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Posted by Heidi N. Moore

Lehman Brothers Holdings Inc. (LEH) has, so far, done everything right in order
to prevent an extended market panic: it announced its earnings early, came clean
about its first loss as a publicly traded company and showed it could be
well-capitalized by raising $6 billion in new capital: $4 billion in common
equity and $2 billion in stock.

It may not be enough. As UBS analyst Glenn Schorr said in a research note Monday:
“We think some would have preferred a strategic buyer too.”

Unfortunately, potential buyers aren’t easy to find. Many of the well-capitalized
big U.S. banks are either no longer terribly well-capitalized - having sought
capital infusions of their own - or they are focused on their own big
integrations or restructurings. JPMorgan Chase & Co. (JPM) has its hands full
with the Bear Stearns Cos. (BSC) integration; Bank of America Corp. (BAC) is
wrestling with its proposed acquisition of mortgage lender Countrywide Financial
Corp. (CFC); and Citigroup Inc. (C) is trying to slim down by hiving off non-core
assets. Besides, they all already have big investment banks housed within them,
and the amount of overlap with Lehman would create the recipe for a rash of
disastrous defections, a la Credit Suisse’s ill-fated acquisition of Donaldson
Lufkin & Jenrette in 2001.

Private-equity firms may be interested - as they were with Bear Stearns, and as
they are in many troubled financial institutions. J.C. Flowers, a firm known for
its deliberate, thorough due diligence, has said it is interested in investing in
banks. Kohlberg Kravis Roberts & Co. L.P. would have the equity, but probably
would need or want partners. Still, how many would be willing to pull the trigger
on an acquisition of Lehman’s size ($17.9 billion market cap)?

Instead, might European banks step forward? Barclays PLC (BCS) has been rumored
as a potential partner for Lehman. It is easy to see the appeal. Such an
acquisition would be easily affordable: Barclays has a market capitalization of
more than 20 billion British pounds (nearly $40 billion). And Lehman must look
like a bargain: Not only has Lehman’s stock value fallen, but devalued U.S.
dollars are essentially the equivalent of Monopoly money overseas. Barclays
doesn’t have much in the way of investment banking in the U.S. It could use a
Lehman-size footprint. And while Barclays is looking to raise capital as well -
as much as GBP3 billion, according to the Sunday Telegraph - the conventional
wisdom holds that the United Kingdom bank still is looking for acquisitions.

The big drawback to a Barclays-Lehman merger, of course, is the amount of overlap
the two banks would have in the credit area. Debt markets are one of Barclays’
strengths, and it continues to expand, with plans to increase its commodities
team 30% in the next two years. Lehman, it has also become abundantly clear from
its exposure to complicated bonds and its $700 million in losses from market
movements, still is a bond house at its core. And it isn’t giving up on that
identity, according to Monday’s conference call, as live-blogged by MarketBeat
chieftain David Gaffen:

“I want to be clear at this point that we do not intend to lower our leverage
ratios from these levels,” Lehman finance chief Erin Callan told analysts and
investors. (The levels she was talking about are the firm’s net leverage ratio -
net assets divided by tangible equity capital - and it currently stands at about
12.5, down from 15.4 at the end of the previous quarter.)

There are many who believe it would be no bad thing if Lehman were to reduce its
determination to be a big player in debt. Fitch Ratings earlier Monday put Lehman
on ratings outlook negative: “Lehman’s Rating Outlook remains Negative because
profitability is expected to be challenged with continued fixed income
volatility. Despite asset sales, Lehman’s exposure to higher risk asset
categories as a percent of Fitch core capital is higher than peers. Lehman’s has
been active hedging its exposure in these asset categories. However, its hedging
strategy, while generally reducing earnings volatility, has not always been
effective.”

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