Lehman Brothers' fixed-income revenue drops 60%; decline partially offset by leveraged loan sales

By Jennifer Lanning Drey

Portland, Ore., Dec. 13 - Lehman Brothers Holdings, Inc. reported a 60% year-over-year drop in net revenues from fixed-income capital markets during the fourth quarter due to continued difficult market conditions, Chris O'Meara, the firm's global head of risk management and former chief financial officer, said Thursday during Lehman's fourth-quarter earnings call.

"Clearly, [this is] one of the most difficult quarters we have seen in fixed income," he said.

The fixed-income capital markets' $830 million net revenue reduction resulted from negative valuation adjustments in the firm's securitized products and real estate businesses. The valuation adjustments were offset, in part, by gains from the sale of some leveraged loan positions, O'Meara said.

At the Nov. 30 close of the fourth quarter, New York-based Lehman had non-investment-grade contingent acquisition facilities of $9.8 billion, down from $27 billion at the end of the third quarter and $44 billion at the end of the second quarter.

"The decline in our commitments is the result of deals being completed and sold in the market and some deals being closed but still being in the process of being syndicated," O'Meara explained.

The current $9.8 billion exposure is spread over 16 transactions.

The bank also reported its mortgage inventory totaled $91 billion at the end of the quarter, reflecting a decline in securitization activity.

Subprime balance sheet exposure within the residential mortgage piece was $5.3 billion, compared with $6.3 billion at the end of the previous quarter.

"Although we have not emerged unscathed from the recent market turmoil, we believe we have done a good job at managing our risks," O'Meara said.

Improvement in 2008 second half

Lehman expects fixed-income capital markets to continue to face uncertainty in the near term as products remain impaired or trade at distressed prices, Erin Callan, Lehman's chief financial officer, said during the call.

"Conservatively our view right now is that the asset prices in the fixed-income market will begin to stabilize over the next six months, which will serve as an inflection point for improvement for fixed income later in the 2008 calendar year," she said.

Callan pointed out that distressed investment pools have been established in the leveraged loan space and are increasing in the asset-backed space as well.

"Although risk aversion has prevailed in recent weeks, I would note that fixed-income investors cannot stay on the sidelines for extended periods of time due to the intense cash accumulations in portfolios from regular interest payments and maturities," she said.

Lehman expects fixed-income origination to grow to about $10 trillion for the full-year 2007 but then decline by 8% to $9.2 trillion in 2008 due to a lower component of securitizations in merger and acquisition financing.

Lehman reported total net income of $886 million for the fourth quarter, down from $1 billion in net income at the end of 2006.

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