Lehman denies rumors about its subprime exposure

NEW YORK/CHICAGO (Reuters) - Lehman Brothers Holdings Inc LEH.N has denied speculation it would announce it has more exposure to subprime mortgage loans than disclosed, yet its shares still slumped, as did those of its rivals.

The denial on Wednesday was in response to talk in financial markets that Lehman, like rival investment bank Bear Stearns Cos BSC.N, may be suffering losses on subprime mortgage securities.

"The rumors regarding subprime exposure are totally unfounded," said Lehman Brothers spokeswoman Kerrie Cohen.

Yet the bank's shares closed down nearly 2 percent on those concerns, while investors furiously bought put options on fears deepening subprime problems would inflict yet more damage. Lehman's bonds weakened, too.

According to market research firm Track Data, 57,074 puts compared to 38,481 calls had traded in Lehman by the close far outpacing the normal volume of 28,682 contracts. Investors buy puts when they think shares will move lower.

"Lehman Brothers shares are under pressure due to the fact that they may have more exposure to the subprime market than previously thought," said William Lefkowitz, options strategist at brokerage firm vFinance Investments in New York.

Lehman's option volatility was also higher on those subprime risk concerns, said Paul Foster, options strategist at Web information site theflyonthewall.com. Lehman Brothers shares closed down $1.41 at $71.65 on the New York Stock Exchange.

Lehman bonds also weakened relative to U.S. Treasuries. Notes with a 6.5 percent coupon maturing in 2017 were trading at a yield of 1.60 percentage points more than Treasuries. That margin widened from 1.50 percentage points late Tuesday and from 1.4 points when the bonds were first sold last week.

And in another sign investors were concerned about Lehman, the cost of insuring Lehman's debt with credit default swaps rose around 10 basis points to 68 basis points, or $68,000 per year for five years to insure $10 million in debt.

Lehman Brothers shares are down 8.3 percent so far this year, including Wednesday's losses, compared with a 5.2 percent gain in the Amex Securities Broker Dealer Index .XBD.

The shares have been under pressure because of a perception that Lehman, for decades best known as a bond trader, has more mortgage exposure than its larger rivals. Better-than-expected earnings reported in June allayed some concerns, but the shares have since turned down.

Other brokerage shares also slumped the day after Bear Stearns Cos BSC.N disclosed that two hedge funds it runs were essentially wiped out by losses on subprime mortgage securities.

Analyst David Trone of Fox-Pitt, Kelton said broker-dealer shares fell as a series of headlines fueled worries financial markets and the broader economy could slow.

"It's a combination of (Federal Reserve Chairman Ben) Bernanke's comments, together with this Bear Stearns hedge fund news," he said.

Morgan Stanley closed down $2.00, or 2.75 percent, at $70.85, while Merrill Lynch was $2.80, or 3.25 percent, lower at $83.40.

Bonds backed by subprime home loans have slumped recently as housing prices fell and loan defaults spiked. Bernanke said earlier on Wednesday that housing market problems could dampen an expected pickup in the U.S. economy, but also said the Fed still remains worried about inflation.

Brokerage firm Punk Ziegel & Co downgraded Bear Stearns, Merrill Lynch, Morgan Stanley and other firms on Wednesday, citing concern that companies and individuals were not generating enough wealth to make interest payments on debt.

But Trone, who has a "buy" rating on brokerage stocks, says the selling ignores the most important driver of banking and trading earnings -- global economic growth, which remains robust. Instead, investors are responding to the same old news.

"It's just a rehash of what we've been fussing about the past few months," Trone said. "But when you see stories that these hedge funds are 'worthless,' that creates opportunities for doomsayers to jump out of the woodwork."

(Additional reporting by Dan Wilchins, Karen Brettell and Joe Giannone)