Like commercial real estate? Lehman has a deal for you

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From Times staff writer Walter Hamilton:

A big part of Lehman Bros. Holdings Inc.’s plan to save itself is to spin off to shareholders the bulk of the investment bank’s commercial real estate portfolio.

Would that be a gift -- or a bomb?

The commercial real estate market hasn’t suffered on par with the worst of the residential real estate market’s decline, but there are growing signs of weakness on the commercial side.

Lehman has been a huge player in financing commercial projects. Now it proposes to move up to $30 billion of its $32.6-billion portfolio of commercial mortgages and other real estate holdings into a new entity to be called Real Estate Investments Global -- REI Global, for short. That entity then would be spun off to Lehman shareholders and would trade publicly.

The spinoff would include the company’s mortgage investments tied to California land developer SunCal Cos.

In effect, Lehman is taking a page from one crisis to try to overcome another: The firm is proposing a restructuring technique known as ‘good bank/bad bank,’ which was used by other battered institutions with real estate problems during the savings-and-loan crisis of the late 1980s and early 1990s.

The idea is to segregate worrisome assets into a subsidiary (the ‘bad’ bank) and then legally separate it from the main company (the ‘good’ bank).

In Lehman’s case, the goal is to revive investor confidence in the firm by shearing off assets that could fall further in value.

‘You’re basically bringing some closure to a mess,’ said veteran bank analyst Bert Ely. ‘You’ve gotten [faltering assets] off your books. You’re no longer on the hook and you’ve capped your downside.’

Lehman could have tried to sell its commercial assets at a loss in the market -- as rival Merrill Lynch & Co. is doing with certain real estate securities. But Lehman has bent over backward to avoid a fire sale that would result in further balance-sheet write-downs.

From shareholders’ perspective, the question is whether they would be getting something of real value in REI Global, or an investment that could collapse as soon as it begins trading.

Lehman sought to paint its commercial assets as fairly valued now, after the write-offs the firm already has taken. ‘We do not envision large write-downs in the commercial mortgage portfolio given the present market,’ Lehman CEO Richard Fuld told analysts on a conference call Wednesday.

‘REI Global will own a high quality portfolio of assets, which is diversified by geography, property and lien type,’ Lehman said. ‘REI Global’s primary focus will be to maximize shareholder returns by selling assets or holding them to maturity, whichever provides the greatest return.’

The catch is that the good bank has to pour in capital to finance the bad bank. Lehman signaled that it would inject at least $5 billion in capital into REI Global.

The spinoff ‘has to have enough equity capital that it can stand alone,’ Ely said.

Yet Lehman’s core problem has been that it needs fresh capital for itself, and has been unable to find a deep-pocketed investor to step up. The breakdown of talks with a South Korean state bank triggered the 45% plunge in the brokerage’s shares on Tuesday -- and forced the firm to move up its restructuring announcement from next week.

The market’s verdict on the restructuring plan on Wednesday wasn’t encouraging: Lehman’s shares stabilized for much of the session but finished down 54 cents to $7.25 -- a new 10-year low.