Rating Itself: S&P Defends Lehman’s “A”

Detailed self-review lets it off the hook for giving the bank high marks during its slide toward bankruptcy. Why? Investor fear did it in.

Standard & Poor’s is taking great pains to defend its “A” rating for Lehman Holdings Inc.

The rating company fired off a report Wednesday asserting that the recent collapse of the investment banking firm was a case of negative market sentiment — whether or not grounded in fundamentals — creating significant difficulties that led the company to the point of failure.

“In our view, Lehman had a strong franchise across its core investment banking, trading, and investment management business,” S&P stated. “It had adequate liquidity relative to reasonably severe and foreseeable temporary stresses.”

The ratings service insisted that looking beyond the current downturn, the firm had good earnings-generating ability. “We believe the downfall of Lehman reflected escalating fears that led to a loss of confidence — ultimately becoming a real threat to Lehman’s viability in a way that fundamental credit analysis could not have anticipated with greater levels of certainty,” said S&P credit analyst Scott Sprinzen.

S&P emphasized in the detailed four-page report that, historically, ratings have provided value to the market by taking an intermediate- to long-term perspective primarily based on fundamental credit analysis. It adds that if ratings merely reflected prevailing market sentiment, they would not provide such independent analysis and value to the marketplace.

This said, it does concede there are cases where negative market sentiment — whether or not grounded in fundamentals — can create significant difficulties for a company, and can even precipitate a failure. “Companies that operate in particularly confidence-sensitive businesses and/or place heavy reliance on short-term borrowings are especially vulnerable to this phenomenon,” it added.

It said that this can give rise to a potential “credit cliff,” where credit quality can deteriorate precipitously in a short period. “We view the recent collapse of Lehman Brothers Holdings Inc. as a case in point. In our view, Lehman had a strong franchise across its core investment banking, trading, and investment management business. It had adequate liquidity relative to reasonably severe and foreseeable temporary stresses. And looking beyond the current downturn, the firm had good earnings-generating ability.”

In fact, currently pending negotiations to sell parts of Lehman’s global businesses attest to the strength of Lehman’s franchise, the credit rater noted.

S&P does acknowledge that Lehman has had its share of challenges, too. It said that since the turn in the credit cycle that started in mid-2007, weak business conditions and dislocation in the capital markets had affected Lehman adversely. “In our view, Lehman was affected more than some of its peers among the broker-dealers because of its particular emphasis on leveraged finance underwriting, residential mortgage origination and securitization, and commercial real estate (CRE) finance — business lines that have been hit especially hard by the current slump,” S&P wrote.

And during 2007, Lehman aggressively accumulated residential mortgages, residential mortgage-backed securities, and CRE loans and equity investments on its balance sheet. Although hedges during the second half of fiscal 2007 ended Nov. 30 largely offset deterioration in the value of these assets, hedges were insufficient during the first half of the current fiscal year, S&P adds.

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