Thursday, June 19, 2008

Lehman sold $5 billion of assets to investee hedge fund

A Bloomberg article shed some light on a story passed to us, namely that some of the Lehman asset sales had been achieved via transfers to 2 funds in which Lehman retained an economic interest. While we indicated that our information fell in the category of a rumor, since it came from a single source and the information was not of the sort that could be readily corroborated, the Bloomberg article confirms many of the elements he presented.

Lehman did indeed sell $5 billion of assets to a fund in which the investment bank has an economic interest, R3 Capital Partners, and its founder was indeed the former head of Lehman's principal investing group. The disparity with our report was that the amount alleged to have been sold was much greater, $55 billion versus the $5 billion in the Bloomberg story. However, this $5 billion is material relative to the $70 billion of net asset sales Lehman reported for the last quarter and begs the question of whether it should have been disclosed in the supplemental information provided at the same time as the earnings press release. We hope that the 10-Q filing, which will contain the balance sheet and footnores, will be more forthcoming.

The second fund mentioned in the earlier post, One William Street, is also run by a former Lehman staffer, as our source had indicated. However, the Bloomberg piece is silent on whether Lehman in an investor in this fund or not. The Bloomberg story says the assets sold by Lehman to that fund were a mere $5 million.

Note that while this information is very helpful, it still leaves unanswered the question of how Lehman achieved these sales, particularly since they were spread across a wide range of instrument types and credit qualities. The markets are still difficult; it is normally much easier to sell better rated paper at decent prices than lesser rated instruments. Even if Lehman's marks were reasonable assuming small transaction sizes, larger sales generally have a negative market impact and thus could lead to losses upon disposition (and have the unfortunate side effect of forcing Lehman to mark down remaining positions similar in type). Other banks have financed sales of leveraged loans and some Alt-A portfolios. It isn't out of the question that some of the other assets sold by Lehman were financed or placed with entities in which the firm has an economic interest.

From Bloomberg:
Lehman Brothers Holdings Inc. invested in former trader Rick Rieder's new hedge fund and sold it about $5 billion of assets, positioning the investment bank to profit from the stakes while shrinking its own balance sheet.

Lehman, the fourth-biggest U.S. securities firm, is a minority investor in the fund, called R3 Capital Partners,...

``These are assets we feel very comfortable with,'' Rieder, 46, said in an interview today. ``They have terrific potential for great returns. Just like other shareholders, Lehman will benefit from the returns we'll make going forward.''

The 21-year Lehman veteran most recently ran the global principal strategies group, investing in credit arbitrage, aviation finance and private equity, and left the firm last month to start R3 in New York. Lehman, which reported a $2.8 billion second-quarter loss earlier this week, sold $147 billion of assets in the three months ended May 30 as it hunkered down to weather the credit crisis.

Rieder said 75 percent of the assets his fund bought from Lehman were corporate bonds and loans. There were also some distressed debt and aviation stakes in the mix, two other areas he focused on while at Lehman. The fund will continue to acquire similar holdings in the marketplace, Rieder said....

Among the assets sold during the past quarter were $26 billion of mortgage bonds and leveraged loans, which have plummeted in value during a credit-market contraction that has saddled banks and brokerages worldwide with about $396 billion of losses.

R3 bought about $100 million of Lehman's so-called Level 3 assets, which are the hardest to value because market prices are scarce, according to people familiar with the matter. Most of the firm's mortgage-related holdings are categorized as Level 3, along with other distressed debt.

Lehman sold $3.5 billion of Level 3 assets during the quarter, the firm's finance chief, Ian Lowitt, told analysts in a June 16 conference call.

David Sherr, another former Lehman executive who set up his own hedge fund, bought less than $5 million of assets from Lehman, according to people with knowledge of the transaction. His New York-based fund, One William Street Capital Management, has about $500 million under management.

Sherr, who headed Lehman's securitization division until he left the firm in December, didn't reply to a phone call seeking comment.

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