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Tuesday, 18 March 2008 01:00

As I anticipated, Bear Stearns is not a done deal

And those BSC calls that were going for a few pennies yesterday were a
good deal when nobody wanted them. Contrarian investing at its best!!!

From CNN:

British billionaire Joe Lewis is working to
block JP Morgan Chase's 236 mln usd takeover of peer Bear Stearns
(NYSE:BSC) in order to negate a 1 bln usd loss he now faces as a major
shareholder of the ailing investment bank, the Daily Telegraph reported.

Lewis, whose Tavistock Group is Bear's second largest investor with a
9.4 pct stake, is understood to be deeply unhappy with JP Morgan's 2
usd-a-share offer, the newspaper added without naming sources.

Lewis is involved in a number of alternative strategies, including
talking to potential rival bidders who might act as a white knight, it

Other options he is considering include voting against JP Morgan's
offer at the scheduled shareholders' meeting, something that would only
work if he were to garner the support of other investors.

Last modified on Tuesday, 18 March 2008 01:00

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be advised that current margin requirements for Lehman Brothers
Holdings Inc (LEH) are currently under review by our Risk Management
group and will likely be increased shortly. Please take appropriate
actions and manage your risk accordingly."

management is expecting a lot of downward pressure and the word is at
least a few institutional client have left the bank. I am sure Lehman
is probably hitting the Fed fund window. I wonder what the mentality of
their counterparties are. The issue is not whether you think they are
sound or not, but whether it is worth the risk to find out. I know I
wouldn't take the chance, despite the fact the risk is not extravagant,
it is still more than my tiny operations can afford.

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"Bear Stearns' second largest shareholder, Joe Lewis, said Monday JPMorgan's $2 a share offer for the investment bank is "derisory."

"I think it's a derisory offer, and I don't think they will get shareholder approval," Lewis said, in an interview with CNBC.

Lewis also discounted rumors that his position in Bear Stearns was leveraged.

The British-born billionaire, who amassed his fortune as a currency trader, is the biggest individual loser in Bear Stearns' debacle. It is estimated that he has lost nearly $1 billion from his decision to pile into Bear Stearns stock in recent months."

The problem with the deal is that it is too low, and too favorable for Morgan. It is literally guaranteed to drive angst from the other side. Whenever you do a deal, you always make sure the other side gets to walk away with something. If you don't you always risk the deal falling though unnecessarily. $2 is a slap in the face to employees who have lost a life savings and have the power to block the deal. At the very least, by the building at market price and get the company for free!

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  • WSJ: Lehman's liqudity position stronger than BS was but weaker than other peers. Lehman learned lesson from 1998 liquidity crunch: less reliance on short-term funding.
  • Cumberland: Main difference to BS: Lehman generated over 60% of their revenues outside the U.S. in Q4 2007.
  • Bloomberg: March 14: Lehman Brothers, largest mortgage underwriter in U.S., obtained a $2 billion, unsecured, three-year credit line from 40 banks. "The unsecured facility replaces an existing credit line"; JPMorgan and Citigroup led the effort.
  • Reuters: CDS spreads spiked to 465bp after Bear announcement, most among investment banks.
  • Fitch (via RGE): At the beginning of the turmoil Bear Stearns had the highest toxic waste ("residual balance") exposure as percent of adjusted equity on balance sheet: BSC = 54.5%; LEH = 53.3%; GS = 21%; MER = 17.8%; MS = 8.3%.
  • Fahey (Fitch): Lehman Brothers reported Level 3 assets-to-equity of 1.68x in 3Q07 (BSC 1.56; GS 1.84; MER 0.70; MS 2.74: gross notional Level 3 asset value, not netted with derivatives hedges in Level 1 or 2 as reported by other banks)
  • Hedges on Level 3 assets (i.e. "short their own instruments") produced book gains of $750m at Lehman (largest amount among 5 brokers) but Fitch decided that gains from credit spread widening will not be considered in evaluating operating performance
    --> Gains from structured notes spread widening as percentage of pre tax earnings was 62% at Lehman in Q3; 129% at BS; 7% at GS; -17% at ML; 17% at MS.

It would appear that Lehman's hedges are paying off for them. The have the most CMBS and RMBS as a percent of tangible equity on the street following BSC. The question is, "Can they monetize those hedges?". I'm curious to see how the options on Lehman will be priced tomorrow. I really don't have enough. Goes to show you how stingy I am. I bought them before Lehman was on anybody's radar and I was still to cheap to gorge. Now, all of the alarms have sounded and I'll have to pay up to participate or go in short. There is too much attention focused on Lehman right now.

As I have said all along, the golden boys at Goldman are not that golden.Bloomberg and the Telegraph are reporting a 50% drop in net and $3 billion in write downs. Told ya'. I wasa little stingy on Goldman too. I need to loosen up, I just hate overpaying. It appears that the Riskiest bank on the street is still flying under everybody's radar, despite having the most exposure to level 3 assets and the most leverage, and the most exposure to counterparty risk. Amazing. I suppose I should take my stingy self over to buy some more puts on them before they get too popular.

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Thursday, 21 February 2008 00:00

Is Lehman really a lemming in disguise?

This is an email I got from one of the individual investors of who frequent the blog before Lehman announced its record writedown. It appears as if he was onto something!

"I think Lehman may be an interesting bank to look into (even though I believe Bear Stearns is in the absolute worst position, Lehman is not much better off I think, while at the same time being perceived as having dodged excessive write-downs a-la Goldman Sachs). It starts with FAS 159 which you may be aware of. You can read how this has helped out the investment banks in the link below.

Lehman has benefited the most on a relative and absolute basis thus far from FAS 159 accounting. Since they've filed their 10K recently we can update the total benefit they've booked as a result of a decline in their own credit worthiness for the liabilities they've elected to measure at fair value (FAS 159 allows companies to apply fair value to both their assets and LIABILITIES). From the 10K, on page 109 it states that "The estimated changes in the fair value of these liabilities were gains of approximately $1.3 billion, attributable to the widening of our credit spreads during fiscal year 2007." Lehman appears to have used $900 million of this gain to decrease the impact of write-downs (see table on page 49 of the LEH 10K, under "Valuation of debt liabilities"). For the year, Lehman booked write-downs of $1.9 billion total, however backing out FAS 159 gains would have substantially increased this amount. Again, looking at the write-down table on page 49 Lehman describes their gross and net write-down totals. From this we can back into how hedged Lehman is in each category of investment. The two primary categories to look at are there Residential mortgage-related and Commercial mortgage related positions. Looking at Residential, they booked a $4.7 billion gross write-down but only a $1.3 billion net write-down, implying that they are 72% hedged on their exposure to Residential Mortgage positions. Their commercial positions saw a $1.2 billion gross write-down, and a $900 million net write-down, suggesting they are only 25% hedged to their commercial positions.

I believe that the commercial mortgage/real-estate market still has a ways to go on the downside, and is much earlier in its trajectory than the residential market (as I'm sure you'll agree judging by some of your posts on the subject). Lehman's residential and commercial mortgage exposures are roughly equivalent ($37.3 vs $38.9 billion as of 11/30/07).

I also believe that even on a gross basis, Lehman has not taken large enough write-down in comparison to other companies. I believe they have accomplished this by moving mortgage assets to Level 3. I've loved reading your blog and truly appreciate the unique and in-depth analysis performed on target companies thus far."

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