Barclays and Lehman? Seriously?

I've heard some crazy Lehman rumors in my time, most of them true, but the rumor du jour circulating about Barclays evaluating a take-under of Lehman may take the cake.  Lehman received yet another drubbing in the market today for seemingly no reason, ending the session below $20, an eight-year low.  Bloomberg reported that this particular beatdown in the stock was attributed to speculation among traders that Lehman was going to sell itself at a below-market price to some bank.  Reuters claimed that one version of the rumor pointed at Barclays buying Lehman at $15.  Although referred to as a "take-under", if the stock continues its spiral downward at this velocity, $15 will appear to be a very attractive premium by the end of the week.

When I first hear a crazy rumor such as this one, I instinctively instant message or call every trader I know and ask if he's heard the rumor, thus contributing to the spreading of the rumor without really knowing the origin or having any facts to support the supposition.  As I spent all day today in a courtroom hoping I wouldn't end up as a juror on a one-month murder trial, I didn't have a chance to engage in any rumormongering.  Inspired by the strict instructions handed down by the judge for the murder trial, I have decided to look at the evidence before jumping to any conclusions:

• Barclays raised $8.9 billion from investors last week to raise its capital adequacy ratios.
• Lehman raised $6 billion three weeks ago, including $4 billion in common stock at $28.
• Lehman is a pure play US investment bank with significant mortgage related risks sitting on its balance sheet.
• Barclays is already in the US investment banking business.
  

I would like one of the rumormongers out there who actually believes this one to explain to me why a bank that just raised nearly $9 billion in capital because it had one of the lowest Tier 1 ratios of any European bank, would immediately spend that fresh cash to acquire a US investment bank caught in a vicious death spiral.  Barclays is already in the US investment banking business.  There is just too much overlap for the deal to make any sense from an operational perspective, which would imply that Barclays is interested in scooping up Lehman's assets at a discount.  Yeah, I thought that was funny too.  Who knows what those assets are really worth?  Maybe David Einhorn, but he's not telling until he's finished covering his short.  

From Lehman's perspective, it makes absolutely no sense that Dick Fuld would be looking for an opportunity to sell the bank at $15 a share a mere three weeks after he just raised money at $28 from a slew of supposedly savvy institutional investors.  That would absolutely put the final nail in Lehman's credibility coffin.  Because if Mr. Fuld was shopping the bank around at $15, the implication would be that Lehman is having counterparty or liquidity problems.  In that case, it would be better to wait for the opportunity to buy Lehman at $2 with the Fed promising to take the first $30 billion in losses. 
        

Wachovia Takeover Speculation Heats Up

The rumors concerning potential suitors for Wachovia continue circulate.  Wells Fargo?  JPMorgan?  Anyone?  The speculation has intensified since Wachovia disclosed on Tuesday that it had hired Goldman Sachs to evaluate its loan portfolio, leading many to speculate that it had hired the investment bank to find a merger partner.  Wachovia would be an ideal takeover candidate, if it weren't for one big stinky problem: the "pick-a-pay" mortgages sitting on its books.  Wachovia paid $25 billion for Golden West in 2006, roughly $15 billion more than book value at the time.  Wachovia is left with $120 billion in option arm loans which includes $3.5 billion in deferred interest as of the quarter ended 3/31/2008.  Deferred interest is interest that the borrower has yet to pay because he has opted to pay the minimum amount required by the lender, thus the catchy name "pick-a-pay".  The borrower is not off the hook, he is merely deferring his liabilities.  Under GAAP accounting rules, Wachovia can book this amount as interest income, although it shows up on the cash flow statement because the company has yet to collect the cash.  How much of this deferred interest will Wachovia actually ever collect?  That is highly dependent on the delinquency and default rates of the loans, which are growing significantly due to falling housing prices across the country. 

According to Wachovia's 10-K, 59% of the "pick-a-pay" loans were based in California, 10% in Florida, and the remainder in various other parts of the country.  To summarize, nearly 70% of Wachovia's option arm portfolio is concentrated in two states where home prices have plummeted in the past year.  So Wachovia has $90 billion in exposure to borrowers in California and Florida who are making minimum payments more than likely because they could never afford a fully amortizing mortgage, and are probably now underwater on their mortgages.  According to Housing Wire, performance on Alt-A mortgages significantly deteriorated in May.  The 2006 vintage of Alt-A loans saw 60+ day borrower delinquencies among first liens reach 21.22 percent in May, up 10% in a single month.  The 2007 vintage saw 60 day delinquencies up 22% to 18.55%.  My guess is that Wachovia has seen its own delinquencies surge since the last quarter ended and realized it finally needed to take significant action.  This is why Ken Thompson, the ex-CEO who was a staunch defender of the Golden West acquisition, was given the boot in early June.  The company, which STILL has not written down the $15 billion in Goodwill from the Golden West acquisition, finally realizes that the loans are impaired, the acquisition was a big mistake, and Wachovia has not taken enough in reserves against potential losses.  What will Goldman conclude after its analysis?  Does any investor was to buy these assets?  My guess is that Wachovia will be forced to take an enormous, eye-popping loss if it sells the "pick-a-pays".  Furthermore, I don't think any bank will buy Wachovia until it can rid itself of the risky loans.  Wachovia is already trading at a significant discount to book value, so it is clear that investors are bracing for some very bad news.  But have they prepared for the worst? 

