Financial life in a big town

Lehman Brothers Holdings Inc. shares bounced from its lows Thursday after an analyst upgraded his rating on the investment bank to "Buy," and believes it now has become a "hostile takeover candidate."

Ladenburg Thalmann analyst Richard X. Bove believes that Lehman Brothers (LEH, Fortune 500) management values the company at a premium, and would be willing to sell at the right price. He believes that a "deep pocket buyer" could emerge to buy the nation’s fourth-biggest investment bank.

"So the market is at a stand-off," Bove said in a note to clients. "Investors are unwilling to accept any positive view of the company; management is unwilling to sell out at a deeply distressed value. The stage is set for a hostile bid to take over the whole company."

Immediately after the note was published, Lehman Brothers shares - down about 6% earlier in the session - bounced higher. Shares of the company were down 9 cents at $13.64 in afternoon trading. The stock has traded between $12.02 and $67.73 over the past year.

Before the opening bell in New York, shares were initially under pressure after another analyst increased his third-quarter loss estimate and slashed his price target for the investment bank, projecting yet another tough quarter of write-downs.

In a note to clients issued Wednesday night, Citi Investment Research analyst Prashant A. Bhatia also said he saw a "lower probability" that the New York-based investment firm would sell its Neuberger Berman business or raise capital in the near term.

Several Wall Street analysts have been speculating about a possible sale of all or a portion of Lehman’s asset-management business.

"Even under the potentially more stringent rating agency guidelines related to the amount of preferred securities in the capital mix, we anticipate that Lehman can absorb over $3 billion of after-tax losses without adding more common equity," Bhatia wrote in a research note.

He lowered his third-quarter estimates on Lehman, predicting a "difficult operating environment, characterized by lower client-related trading volumes and losses on hard-to-sell assets."

Bhatia widened his projection of a quarterly loss to $3.25 per share from a previous forecast of a loss of 41 cents per share. Wall Street analysts expect a profit of 12 cents per share, according to a poll by Thomson Reuters.

The analyst also axed his price target to $35 from $50. Nevertheless, he rates Lehman Brothers as a "Buy."

Bhatia said he expects Lehman to take fresh asset related write-downs of $2.9 billion during the most recent quarter.

"Based on further deterioration in several indices, we expect further write-downs, primarily related to mortgage assets," he wrote.

Investment banks have been struggling with mounting losses and write-downs on bonds and debt backed by mortgages. As mortgages increasingly have defaulted over the past year, the value of bonds backed by the troubled loans has declined.

Banks have been forced to cut the value of their holdings or sell their investment at losses. 

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The American banking system has become a melting pot in recent years as financial institutions from all over the world have set up shop in the United States.

Now more Chinese banks, bolstered by a booming economy and recently forged alliances with big Western players, are eyeing a stateside presence.

Earlier this month, the Federal Reserve gave the go-ahead to Industrial and Commercial Bank of China, China’s largest lender, to open a wholesale banking operation in New York - a sign that some experts say could herald a wave of other Chinese banks entering the United States.

"This is an acknowledgement that they are on the way," said Henry Fields, a partner at the law firm Morrison & Foerster whose practice has centered around assisting foreign banks looking to establish operations in the United States.

China’s ICBC is hardly the first foreign financial institution to put down roots in the United States. This year alone, a number of banks from such far-flung countries as Azerbaijan and India were approved by the Fed to establish representative branches here in the United States.

ICBC is the second Chinese bank to set up shop in the United States over the past year. China Merchants Bank won similar approval from the Fed in November. Currently, only a handful of Chinese banks are chartered domestically.

Under the Fed authorization, ICBC will be able to finance trade and support the increasing number of its clients doing business in the United States.

ICBC will not be able to take in FDIC-insured deposits, but the start of a commercial branch is often considered to be the first step for a foreign bank looking to expand into the United States.

"Foreign banks have traditionally come through wholesale branches and then the banks usually expand into retail banking if there is a strategic reason to do so," said Fields.

Indeed, Chinese banks are enjoying a period of robust growth. Last year, the country’s four largest financial institutions experienced a surge in loan growth, reporting double-digit percentage profit increases or better. Combined, ICBC and China Construction Bank collected close to $20 billion in profits in 2007, based on the latest figures compiled for the Global Fortune 500.

