The second quarter was a tumultuous one for Lehman Brothers and Wachovia Corp., two of the nation’s top financial institutions.
Continuing a recent pattern of financial services firms firing their CEOs, Wachovia’s board has asked CEO G. Kennedy Thompson to retire. As of press time, Lehman Brothers CEO Richard S. Fuld, Jr. had avoided the same fate. But president and chief operating officer Joseph Gregory and chief financial officer Erin Callan were suddenly reassigned after disappointing second-quarter results and writedowns totaling $11 billion.
Ian Lowitt succeeded Callan as CFO, while Herbert McDade III took over from Gregory. Callan was reassigned to a senior executive position within Lehman’s investment banking division. Gregory’s new role was unclear.
The reallocations came on the heels of news that Lehman expected to see a $2.8 billion loss in the second quarter and that it planned to raise $6 billion through mandatory convertible and common preferred stock issues.
Just days before being reassigned, Callan said during Lehman’s earnings conference call that the capital the company hopes to raise is not held against particular asset exposures on the company’s balance sheet. The efforts to raise capital are “so that we can get back to operating our business day to day and stop the distractions and discussions that we have related to our balance sheet,” Callan said during the call.
Meanwhile, Wachovia’s board asked Thompson to step down after the bank suffered a series of disappointing results. An analyst at Robert W. Baird & Co. said he expects more bad news from Wachovia. “Although we are not completely surprised by the announcement, Thompson’s departure was sudden in our opinion,” wrote David A. George, a Baird equity analyst. “We wouldn’t be surprised to see more bad news (credit, capital markets, dividends) from [Wachovia] in the coming weeks.” George maintains a neutral stance on Wachovia, saying that although the company’s share price underperformed in the early days of June, he believed the risk/reward ratio was not attractive enough to to justify a stock purchase.
Unlike Wachovia’s Thompson, Lehman Chairman Fuld did not appear to have been under any pressure to resign or step down as of press time. Indeed, Fuld and Lehman still enjoyed the confidence of at least two high-profile banking analysts. “We are buyers of the stock on the assumption that CEO Dick Fuld will stabilize Lehman’s ship and, with further stability, the stock will appreciate,” Deutsche Bank analyst Mike Mayo wrote in early June.
Merrill Lynch analyst Guy Moszkowski said Lehman’s share price correction in early June had been overdone and concerns about the bank’s share price suffering further from a funding challenge at Bear Stearns style were unfounded. Lehman shares “have fallen significantly below fair value in recent days due to speculation and concerns that are not justified, in our opinion, given access to [Federal Reserve’s] primary dealer and ample liquidity,” Moszkowski wrote.
Those persistent rumors about liquidity put Lehman in need of some praise from analysts. Rumors of a possible sale abounded, along with reports that the company had approached several South Korean investors, including the Korea Development Bank and Woori Financial Group.
Those concerns were not entirely unfounded. Credit default swaps had widened from 140 basis points in early May to about 260 basis points a month later. In addition, Standard & Poor’s had downgraded Lehman’s long-term rating to A, from A+, in line with a review of the global securities industry.
Before Lehman’s early announcement, Deutsche Bank’s Mayo predicted that Lehman would take action by raising some $4 billion in capital, citing the company’s management’s desire to remain in control of its destiny and focus more of its efforts on the offensive, instead of defensive, tactical. Still, Deutsche Bank lowered its share price target estimate to $49, from $52, and said it expects hedging losses on Lehman, as well as dilution if the company issues additional capital.
Also, before Lehman’s earnings were announced, Merrill’s Moszkowski reversed his second-quarter forecast from a profit of 6 cents a share to a loss of 74 cents a share. He blamed potential market-adjusted asset values that could fall by around $1 billion, ineffective hedges and general market weakness in May.
In early June, rumors circulated that both Lehman and Wachovia would be acquired by other companies. In the case of Wachovia, such a deal is unlikely, George de Baird said. For one thing, he said, the list of potential buyers is limited to JPMorgan Chase & Co., which is already busy digesting Bear Stearns, and San Francisco-based Wells Fargo & Co. Neither company is likely to command a significant premium. of a Wachovia purchase, given all its current challenges.