Lehman liquidation to pressure capital ratios: analysts

BANGALORE (Reuters) - The liquidation of Lehman Brothers Holdings Inc will force other brokers to mark down their assets and pressure capital ratios, analysts said, with Oppenheimer & Co's Meredith Whitney saying the financial markets will be under unprecedented strain over the next several days.

The immediate impact of Lehman liquidation will be a dramatic credit spread widening and ultimately negative valuation marks for the remaining players, Whitney wrote in a note issued late Sunday.

In a separate research note, veteran banking analyst Richard Bove on Monday said he expects the credit default swaps (CDS) market to be in turmoil.

"The biggest issue today will be following the money trail. Who has the most indirect lending to Lehman? Who has the greatest counterparty risk?," Ladenburg Thalmann & Co's Bove said.

Panmure Gordon & Co's analyst Sandy Chen echoed Bove's sentiment. Chen said the market's focus will now shift from estimates of write-downs, capital needs and merger and acquisition scenarios, to concerns about counterparty exposures and default risks.

Chen said he expects counterparty default charges to "sweep" through the global financial sector over the next few weeks.

"Unfortunately given their nature... we will only find out after those defaults have occurred," Chen said.

As of May 31, Lehman had $729 billion of notional derivatives contracts and had estimated the fair value of these derivatives contracts at $16.6 billion, Chen said.

Lehman had also disclosed $25.6 billion in assessed fair value of over-the-counter interest rate, currency and CDS exposures, he wrote in a note to clients.

"We would start building initial loss estimates for counterparty derivatives exposures from this number and noting that derivatives tend to settle much more quickly than other financial assets," Chen said.

The real stress, however, will come from the CDS markets, the analyst said.

Given that the CDS market as a whole had notional contracts roughly four times greater than the underlying debts issued, it is not far-fetched to estimate that there are at least $350 billion in CDS written on Lehman debts, Chen said.

"With estimates that Lehman debt will trade at 60 cents on the dollar; this would mean that $140 billion in CDS payouts could be trying to settle over the next days and weeks," Chen said. "This, we expect, will trigger further counterparty defaults," he added.

Lehman on Monday filed for bankruptcy protection, after trying to finance too many risky assets with too little capital, making it the largest and highest-profile casualty of the global credit crisis.

The Chapter 11 filing did not include its broker-dealer operations and other units, such as asset management firm Neuberger Berman. Those businesses will continue to operate, although Lehman is expected to liquidate them.

GLOBAL IMPACT

Analysts expect the collapse of Lehman, once the fourth-largest investment bank in the United States, to have wide-reaching implications for banks, with analysts at Cazenove saying there "...remain questions over at least two other major US financial institutions." They did not name the two.

"Confidence among and between banks is reduced further. De-leveraging will continue if not accelerate," Cazenove said. Following the loss of a counterparty, it was unlikely that banks will compensate by increasing exposures to others, it added.

Cazenove expects additional valuation write-downs from all the UK banks, particularly Barclays Plc, Royal Bank of Scotland Group and HBOS Plc, but did not specify the size of the writedowns expected.

Cazenove said it was particularly cautious on HBOS given its exposures and funding structures, while an analyst at Collins Stewart recommended investors "short" Barclays and go "long" RBS.

"We fear both (Barclays and RBS) will be weak near-term performers due to the Lehman events and fears over capital markets-linked banks but we feel RBS is likely to outperform Barclays," Collins Stewart's Alex Potter said.

Lehman is one of the biggest investment banks to collapse since 1990, when Drexel Burnham Lambert filed for bankruptcy protection amid a collapse in the junk bond market.

(Editing by Jarshad Kakkrakandy)