That’s a sharp contrast to a decade ago when many of those same banks lost money at an alarming rate after after doling out funds to poorly-run government businesses only to find themselves on the hook for those same troubled loans.

Given that growth, Chinese banks would seem to be ideal candidates to expand overseas - except for the fact that many of these financial institutions are still quite unsophisticated.

Currently, most of their investments are financed through retained profits, and their lending, credit card and risk management practices remain largely outdated, notes Edmund Harriss, a London-based investment director for Guinness Atkinson who helps run three Asia Pacific-focused funds.

"Chinese banks are really still learning how to run a fully commercial operation," said Harriss.

Hoping to catch up with the rest of the financial services world, a number of China’s biggest banks have sold stakes or partnered with some of the top global financial firms, including HSBC (HBC), Goldman Sachs (GS, Fortune 500), Citigroup (C, Fortune 500), Bank of America (BAC, Fortune 500) and Merrill Lynch (MER, Fortune 500).

Until then, banks in China are looking inward for growth.

With the industry experiencing further government deregulation and rapid domestic growth, more Chinese banks are teaming up to build out their branch networks domestically, notes Richard Gao, the lead portfolio manager of the Matthews China Fund, which has about $1.4 billion of assets under management and invests primarily in companies located in China.

"Right now they see that the home market is rapidly growing," said Gao.

While Chinese banks from are making the necessary moves to enter the U.S. market, most experts believe it will be several years before one opens a branch on Main Street or becomes a Wall Street player.

A representative at ICBC’s offices in New York declined to comment on whether the company had plans to expand further within the United States.

Breaking out into the U.S. retail banking market, for instance, would require buying a U.S. bank or establishing their own branch network - both of which would require further approval from top U.S. banking regulators, including the Federal Reserve.

And certainly a greater stateside presence by a Chinese bank would raise eyebrows among lawmakers in Washington.

The Chinese state-run oil company, China National Offshore Oil Corp., or Cnooc, sparked a storm of controversy in 2005 when it made a bid for the U.S. oil and gas producer Unocal Corp. Cnooc ultimately dropped its bid in the face of congressional opposition.

Having learned from this experience, Chinese financial institutions, many of which are still majority owned by the China’s government, will exercise plenty of caution in the face of those U.S. protectionist fears, notes Fields.

"There is a lot of xenophobia about China," he said. "They [Chinese banks] have to be careful about their profile politically in the U.S." 

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Washington Mutual reported a $3.3 billion quarterly loss Tuesday — far worse than Wall Street was anticipating — as it set aside more money for bad loans.

The Seattle-based thrift reported a net loss of $6.58 a share, which included a charge related to a $7 billion capital raise the company announced in April.

Excluding the charge, WaMu reported a loss of $3.34 a share. Analysts polled by Thomson Reuters were expecting the nation’s largest savings and loan to report a loss of $1.05 a share on this basis.

Just a year ago, the company reported a profit of $830 million, or 92 cents a share.

Washington Mutual (WM, Fortune 500) shares initially climbed in after-hours trading, before turning lower after the credit rating agency Moody’s put WaMu under review for possible downgrade. WaMu shares finished Tuesday’s regular session more than 6% higher.

When quizzed about the report from Moody’s by an analyst, WaMu management said it didn’t see much impact from the announcement, saying there wasn’t any need to raise debt at this time.

Driving this quarter’s loss was a sharp increase in WaMu’s loan loss reserves, which grew $3.74 billion during the quarter to $8.46 billion.

WaMu warned that the company would need to continue to reserve against loan losses over the next couple years, but said that 2008 would represent the peak of loan loss provisioning.

"I still think there is more to come in the way of provisions because of the increasing rate of non-performing loans in the home loan, home equity, and subprime categories," said Stephanie Hall, a senior analyst with the Scottsdale, Ariz.-based research firm Gradient Analytics. "But they have taken a step in the right direction by increasing the loan loss accrual."

Yet, the company offered some signs of encouragement as delinquencies in its troubled subprime and home equity portfolios showed "early signs of stabilization" during the quarter, according to the company.

