Lehman has filed for Chapter 11 bankruptcy
Kirsty Wigglesworth/AP

Barclays Grabs Bulk of Lehman Brothers

September 17, 2008 03:04 PM
by Anne Szustek
British bank Barclays is buying most of what’s left of the bankrupt investment bank for $1.75 billion, saving the jobs of about one-third of Lehman’s U.S. staff.

Barclays Takes Over What’s Left of Lehman

The same day that Lehman entered preliminary bankruptcy hearings in a Manhattan court, Robert E. Diamond Jr., the president of Barclays, announced late on Tuesday that the British bank plans to take over most of Lehman—save the bad debt it doesn’t want.

If the deal is approved by bankruptcy court, Lehman’s investment banking and capital markets divisions would come under Barclays’ ownership but still operate under the Lehman name. Initial estimates cited by The Wall Street Journal show some 9,000–10,000 of Lehman’s 26,200 U.S.-based employees keeping their jobs after the Barclay’s purchase.

Lehman research analyst Roger Freeman told The Wall Street Journal he felt more sanguine about the potential Barclays takeover. On Monday afternoon he sent an e-mail to his clients bidding them farewell, but in a Tuesday interview, he told the Journal, “Today I’m in a completely different state of mind, excited about the prospect of continuing.”

On Wednesday, Barclays CEO John Varley was quoted by Reuters saying that his company also had “opportunities but not the obligation” to take over Lehman’s operations in Europe and Asia. “It would most typically be around those areas where Lehman has strong positions and [Barclays Capital] has a weak one, so mostly around equities and equity capital markets business,” Diamond said.

But if Barclays’ U.S. purchase offer isn’t finalized by Sept. 24, it could be terminated, leaving Lehman’s fate in question.

Before Lehman filed for bankruptcy, Barclays was believed to be a prime contender to buy the troubled firm this past weekend. But braclays pulled out of talks on Sunday after announcing that it couldn’t obtain financial backing from Wall Street firms or the U.S. government to hedge against Lehman’s losses. And Bank of America, another top contender as a partner for Lehman, opted for Merrill instead.

Background: The sub-prime mortgage crisis and Lehman’s tumble

More than $613 billion in debt, Lehman filed for Chapter 11 bankruptcy Sept. 14. Unlike Chapter 11 bankruptcy filings for companies in other sectors, because Lehman is a financial firm, federal law stipulates that it will not be able to reorganize.

As of midday Monday, Lehman stock hovered in the range of 20 cents per share. This seems steep compared to Wednesday's midday share price just above the dime mark. For purposes of comparison, on Friday, Lehman stock closed at $3.71. On Feb. 2, 2007, Lehman’s price-per-share peaked at $85.80.

Toward the end of last week it was believed that the investment bank was to have its assets liquidated, which would parallel Chapter 7 bankruptcy proceedings.

Federal Reserve Chair Ben Bernanke and Treasury Secretary Henry Paulson told Lehman over the weekend that the U.S. government would be happy to arrange a partnership for the now-erstwhile bank—but not at the expense of taxpayers, as could very well be the case after mortgage companies Fannie Mae and Freddie Mac were taken into Treasury control last week.

Lehman had already slashed more than 6,000 positions since June 2007
, and was gearing up for another 1,500 job cuts August 26.

The investment bank’s woes have roots in the sub-prime mortgage crisis. Lehman closed its subprime lender BNC Mortgage in June 2007, saying in a press release that the market “necessitated a substantial reduction in its resources and capacity in the subprime space.” It slashed 1,200 jobs, had a goodwill write-down of $27 million and accepted an after-tax charge of $25 million. Earlier that summer, Lehman rolled together its nonprime lending unit Aurora Loan Services, which concentrated on Alt-A loans, into BNC.

Opinion & Analysis: Mergers, bankruptcies and deleveraging

Those holding bonds from Lehman could get some 60 cents for each dollar if the bank gets liquidated, CreditSights analysts told Among Lehman’s debts, which total more than $600 billion, is $157 billion due to its 10 largest unsecured creditors, of which $155 billion is owed to bondholders.

Financial players knew that a Lehman failure was a likely outcome, however. “We expect the financial markets to be under unprecedented strain over the next several days as players respond to outsized industry deleveraging,” or cutting back on debt, Oppenheimer analyst Meredith Whitney wrote in a report quoted by the Chicago Tribune.

Less access to loans could spell a greater credit crunch for both businesses and consumers alike. As for consumers, the FDIC insures accounts up to $100,000, and investment retirement accounts held at FDIC-backed institutions are covered for up to $250,000.

Major business players in need of fast capital like the struggling bank Washington Mutual have more reason for alarm.

WaMu’s mortgage-backed losses are a rash on the company’s balance sheets. A WaMu spokesperson emphasized to ABC News a Monday report from credit rating agency Standard & Poor’s “strong regulatory capital cushion.” The same report downgraded WaMu’s credit rating from “stable” to “negative.”

This, on top of the precedent set by Lehman’s scurrying to find capital as late as Sunday, makes for a grim outlook for WaMu. “Anytime that one of these institutions either fails or it does a bunch of things and does not get ‘better’ in the eyes of the stock market, psychologically it does some damage to the other weak sisters,” Douglas McIntyre, founder of financial news site, told ABC News.

Certainly a turnaround in the housing market would speed up WaMu’s convalescence, as would a dose of cash from a foreign sovereign-wealth fund. The Abu Dhabi Investment Authority gave Citigroup a $7.5 billion boost in November 2007.

And Chinese SWF Safe committed to a $2.5 billion stake in private equity fund TPG in July. WaMu should know—TPG agreed to inject $7 billion of capital into the flailing bank in July.
As for other banks, given the shaky state of the financial sector, WaMu doesn’t have a line of suitors in waiting. FAS 157, a new rule instituted by the U.S. Financial Accounting Standards Board, could send them searching for partnerships elsewhere. Set to become effective in December, FAS 157 stipulates that any major write-downs to assets that have gone unaccounted on balance sheets must be noted on accounts following a merger or acquisition. Seeking Alpha’s Edward Harrison writes that the regulation could dissuade regional banks from buying into larger thrifts such as WaMu.

“With loans fetching their greatest discounts since the Great Depression, it sharply reduces the value of a target’s assets,” Harrison quotes Columbia Business School instructor Robert Willens as saying. “That will force an acquirer to raise additional capital in this very difficult environment.”

At least three possible buyers have shied away from investing in WaMu or National City Bank, based in Cleveland, because of the rule, said two bankers involved in the negotiations.

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