NEW YORK: Lehman Brothers is doing business as usual with most of its derivatives trading clients, but at least a couple have scaled back their operations as the bank prepares to post its first loss since becoming a public company 14 years ago, in a sign of the challenges being faced by the investment firm.
Traders and managers at more than a dozen banks, brokers and hedge funds said in the past week that nothing had changed in their dealings with Lehman. Its chief financial officer said Monday that there had been “no material loss” of clients during the quarter. Officials at Lehman declined to comment for this report.
But one portfolio manager at a large hedge fund said his firm had reduced its new trades with Lehman in recent months, and another trader at a leading U.S. institutional fund manager said he was no longer trading with the bank at all. Both declined to be identified because they were not authorized by their firms to speak for attribution.
To be sure, investment banks are always losing and gaining customers. And while concerns about the future of Bear Stearns triggered a run on that bank in March, Lehman is unlikely to suffer a similar fate any time soon.
That is because the U.S. Federal Reserve is willing to lend billions of dollars to investment banks to prevent another collapse like that of Bear Stearns, which was acquired by JPMorgan Chase last month.
Lehman Brothers has about $100 billion of assets at its holding company that are either cash or could be easily used to raise funds. Lehman has also just raised $6 billion of new capital.
Still, Lehman may find that companies, banks and hedge funds are less willing to trade with some of its subsidiaries, which could cut into the profitability of its derivatives franchise, said Brad Hintz, an analyst at Sanford C. Bernstein.
“You would much prefer to do a trade with a higher-rated bank,” said Hintz, a former chief financial officer at Lehman.
Customers buying securities are not usually choosy about the credit quality of the bank selling them. But derivatives – contracts whose value is derived from a security or index – are long-term trades. Clients are typically more careful about entering into a derivatives contract that may require collecting money from a bank in five or more years.
Hintz said Lehman’s derivatives businesses in areas like fixed income, equities, and commodities could face earnings pressure as customers become more selective about their trading partners, known as counterparties.
Given the choice of trading with a commercial bank or Lehman for the same product at the same price, the commercial bank might be a more attractive counterparty now, Hintz said.
Hintz reduced his third- and fourth-quarter estimates for Lehman last week because of these concerns, but said on Tuesday that Lehman’s balance sheet was “bulletproof.”
Lehman Brothers raised $6 billion of convertible preferred securities and common stock Monday, and said it expected to post a $2.8 billion quarterly loss next week.
After closing at a five-month low Monday, its shares closed down another 6.7 percent at $27.50 on Tuesday. They are down more than 60 percent over the last 12 months.
Amid these difficulties, ratings agencies are cutting Lehman’s credit ratings. Standard & Poor’s downgraded Lehman to “A” from “A-plus” last week, and Moody’s Investors Service on Monday changed its outlook on Lehman to “negative” from “stable.”
S&P downgraded Merrill Lynch and Morgan Stanley last week as well, and U.S. investment banks in general could lose derivatives business over time to commercial banks.
Clients, on the whole, are staying loyal to Lehman. On Monday, the chief financial officer, Erin Callan said, “We are not having any conversations with counterparties or lenders about whether they feel confident extending funds and credit to us.”
But not every client that reduces its new trading volume with Lehman will have a conversation with the bank about it, Hintz said.
And even if few clients are scaling back their exposure to Lehman, some are monitoring the bank more closely.
Aneet Deshpande, head of trading at Allegiant Asset Management, has exposure to Lehman Brothers through some over-the-counter derivatives. Allegiant has been reviewing these positions, he said.
“They have the capital,” he said. “We are not worried but we will still be watching.”
Leslie Rahl, president of the risk management advisory firm Capital Market Risk Advisors, said all institutions should plan what to do in the event of a counterparty default. But she added, “I do not think that’s what we have here.”
Dan Fuss, vice chairman at the investment manager Loomis Sayles, which oversees more than $100 billion in fixed-income securities, said last week, “We have no hesitation whatsoever at all in dealing with Lehman.”
“They are a fine firm and financially strong,” he said.
But not all were persuaded by the argument that support from the Federal Reserve eliminated concerns about counterparties.
“Even banks that have been backed by the Fed for a long time fail,” said Adam Compton, co-head of global financial stock research at RCM Global Investors. “It just takes more time. Fed backing does not make you financially invincible.”
LEHMAN BROTHERS SHAKES UP TOP MANAGEMENT