"We believe this portfolio may be starting to burn out," said John McMurray, WaMu’s chief enterprise risk officer during the conference call.

The company also announced that top management, including Killinger, the company’s chief operating officer and finance chief, would not receive bonuses this year in light of the company’s financial performance to date.

Including Tuesday’s results, WaMu has reported three consecutive quarterly losses. Scrambling for cash, the firm has cut its dividend twice, shut down some of its key business units and trimmed its payroll.

Killinger stressed that the company remained well capitalized even as the housing market and the broader economy has deteriorated further since April when it announced a plans to raise $7 billion by selling an equity stake to an investment group led by the private-equity firm TPG.

WaMu also said its Tier 1 capital ratio, a measure of a bank’s ability to absorb losses, stood at 8.44% at the end of the quarter. A ratio above 8% is generally considered a good sign for financial institutions.

"We remain confident that we have sufficient capital to successfully manage our way through this challenging period," Killinger said.

Concerns about WaMu’s fate surfaced last week after Lehman Brothers analyst Bruce Harting wrote in a research note he suggested the company would report $26 billion in cumulative losses when the company delivered its quarterly results, and would have to "substantially" raise its loan loss reserves as a result.

Those concerns were compounded by comments from Ladenburg Thalmann analyst Richard Bove, who warned that WaMu is on the edge of the "danger zone."

That spooked WaMu investors, who were already fearing further bank failures following the high-profile collapse of the California-based mortgage lender IndyMac just days earlier.

WaMu issued a statement later that day stressing it was well capitalized with more than $40 billion in excess liquidity.

Shares of WaMu have nearly doubled in the past week after hitting a new 52-week low. But WaMu’s stock, currently hovering around $6, still trades well below its 52-week high of $41 50.

The latest figures from WaMu come just hours after the Charlotte-N.C.-based Wachovia (WB, Fortune 500) booked a nearly $9 billion loss.

WaMu’s results also come at the tail end of what has been a tumultuous round of second-quarter earnings reports for the nation’s banks.

A number of large financial institutions, most notably Bank of America (BAC, Fortune 500), Citigroup (C, Fortune 500) and Wells Fargo (WFC, Fortune 500), reported quarterly figures that, while not good, still managed to beat analysts’ expectations. Bank stocks have rallied sharply in the past few days on the news.  

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Mervyns LLC, the low-end department store chain that has been languishing for several years, could be the latest casualty of the fiercely competitive retail climate.

The privately held company, which operates about 175 stores in seven states but primarily in California, is facing bare shelves and a cash crunch as vendors are delaying shipments and key lenders that provide finance and credit to apparel makers have stopped approving orders.

"We are advising clients to hold off shipments primarily due to lack of communications from management," said Bob Carbonell, chief credit officer at Bernard Sands LLC, a credit monitoring company.

Carbonell, who said he’s working with several dozen clients that sell to the chain, noted that Mervyns had been consistently providing financial updates until about a week ago.

A person close to the company who spoke on condition of anonymity because of the sensitivity of the issue said GMAC Commercial Finance stopped approving orders of merchandise last week.

Squeezed by high-end department stores at the top and large discounters like Wal-Mart Stores Inc. (WMT, Fortune 500) at the bottom, the 59-year-old Mervyns has been shuttering stores and leaving states such as Oregon and Washington since 2005, after a consortium of private equity players including Sun Capital Partners Inc. bought Mervyns from Target Corp (TGT, Fortune 500). for $1.2 billion.

Mervyns, Sun Capital and GMAC did not immediately return calls for comment.

The chain’s heavy concentration in California, which is among the states hardest hit by the housing crisis, has made a turnaround harder.

Consumers in those hard-hit regions are being forced to make hard choices, Carbonell said: "Do you go shopping at Mervyns or do you pay for gas and food?" He added, "Everybody is fighting for the same piece of the pie."

In April, Mervyns appointed John Goodman, who had been president and general manager of the Dockers brand — a key supplier to Mervyns — as president and chief executive. The company announced the next month that it had hired a real estate advisory firm to sell five to 10 underperforming stores that also had high real estate value. Mervyns said then that the move was expected to generate $25 million to $50 million in cash to fund operations and new growth.

