investment banks have been legion in recent weeks, and have proven false. Goldman Sachs on June 11 was said to be preparing for a large write-off, but its second-quarter earnings report the following week showed just an 11 percent decline in profit.

On June 30 Lehman was said to be selling itself for $15 a share, a discount of about 25 percent at the time. The bank remains independent.

Markets are particularly skittish about rumors of banks in distress after a run on the bank at Bear Stearns in March forced what was once the fifth-largest U.S. investment bank to sell itself.

THE OPEN WINDOW

Pimco's Gross said that with the U.S. Federal Reserve opening up financing facilities to investment banks, there should not be any questions about dealers' solvency. Lehman's share price movement came only because of questions about its future profitability, he said.
Pimco, a unit of giant German insurer Allianz (ALVG.DE), has about $812 billion in assets under management.

Federal Reserve Chairman Ben Bernanke said on Tuesday that the U.S. central bank may keep one of its emergency lending facilities for the Wall Street firm open longer than it had initially intended.

But even with this support, Lehman had $60.8 billion of real estate, mortgages and related securities as of May 31, well above the accounting value of its equity. The company recorded a $2.8 billion loss in the second quarter after recording $3.7 billion of write-downs.

Critics of the company say it has not written down assets enough, and further charges could force more capital raising.

Concerns about Lehman's mortgage exposure heightened on Thursday amid anxiety about the capital of Fannie Mae (FNM.N) and Freddie Mac (FRE.N). Former St. Louis Federal Reserve President William Poole said the two major U.S. mortgage finance companies were insolvent and might need a government bailout, according to Bloomberg News.

"You have to think these guys have a boatload of exposure to Fannie Mae and Freddie Mac," said Matt McCormick, analyst at Bahl & Gaynor Investment Counsel in Cincinnati.


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