Lehman Brothers, Morgan Stanley, Goldman Sachs and Bear Stearns all reported third quarter losses this week on their fixed income portfolios, including large reductions in the values of buyout-related loans.
Lehman reported a net reduction of $700 million (€501 million) in its portfolio of leveraged loans and mortgages. Morgan Stanley reported an even higher reduction of $940 million, and Goldman said it lost $1.5 billion. Bear Stearns recorded a $250 million loss.
But while Lehman's losses were far from the worst this week, the firm might have the most to worry about if credit markets remain tight, according to a study released by Fitch Ratings.
This week, the US investment bank said its balance sheet absorbed more than $1 billion from private equity-related debt it could not syndicate, but the Fitch study indicates the amount may increase.
Lehman has committed to $29 billion in financing for its top 20 pending deals. This is the third largest debt burden on Wall Street, but more importantly, it represents 140 percent of the value of Lehman shareholders' total equity.
No other firm approaches this debt to equity ratio; Deutsche Bank's is the second highest at 75 percent. Citigroup and Bank of America have both committed to more pending LBO debt than Lehman, but Citigroup's $37 billion in commitments is only 29 percent of its equity and Bank of America's $31.7 billion is only 23 percent of its equity.
In a worst-case scenario in which banks are forced to write off 75 percent of their top 20 pending commitments and 50 percent of their top ten completed commitments, Lehman's return on assets would decline by an estimated 82 percent. In a less severe scenario, which Fitch considers far more likely, banks will write off 25 percent of their top 20 pending commitments and 10 percent of their top ten completed commitments, meaning Lehman's return on assets would decline 14 percent.
Morgan Stanley has the second highest potential loss in this category. In the more optimistic of the abovementioned scenarios, Morgan would only lose 8 percent of its return on assets. In the more pessimistic, it would lose 38 percent, or less than half of Lehman's potential loss.
Fitch qualified Lehman's relative ranking in its analysis by mentioning that Lehman's potential losses would be offset by revenues earned in other “very active” trading businesses. Fitch also noted that Lehman's commitments to contingent acquisition facilities could be overstated because the bank includes a significant portion of debt that is reallocated upon the decision of a winning bidder.