The financial struggles of Hayward, Calif.-based Mervyns are another worry for the nation’s malls, which have seen more and more vacancies amid store bankruptcies and closings. On July 9, Steve & Barry’s LLC, once a growing force in low-priced fashion, filed for Chapter 11 bankruptcy protection. At the time, company officials said no decision had been made about possible store closures.

It joins home furnishings chain Linen ‘n Things Inc., catalog retailer Lillian Vernon Corp. and specialty retailer Sharper Image Corp (SHRPQ). in filing for bankruptcy protection this year. Sharper Image, which is now being liquidated, is selling its remaining assets to an investment group for $49 million. 

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NYSE Euronext said Tuesday it will pay $250 million for a 25% stake in Qatar’s Doha stock market, as the operator of the New York Stock Exchange moves to build a financial hub in the Middle East.

Established in 1995, the Doha Securities Market (DSM) began operations in May 1997, and currently has 43 listed companies. Its market capitalization has climbed to $136 billion from $5.2 billion in 2000.

The deal, which represents NYSE Euronext’s largest investment ever in a foreign exchange, is expected to close early in the fourth quarter.

NYSE Euronext will receive three of 11 seats on the DSM’s board. It will be the technology provider for both the cash equities and derivatives markets, and will manage the new exchange’s operations, including naming senior management.

"This represents a hugely significant development for Doha’s financial markets," said Sheikh Hamad bin Jassim bin Jabor Al-Thani, Prime Minister and Minister of Foreign Affairs of Qatar. "It’s a significant endorsement of Qatar’s importance in the world’s capital markets and will provide considerable opportunities for our future generations."

NYSE Euronext (NYX) said it will base a number of its growing Middle East region operational and technology support functions in Doha, growing its financial hub there.

Qatar is retaining a 75% stake in the DSM, but said it plans to sell a minority share of the DSM in a domestic initial public offering within the next three years. 

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CALGARY–Fertilizer producer Agrium Inc. says it is looking forward to record profits as "unprecedented demand for crop inputs."

The Calgary-based company said it expects second-quarter earnings of US$2.80 to $3 per share, up from previous guidance of $1.92 to $2.22, "due to very strong results from both our retail and wholesale operations."

Agrium's results are "particularly impressive given that the North American spring application season has been hampered by excessively cold and wet weather this year," president and CEO Mike Wilson said in a release.

"Continued strong global crop prices have created unprecedented demand for crop inputs and we foresee an extended demand-driven cycle."

The company said its forecast assumes there is no unfavourable financial impact from its Egyptian nitrogen facility EAgrium, at which construction was halted in April“due to permitting and other delays created by the Egyptian government."

A syndicate of banks providing financing for the project has requested the suspension of future draws on a credit facility and says the loan is in default.

Agrium said it expects government approval but has "concerns these issues may not be resolved in the near term, in which event EAgrium's shareholders would be exposed to the loss of their total equity commitment."

Agrium has $165 million invested in the project with a total equity commitment of $280 million.

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General Motors Corp (GM.N: Quote, Profile, Research) expects the recovery in the U.S. auto market will be “a long haul” that only begins in the second half of the year, a senior executive at the No. 1 U.S. automaker said on Wednesday.

The market comments by Mark LaNeve, vice president for sales for GM North America, were the first by a top GM executive since Ford Motor Co (F.N: Quote, Profile, Research) cut its outlook for U.S. sales last week, citing rising gas prices and sharply lower demand for its trucks and SUVs.

“I think it’s going to be a long haul,” LaNeve said at an industry conference in Los Angeles, when asked when he expected U.S. auto sales to recover. “We think it starts to get better in the back half of the year.”

But LaNeve said the battered U.S. housing market and consumer confidence would have to both improve to support a rebound for auto sales.

“We don’t look for it to come roaring back. We think it will be a slow ramp up,” LaNeve said at the event in Los Angeles sponsored by Automotive News.

U.S. sales for GM are down almost 17 percent for the first four months of the year, compared with a decline of about 8 percent for industrywide sales.

Most analysts now see U.S. sales of cars and light trucks dropping to near 15 million units in 2008, down from about 16.15 million in 2007 and the lowest annual tally for the industry since 1994.