Lehman Fends Off Nasty Rumors, Lives to Fight Another Day

Yesterday, as Lehman's stock was getting pummeled for the third day in a row, a rumor started circulating that Lehman was borrowing heavily from the discount window because it was having trouble obtaining financing from its lenders. Just as I was about to risk an SEC investigation of rumormongering by posting the rumor, Lehman's treasurer made a statement adamantly denying the rumor, claiming that the firm had not used the discount window since April 16th. The stock rallied back, only to sell off again into the close. However, a far more interesting and insidious rumor, that Lehman was buying its own stock on the dip, turned out to be true. Although many view a stock buyback as a sign of confidence by management, I happen to have a different opinion. Highly leveraged institutions, particularly those who are actively seeking fresh capital should not be buying their own stock. It is a waste of much needed liquidity. Given that Lehman is in a position where it has to defend its liquidity position every day, this move can almost be viewed as desperate. Sure they have $40 billion in liquid assets, but Lehman also had, as of the end of the last quarter $197 billion in repos on the liability side of the balance sheet. In English, Lehman depends on nearly $200 billion in short term financing, some of it overnight to finance its operations. While $40 billion sounds like a nice round number, it's not that much when put in context. If management wants to show confidence, why doesn't Dick Fuld spend his $40 million bonus from last year to buy some "cheap" Lehman stock? Mr. Fuld has always been considered a very shrewd investor, but I hear they don't call him Dick because his first name is Richard.
Needless to say, the action is set to continue for another day, if the options and credit default swap markets are any indication. Although Lehman hasn't tapped the discount window yet, we may be hearing a different story by the end of the week. Bernake will be waiting for them with outstretched arms, but hopefully with an admonishment or two..."yes, we'll give you money but seriously, stop buying back your own stock..."

Ex-Trader Charged With Spreading False Rumors

Ripples of terror reverberated around Wall Street trading desks yesterday when the SEC accused a former Schottenfeld Group trader with spreading false rumors about Blackstone's proposed takeover of ADS. The SEC demonstrated firmly that it is not messing around with rumor-mongering by going after this pea-shooter whose total profits on the offending trades were $25,000. It is certainly true that Mr. Pea-Shooter (aka Paul Berliner) did make up rumors about a supposed meeting that never took place between Blackstone and ADS. He then forwarded those rumors to 31 of his closest friends ( who are all brokers) through instant messenger. He also shorted the stock at around $77 and watched it fall in response to the spreading of his rumors. However, those who listened to Mr. Pea-Shooter and sold their stock in a panic, or even shorted it, should send this guy a thank you note. The Blackstone/ADS deal never happened and ADS is now a $57 stock.
There are many who believe that Wall Street is built on a firm foundation of rumor-mongering. If traders didn't spend all day making up rumors to support their trading positions, their productivity levels would drop markedly. Within many of these rumors, however, lies a kernel of truth. Finding that kernel is considered part of the game. Were traders spreading rumors about Bear Steans going bankrupt? Absolutely. But Bear Stearns was eventually forced to find a white knight to rescue it. Will the SEC go after those rumor-mongers? Or is it not illegal if the rumors become a self-fulfilling prophecy? Every investment bank relies to varying extent on borrowing in the money markets to finance its trading positions. Theoretically, any investment bank can go bust over a crisis of confidence. Lehman, who was also apparently the target of viscous rumors during the height of the panic in the credit markets, emphatically put its foot down and raised capital to avoid winding up like Bear. Does the SEC go after those who spread rumors about Lehman but not Bear just because Lehman's management did a much better job of dispelling the rumors of its "potential" insolvency? The answer is obviously not straight-forward. But whatever it is, you didn't hear it from me.

Citi Defends Lehman, TSLF a success, No News Out of TMA

An analyst at Citi upgraded Lehman this morning. Just to show how much stock investors put into analyst upgrades from banks that are having their own issues, Lehman's stock reacted with a resounding $.35 rally on the news. I don't have a clue what is going on at Lehman or if any of the liquidity rumors are true. The options market seems to believe them. And given how rumors can become a self-fulfilling prophecy, I'd be very nervous about betting against them.
The TSLF auction seemed to go well yesterday indicating that the pressures in the money markets may not be as bad as everyone believed. The stock market reacted with a sell-off in financials, which I found somewhat perplexing.
We're still waiting for news on whether TMA is going to make it. No announcements were made on the results of the private placement, so I'm guessing it's not going to happen. In any event, I still contend that private placement or no private placement, owning the common stock is a bad idea.

Merrill Downgraded Again, But Real Story is Lehman

Although Merrill is set to report earnings in April, and analysts persist in making up numbers to show that they slashed earnings before the earnings release, the real story in the options market is Lehman. Much like the bets in the options market that predicted Bear's demise (please refer to my prior posts that pointed these out before the institution's near collapse), traders are betting that Lehman may be facing the same situation soon, in the next 22 days. Nearly every out of the money put has traded furiously today, with a particular emphasis on the ap 20's, which have changed hands nearly 10,000 times today with several hours remaining in the trading day. What's the story? Rumors must be flying around about Lehman's liquidity. Are the rumors true? Will the rumors be so persistent that they will kill Lehman just like they did Bear?