We wrapped last week’s ‘Map’ saying we expected equilibrium by Wednesday Sep 10 ahead of this week’s spate of options expirations concluding Sep 19.
Well.
We anticipated a full complement of Prime brokers to be on hand, including Lehman Brothers and Merrill Lynch. Of course, Merrill’s trading operation hasn’t gone away. But what’s the demise of Lehman mean to you Investor Relations Officers and public company execs sorting out how investors value your businesses?
Let’s look at both money-management ramifications and the trading vacuum present while Lehman’s capital-markets unit idles (somebody like Barclays, with maybe Morgan or Goldman getting Lehman’s international businesses, will buy these assets soon). The good news is that Lehman excluded its Neuberger Berman unit, a major institutional investor with roughly $220 billion in managed assets, from its bankruptcy filing, protecting the markets from a mass equity exodus that could’ve been ordered by bankruptcy trustees.
The bulk of Lehman’s other equity holdings appeared to reside in proprietary trading operations, and we observed heightened Lehman trading the past 20 trading days as the firm worked to raise capital without tipping its hand to speculators. But trading was diminishing on Lehman’s agency desk by Thursday, Sep 11. It’s possible that the bulk of proprietary holdings have already thus been liquidated. Long story short, additional selling hitting your stock as Lehman’s bankruptcy proceeds may be nominal, likely less than a 5% impact on equity values, except in cases where Lehman had concentrated exposure.
Now to prime brokerage and banking operations. Lehman provides margin accounts, custodial services, capital for buying and selling financial instruments of all kinds ranging from equities, to currencies, to commodities. It participates in syndicated revolving lines of credit, no doubt adds liquidity to overnight and auction-rate markets that small banks use to meet demand-account needs, provides counterparty services to insurance companies, hedge funds and other institutions, fields outsourced algorithmic black box solutions for both trading and risk-management, creates synthetics for traders and investors, trades in the convertibles and derivatives markets, underwrites offerings and serves as one of eighteen primary dealers helping the US Federal Reserve manage liquidity in the mortgage-backed securities, treasuries, and cash money-supply markets.
This is no small demise, folks, and to think we won’t feel ripples for months is naïve, seems to me. Hedge funds are now without a major source of liquidity, financing and support services. Risk managers are without a major counterparty. This will absolutely discount equity prices by 10% at least we think, because higher risk and less access to capital means lower stock prices. The good news is that at last the government stayed out, and we can finally rinse ourselves of financial cholesterol and get healthy again. But it’ll take two years to sort the mess out. And understand this, no matter what you hear from politicians: These problems are not the fault of private businesses nearly so much as they are a direct product of US government monetary policy that tries to socially engineer things like levels of home ownership, with arrogant disregard for the Heisenberg Uncertainty Principle’s effect on free-market systems. Ultimately, businesses and individuals will solve these problems, not government.
And to that end, wrapping up: consider that Lehman Brothers and Bear Stearns were the only two pure-play institutional bulge bracket firms. Merrill had 16,000 retail offices, but had gotten too deeply into derivatives and away from its retail roots. Morgan Stanley has Dean Witter. B of A has its bank networks. UBS has Paine Webber and its private client group. Citigroup has commercial banking and Smith Barney. Deutsche Bank just bought Deutsche Post’s 11 million retail accounts and the associated network.
That does not mean these firms won’t fail. But it does mean that individuals matter in times of trouble. So don’t forget to spend time with your retail investors, IR folks and execs. And pay attention to smaller broker-dealers that stuck to basics.
Margaret E. Wyrwas - Knight Capital Group, Inc. (Nasdaq: NITE)
Senior Managing Director, Corporate Communications & Investor Relations
Equity Analysis™ subscriber since March 2007
"In global markets driven by automation, changing market structure regulation and dynamic investment objectives, today's investor relations professionals require new data points in order to remain relevant and add value in their company's quest to reduce its cost of capital."
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