Toomre Capital Markets LLC

Toomre Capital Markets LLC ("TCM") is an active consultancy in the areas of structured finance, risk management and financial engineering. As a result, we have many conversations with numerous people across the spectrum of clients, prospects, former associates and other industry contacts. In the past several months, many of these conversations have touched upon Lehman Brothers, especially given Lars Toomre's personal history of working there and back in the 1980's running that firm's very influential ABS and mortgage derivatives trading business(es).

Toomre Capital Markets LLC ("TCM") has been quite busy during the past few weeks on client work ahead of the summer vacation period. As a result, there has been limited time to update this blog. Today's news of the Treasury Department's defense of the struggling GSE's known as Fannie Mae and Freddie Mac though deserves some comment.

That both of these GSE's need to be supported in at least an oral sense is more than a ripple in the Capital Markets pond. It is much more like a major wave. Just what the final cost to tax payers will be remains to be seen. TCM suspects that the final bill will not be known until well after residential home prices stabilize and even begin to appreciate again. No doubt, though, the costs will be significant.

Lost in all of the GSE consternation is the lack of discussion about the critical policy decision on the future of mortgage finance in the United States. TCM has highlighted this critical issue before. Until the late 1980s, the S&L's were the primary holders of mortgage debt. Commercial banks also have owned some mortgage debt (with significant capital haircuts). The relatively lower capital requirements and the ability to "turn" the mortgage origination portfolios led to the rapid growth in securitization and the funding of mortgage debt through investors in the capital markets.

On the morning of Monday June 9^th 2008, Lehman Brothers pre-announced their second quarter earnings report and gave limited details on their capital raise efforts. [A link to the press release can be found here.] The numbers are larger than what Toomre Capital Markets LLC ("TCM") wrote about last night in the post Lehman Brothers Said to Lose $2 Billion Plus in Second Quarter. Lehman Brothers now expects to lose $2.8 billion for the period ended May 31^st 2008 as well as raising close to $6 billion through a combined common stock and preferred offering.

Partly as a result of this announcement, Moody's Investors Service has put the ratings of Lehman Brothers under review for a likely downgrade. Lehman Brothers will be conducting a 10 AM conference call to discuss further this press release. From the press release, it appears that the fixed-income division had a net loss of approximately $5 billion, which is much larger than the losses that Lehman Brothers has announced in prior quarters.

Lehman Brothers in the past months has pledged to increase its transparency regarding its financial transparency. It certainly will be quite interesting to learn more about where these losses came from. Toomre Capital Markets LLC will post more about this company later in the day as further information becomes available.

Late on Sunday June 8^th 2008, The Wall Street Journal is reporting Lehman Set To Raise $5 Billion Amid Losses. Supposedly the equity offering will be placed primarily with United States institutional investors, including the State of New Jersey Division of Investment. What is most interesting about the article though is that Lehman Brothers' second quarter loss is expected to exceed $2 billion, much more than the market consensus of a $300 million. Such a number, if true, makes it highly likely that the Lehman Brothers common stock will likely open down again on Monday morning. Such a decline tied both to a bigger than expected quarterly loss as well as the dilution from a secondary stock offering will make it much more difficult to price a big common stock offering.

Toomre Capital Markets LLC ("TCM") hopes that Lehman Brothers can succeed in placing the $5 billion in equity. While it will be highly dilutive to existing shareholders, such a capital raise should ensure that Lehman Brothers will be able to continue as an on-going entity, particularly in the fixed-income markets where their credit rating is critically important both for funding needs and the derivatives businesses. One might remember that a significant portion of the common equity currently is owned by the employees of Lehman Brothers who have seen the value of their holdings decline by close to fifty percent since the start of the year. Those employees might well be asking how Lehman Brothers allowed itself to get so off-sides to own some $80 billion odd in mortgages securities at the start of this credit crunch.