Lehmans unveils survival plan after record loss

Lehman Brothers announced a complete overhaul of its business yesterday as the US investment bank made a desperate bid to convince investors it could survive despite posting its worst-ever quarterly loss.

The embattled investment bank revealed a $3.9bn (£2.2bn) net loss for the third quarter, significantly worse than analysts had forecast, driven by $5.6bn of writedowns on real estate assets. Lehman brought the results forward by more than a week to clarify its position after its shares lost almost half their value on Tuesday.

The bank also gave details of a plan to clear out many of the assets that have threatened its survival. Between $25-30bn of commercial real estate assets will be spun off into a separate company owned by its shareholders. The company is also in talks with BlackRock, the asset manager, to sell about $4bn of UK residential mortgages in the next few weeks.

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Lehman's shares slumped 45 per cent on Tuesday ahead of yesterday's announcement from Korea Development Bank that it had pulled out of long-running talks to inject up to $4bn of capital into Lehman. Last night, they fell a further 6.9 per cent.

The bank said it was also in advanced talks to sell a majority stake in its investment management business, excluding some operations. The stake includes its prized Neuberger Berman business, resulting in the elimination of Neuberger's goodwill and an increase of more than $3bn to Lehman's tangible book value and capital buffer. Kohlberg Kravis Roberts is said to be the private equity firm leading the race to buy the business.

Lehman will slash its annual dividend to 5 cents from 68 cents to save $450m a year. Lehman's finance director, Ian Lowitt, said with the expected boost from the investment management sale it would not need extra capital to support the spun-off real estate company. The bank is understood to have adjusted its plans, including selling a bigger stake in investment management, to make up for the lack of funding from Korea.

Dick Fuld, Lehman's under-fire chief executive, tried to draw a line under the recent woes of the once highly respected firm that he has run since 1993.

"We are on the right track to put these last two quarters behind us," he said. "As a whole, [the plan] significantly reduces our remaining risk and greatly improves our ability to create value for our shareholders. Today we have taken definitive steps and put in place a definitive plan."

Pressed by analysts, Mr Fuld said he expected no more major writedowns on commercial real estate before the creation of the new company, expected in the first quarter of 2009. Lehman said spinning off the real estate assets would maximise value for its shareholders because the new company would hold the loans to maturity or sell them at a higher price than Lehman could get for them now.

Lehman grew to be the biggest underwriter of US mortgage-backed securities during the debt boom and was left with tens of billions of dollars worth of the assets on its balance sheet when the market froze in summer last year. Investors have feared the bank's collapse since the implosion of its rival Bear Stearns, sending Lehman shares down almost 90 per cent this year.

The plan sees Lehman renouncing its move into the warehousing of assets and going back to advising clients on mergers and finance and trading securities. In the meeting with analysts, Mr Lowitt repeatedly referred to the remaining business as "clean Lehman" and "core Lehman".

However, many analysts believe Lehman will ultimately have to be sold to a bigger rival. Mr Fuld said yesterday the board was open to an approach at the right price.

HSBC's head of Asia damped speculation Britain's biggest bank could go for Lehman, saying a purchase of an investment bank was "highly unlikely". Josef Ackermann, chief executive of Deutsche Bank, said he was not interested in buying any of Lehman.

Cubillas Ding, an analyst at the consultancy firm Celent, said: "If Lehman moves into the future without its investment management business, issues regarding its future and sustainability as a pure-play investment bank arise."

Speculation mounted yesterday that Andrew Gowers, the bank's European head of communications, would also leave soon. Mr Gowers, a former editor of the Financial Times, was hired by Jeremy Isaacs, who stepped down as head of European operations this week, and is now understood to be considering his position.

Now the firesale will begin

* Lehman's survival plan will see it separate off most of the assets whose plunging values have forced the bank to make massive writedowns, rocking investor confidence.

* The bank reduced its residential mortgage exposure by 31 per cent in the third quarter to $17.2bn (£9.8bn). A further sale of about $4bn of UK mortgages to BlackRock will take its residential exposure to $13.2bn, almost halving its holdings since the end of the second quarter. Lehman will lend BlackRock $3bn to finance the purchase of the UK assets.

* Lehman cut its commercial real estate exposure by 18 per cent in the third quarter to $32.6bn. Up to $30bn of commercial real estate assets will now be spun off into a separate publicly traded company, Real Estate Investments Global, that will be owned by Lehman's shareholders.

After talks with the Securities and Exchange Commission, Lehman is able to structure the company so that it does not have to take the "mark-to-market" writedowns that have battered Lehman as asset prices have fallen. The new operation will be able to hold the assets to maturity or sell at a good price for shareholders instead of Lehman being forced to sell cheaply to clear its balance sheet.

* The bank also expects to sell about 55 per cent of a "subset" of its investment management business to a private equity bidder, releasing about $3bn of goodwill from the acquisition of the Neuberger Berman business it bought in 2003. The sale will exclude the investment management business's middle-market institutional distribution operation and Lehman's minority stakes in hedge funds.

Lehman said that this arrangement would allow it to retain most of the pre-tax income from the investment management division. The businesses will continue to trade under the Lehman and Neuberger Berman names.

* The fourth element of Lehman's plan is to cut its annual dividend to 5 cents from 68 cents to conserve capital.