GM said in late April when it announced a $3 billion first-quarter loss that it would face a slower recovery in its home market than it had first forecast and a faster shift out of higher margin trucks and SUVs in response to higher gas prices. 

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Canadians shouldn’t let the gloomy news about the United States’ economic crunch persuade them that things are bad in this country, too, says Finance Minister Jim Flaherty.

In an address in Toronto, he admitted that manufacturing - particularly in forestry and autos - faces major challenges in Canada. But Flaherty said the economy, overall, is faring much better in the current uncertain economic period than in the U.S.

"There is a steady drumbeat of negative media coverage on the state of the U.S. economy," he told a business audience this morning.

"Sometimes I think this spills over into Canadian readership and influence on Canadians. Often, when you pick up a newspaper, economic forecasts are being adjusted downwards. And certainly there’s been a psychological effect of the recession in the U.S. housing sector."

The Bank of Canada has recently said that the economy is barely limping along in the April-to-June period and will grow by a weak 1.4 per cent for the year as a whole.

But Flaherty, clearly trying to deflect complaints about his management of the business environment, stressed that no one is predicting a decline in output in Canada.

"Keep in mind: Canadian projections are on the positive side of the ledger," he said.

He said Canada continues to have low unemployment, tame consumer-price inflation and balanced government books in Ottawa.

"We have the strongest economic fundamentals of all of the major industrialized countries" in the Group of Seven nations, Flaherty added.

And Canadians and Canadian businesses have shown resilience in face of the collapse of the U.S. housing bubble, higher energy prices, increased competition from abroad and the higher-valued loonie, he said.

"Canada is in a good position to weather this economic storm."

He added, "We are not the United States," pointing out that the causes of the "current American malaise" are not likely to be duplicated here.

Canada’s financial institutions have not faced the drastic credit crunch that has rocked banks south of the border. And Canadian banks are not heavily exposed to risky securities backed by U.S. subprime mortgages, he said.

"Canada’s housing market remains solid. It has not experienced the same stresses as in the United States, certainly not the same bubble."

For Ontario, which is facing near-recessionary conditions, Flaherty had nothing new to offer today. He said the Conservative government’s major policy thrust has been trying to stimulate the economy by cutting personal and corporate taxes and the GST.

He rejected direct support measures for troubled industries, saying a program of short-term assistance to help struggling regions "always leads to failure."

"In our view, it is not only misguided, it’s expensive and it does long-term damage."

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Citigroup offered some investors an unwelcome dose of deja vu on Friday.

The largest bank in the United States presented its most comprehensive turnaround plan since Morgan Stanley banking and trading veteran Vikram Pandit took over as chief executive in December, but many of its key plans sounded all too familiar.

Pandit said on Friday that Citigroup Inc (C.N: Quote, Profile, Research) businesses would work together, allowing them to squeeze more revenue from individual products by selling them across multiple units. He also said he would cut costs and invest overseas.

If all this sounds familiar, there’s a good reason: it’s exactly what was promised at Citi’s last analyst day in December 2006 by the then-CEO, Chuck Prince, before he was succeeded by Pandit a year later.

“We thought Citi was going to start on a new road, and lo and behold, we’re down the same road again,” said Helena Ocampo, an analyst covering financial stocks at Sentinel Investments, which manages $5.6 billion of assets and owns Citi shares.

Skepticism helped push Citi’s stock down 2.8 percent to $23.63 on Friday, bringing its loss this year to nearly 20 percent.

To be sure, Pandit is making some bold moves. He said Citi would shed some $400 billion of non-core assets within three years, scale back in businesses like bond trading and ramp up in prime brokerage and electronic trading.

But by and large, Pandit is not proposing massive strategic changes, and is focusing instead on making sure Citi doesn’t see a repeat of the last two quarters, when it posted more than $15 billion of losses. 

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Defense contractor General Dynamics Corp. said Wednesday that its first-quarter earnings rose nearly 32 percent.

The Falls Church, Va.-based firm said it earned $572 million, or $1.42 per share, up from $434 million, or $1.06. Sales totaled $7 billion, up 11 percent.

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