Sunday, 16 March 2008 05:00

WSJ on brokerage liquidity

From WSJ.com :

Investors
were astonished at the speed of Bear's demise, which added to the
jitters. On a conference call Friday, Bear executives said the firm's
liquidity suddenly worsened over the past week. Bear's plight indicates
how important it is to have enough ready cash on hand to replace
liquidity that is withdrawn by creditors.

Sanford
Bernstein analyst Brad Hintz explained the nightmare that can befall a
broker in a liquidity squeeze. "As lenders demand their money, a broker
has no choice but to sell assets and shrink its balance sheet. At some
point the liquid assets are all gone and the firm cannot sell the
illiquid ones," he said.

Brokerages amass large
cash piles -- often called liquidity reserves in their financial
statements -- that are meant to see them through rocky periods in the
markets. Analysts are now trying to assess whether these liquidity
reserves, which measure the amount of high-quality assets that
brokerages could easily sell, are sufficient.

Compared
with other brokerages, Bear's cash reserve gives it the least cushion
for a cash crisis. This same analysis makes Lehman's cash cushion look
slimmer than its peers', although on other measures it is just as
strong.

Brokerages break out the size of this
emergency cash in their financial filings with the Securities and
Exchange Commission. To gauge its sufficiency, the reserve can be
compared to the main type of debt that brokerages rely on to finance
their operations. This debt is called collateralized borrowing, because
to get the loans the brokerages have to pledge assets as security to
the creditor. If these creditors pull back sharply, a brokerage is in
deep trouble.

From public comments by Bear
executives Friday, it appears much of the liquidity squeeze was caused
by a pulling back by creditors that had extended loans based on
collateral provided by Bear. These types of creditors "were no longer
willing to provide financing," Samuel Molinaro, Bear's chief financial
officer, said on the Friday call.

Bear would have
been particularly exposed to this withdrawal, because its emergency
cash pile was small compared to this debt. On Nov. 30, that cash
reserve of $17 billion was only about 17% of the $102 billion owed
through secured financings.

If the prices of
assets Bear had pledged fell, the brokerage would have had to post a
payment to the creditor called margin. One big purpose for the
emergency funds is to have the cash to make margin payments during a
credit-markets crisis. "My guess is that Bear did not adequately
stress-test and didn't have enough liquidity to meet those margin
payments," said Michael Peterson, director of research at Pzena
Investment Management.

Like Bear, Lehman is a big
bond player and also one of the smaller Wall Street firms. But it is on
sturdier ground than Bear, many investors said. "I'm pretty comfortable
with Lehman's liquidity," said Mr. Peterson, whose firm owns Lehman
shares. "The lessons of 1998 were not at all lost on Lehman."

Aiming
to make its balance sheet sturdier after 1998, Lehman became less
reliant on short-term borrowing, which can dry up quickly. At the end
of November, it had $28 billion in debt coming due in the following 12
months, well below the $34.9 billion in its liquidity reserve. "What
gives me comfort right now is that Lehman has very little short-term
debt," Mr. Peterson said.

The firm's
emergency-cash pile was 19% of its $182 billion in secured financings,
putting it below the numbers for Goldman Sachs, Morgan Stanley and
Merrill Lynch. At those firms the emergency cash was 38%, 39% and 34%,
respectively, of collateralized financings.

Yesterday, Lehman announced that it closed a new $2 billion unsecured credit line that was "substantially oversubscribed."

In
a crunch, Lehman may be able to raise cash by selling another big pool
of liquid assets, which is valued at more than $60 billion. Adding that
to the liquidity cash reserve gives Lehman a potential $100 billion
cash pile, equal to 54% of collateralized financing. That is ahead of
some other brokers and far stronger than Bear's 31%.

In
addition, the debt that comes from the collateralized financing
typically is matched by a similar loan to another customer, which
creates an asset. When offset against each other, the collateralized
financing liability becomes much smaller. In Lehman's case, it is about
$20 billion, which is only about 60% of its emergency cash.

Last modified on Sunday, 16 March 2008 05:00