Thursday, June 5, 2008

Lehman trading hurt by counterparty worry

NEW YORK (Reuters) - Lehman Brothers Holdings Inc (LEH.N: Quote, Profile, Research) has seen its trading earnings hurt as clients worry about the credit strength of unregulated derivatives units, though it has sufficient capital and access to government funding, a veteran brokerage analyst told clients on Thursday.

But Brad Hintz, who follows brokers for Sanford Bernstein, said that while broker-dealer units in the United States, UK, Japan and Germany "are still being fully accepted by the market, cautious credit officers at clients of the firm are limiting trading with the unregulated derivatives subsidiaries of the company."

Hintz, a former Lehman chief financial officer, reduced his 2008 earnings estimate to $3.20 from $3.42, and his 2009 estimate to $5.95 from $6.11.

"We recommend investors remain on the sidelines with Lehman until the firm demonstrates a reduction in leverage and lowers its exposures to troubled asset classes," Hintz said.

The cost of insuring Lehman Brothers' debt with credit default swaps tightened on Thursday, according to data from Phoenix Partners Group.

Lehman's five-year credit default swaps fell to 240 basis points, or $240,000 a year to protect $10 million of debt, down from 263 basis points at Wednesday's close.

Hintz, in his client note, added that Lehman's fixed income derivative business is under pressure after Standard & Poor's cut Lehman's credit rating to single-A from A-plus.

"Such a downgrade makes it less likely for counterparties to enter into long-dated derivatives," he said, and that will erode profit. Hintz rates Lehman stock "market perform."

Hintz said unregulated subsidiaries that are now "somewhat suspect" include Lehman Brothers Special Financing Inc, Lehman Brothers Finance SA, Lehman Brothers OTC, and Lehman Brothers Commodity Services Inc.