Lehman writes off more than $1bn in private equity loans

Lehman Brothers has provided the first glimpse of the effect of the credit crisis on Wall Street banks, saying it has been forced to write off more than $1bn from the value of loans to private equity-owned companies.

While Lehman warned that the once highly profitable market for exotic credit products would be subdued for the foreseeable future, it said it believed the worst of the crisis had passed, and investors breathed a sigh of relief that the figures were not as bad as feared.

The company scaled back the amount of money it is setting aside for employee bonuses this year to reflect a 30 per cent quarter-on-quarter fall in profits. Lehman recorded net income of $887m (£441m) in the three months to the end of August, compared with $1.3bn in the previous quarter and 3 per cent lower than the same period a year ago.

Wall Street banks have lent hundreds of billions of dollars to fund private equity buy-outs, in the expectation that those loans can be sold on to other investors, but those investors are no longer willing to pay as much for high-risk debt and parts of the debt markets seized up entirely over the summer.

The banks' shares have tumbled as analysts struggled to guess how much each is exposed to mortgage-backed assets and leveraged buy-out loans, and Lehman was yesterday the first in the industry to report figures from its third quarter.

Chris O'Meara, Lehman's chief financial officer, told investors that it had written down the value of its leveraged loan portfolio by a figure "well above" $1bn. It also wrote-down the value of mortgage-related securities, but other positions it had taken in the debt markets increased sharply in value at the same time. Netted out, the reduction in value of its portfolio was $700m, less than Wall Street had expected.

As a result, net income from the fixed income division of Lehman's capital markets business halved in the quarter, coming in almost $1bn lower than the same period last year.

The new valuations were calculated using data from real transactions, not simply using mathematical models, Mr O'Meara insisted.

Lehman has been at the forefront of innovation in the debt markets, recording booming profits from so-called "structured credit" products which slice and dice mortgages and private equity debts into small parcels that can be sold to hedge funds and other investors. It is these structured credit products that fell suddenly and dramatically out of favour over the summer, when investors feared that rising defaults on the underlying mortgages and slower corporate profit growth might render many of them worthless.