Lehman keeps most derivatives clients, loses a few

NEW YORK (Reuters) - Lehman Brothers LEH.N is trading normally with most of its derivatives trading clients, but a few have pulled back as the bank gets ready to post its first loss since becoming a public company 14 years ago in a sign of the challenges Lehman faces.

Traders and managers at more than a dozen banks, brokers and hedge funds that spoke to Reuters in the past week said nothing has changed in their dealings with Lehman, and the investment bank's chief financial officer said on Monday there was "no material loss" of clients during the quarter. Lehman declined to comment for this report.

But one portfolio manager at a large hedge fund said his firm had reduced its new trades with Lehman in recent months, and another trader at a significant U.S. institutional fund manager said he now wasn't trading with the bank at all. Both declined to be named because they are not authorized by their firms to speak for attribution.

To be sure, investment banks are always losing and gaining customers. And while concerns about Bear Stearns' future triggered a run on it in March, Lehman is unlikely to suffer a similar fate any time soon.

That's because the Federal Reserve is willing to lend billions of dollars to investment banks to prevent another collapse like that of Bear Stearns, which was acquired by JPMorgan Chase (JPM.N) last month.

Lehman Brothers has about $100 billion of assets at its holding company that are either cash or could be easily sold or financed. Lehman has also just raised $6 billion of capital.

Still, Lehman could find that companies, banks and hedge funds are less willing to trade with some of its subsidiaries, which could cut into the profitability of its derivatives franchise, said Brad Hintz, analyst at Sanford C. Bernstein.

"You would much prefer to do a trade with a higher-rated bank," said Hintz, a former Lehman chief financial officer.

LONG-TERM TRADES

Customers buying securities aren't usually choosy about the credit quality of the bank selling them. But derivatives, or contracts whose value is derived from a security or index, are long-term trades. Clients are typically more careful about entering into a derivatives contract that may require collecting money from a bank in five or more years.

Hintz said Lehman's derivatives businesses in areas like fixed income, equities, and commodities could face earnings pressure as customers become more selective about their trading partners, known as counterparties.

Given the choice of trading with a commercial bank or Lehman for the same product at the same price, the commercial bank might be a more attractive counterparty now, Hintz said.

Hintz reduced his third- and fourth-quarter estimates for Lehman last week because of these concerns, but said on Tuesday that Lehman's balance sheet is "bulletproof."

Lehman Brothers raised $6 billion of convertible preferred securities and common stock on Monday, and said it expects to post a $2.8 billion quarterly loss next week.

After closing at a five-month low on Monday, its shares closed down another 6.7 percent at $27.50 on Tuesday on the New York Stock Exchange. They are down more than 60 percent over the last 12 months.

Amid these difficulties, ratings agencies are cutting Lehman's credit ratings. Standard & Poor's downgraded Lehman to "A" from "A-plus" last week, and Moody's Investors Service on Monday changed Lehman's outlook to "negative" from "stable."

S&P downgraded Merrill Lynch MER.N and Morgan Stanley (MS.N) last week as well, and U.S. investment banks in general could lose derivatives business over time to commercial banks.

Clients, on the whole, are staying loyal to Lehman. Chief Financial Officer Erin Callan said on Monday, "(W)e are not having any conversations with counterparties or lenders about whether they feel confident extending funds and credit to us."

WATCHFUL WAITING

But not every client that reduces its new trading volume with Lehman will have a conversation with the bank about it, Hintz said.

And even if few clients are scaling back their exposure to Lehman, some are monitoring the bank increasingly closely.

Aneet Deshpande, head of trading at Allegiant Asset Management, has exposure to Lehman Brothers through some over-the-counter derivatives and Allegiant has been reviewing these positions.

"They have the capital," he said. "We are not worried but we will still be watching." Allegiant had more than $30 billion of assets under management as of March 31.

Leslie Rahl, president of risk management advisory firm Capital Market Risk Advisors, said all institutions should plan what to do in the event of a counterparty default, but she added, "I do not think that's what we have here."

Dan Fuss, vice chairman at investment manager Loomis Sayles, which oversees more than $100 billion in fixed-income securities, said last week, "We have no hesitation whatsoever at all in dealing with Lehman."

"They are a fine firm and financially strong," he added.

But not all were persuaded by the argument that Federal Reserve support eliminates concerns about counterparties.

Adam Compton, co-head of global financial stock research at RCM Global Investors, said, "Even banks that have been backed by the Fed for a long time fail. It just takes more time. Fed backing does not make you financially invincible."

(Reporting by Elinor Comlay; Editing by Brian Moss)