Capital punishment

As gags go, it was cheap, but irresistible. As a banker from Citigroup attending this year’s conference of the American Securitization Forum in Las Vegas placed his chips on the roulette table, a watching wise guy sniggered: “There goes another $15 billion”. That was last February, and the news since then has been anything but a joke. And now Lehman Brothers looks poised to sell the bulk of its portfolio of commercial real estate assets and securities that has been weighing so heavily on its share price. An alternative plan would see these property nasties spun off into a separately listed entity.

Neither will be easy. Lehman has been punished for buying into commercial real estate close to the market’s top. In particular there was last year’s $22 billion takeover, alongside Tishman Speyer, of apartment specialist Archstone and its tie-up to develop land in southern California with SunCal. Lehman has already reduced the size of its portfolio – from $52 billion at the end of November to about $40 billion in May, predominantly by sales rather than write-downs.

The bank must hope it can attract better prices than those set by peers that have recently dumped their residential exposure. Commercial property remains behind the freefall in residential values. In an admittedly less-stressed environment, commercial mortgage-backed securities (CMBS) have proved more resilient. Ratings upgrades continued to outpace downgrades in the second quarter, says Fitch. But, with the downturn gathering speed, deals will have incorporated boom-time assumptions that do not bear out.

CMBS are helped by the attention paid by banks in underwriting a smaller number of large, commercial loans. But size and complexity can slow due diligence. Investors and financiers will demand a cushion against further falls so a deal may well require more write-downs, and Lehman may have to shoulder the first $5 billion of any loss. The type of vendor financing offered by Merrill Lynch to sweeten its asset sale would be harder for Lehman to provide.

A spin-off could meanwhile mean taking an upfront hit to capitalize the newly formed entity, without raising funds for the core business. Lehman’s efforts are only the first in what may prove a Sisyphean challenge.