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Hedge Fnds Pulled Back From Lehman Prime Bkg Before Bankruptcy

Date: Tuesday, September 16, 2008
Author: CNN Money.com

NEW YORK -(Dow Jones)- Hedge funds were leaving the prime brokerage business of Lehman Bros. (LEH) long before Lehman filed for Chapter 11 bankruptcy Sunday, and now, business there has all but stopped, according to sources.

But in certain areas, like the statistical arbitrage and repurchase, or repo markets, Lehman was and still is a top player. What happens to the prime brokerage is a complicated question, because most of that business is located in the U.K. While Lehman included its prime brokerage as part of its bankruptcy, it is not thought to be subject to the laws of Chapter 11 since the business is in the U.K.

Lehman's prime brokerage, which like others lends money and securities to hedge funds as well as provides administrative services from back-office help to processing trades, was a key revenue-earner for the bank as recently as earlier this year. In its first-quarter earnings report in March, Lehman had reported a 38% year-over-year revenue increase in its securities service unit, which includes prime brokerage. At that time, it said it had $194 billion in hedge fund balances.

But as the investment bank started stumbling more and more the past few months - along with the rest of the financial services industry - Lehman started losing all or part of the business of hedge fund customers afraid of the counterparty risk attached with dealing with Lehman.

In a note to investors reviewed by Dow Jones Newswires, one hedge fund admitted it used Lehman's prime brokerage services as recently as last week, but minimally. At that time, it moved its money from Lehman to the prime brokerages of UBS AG (UBS) and Goldman Sachs Group Inc. (GS), which it already had been using as its main prime brokerages. Hedge funds typically use multiple prime brokerages, to minimize risk if one of those brokers falters.

The same hedge fund promised investors it would continue to form prime brokerage relationships with other banks to diversify counterparty risk.

The large question is what happens to Lehman's existing prime brokerage business, or what's left of it.

"There are certain niches they have pretty good market share in," said Robert Sloan of S3 Partners, a hedge fund adviser, pointing to the repo and stat arbitrage areas. He said the sorting out of what happens with the prime brokerage, because it's a U.K. part of a business that filed Chapter 11 bankruptcy in the U.S., is unprecedented as far as he can tell.

Lehman's prime brokerage is headed by John Wickham worldwide and Gunner Burkhart for Europe. Wickham did not return an e-mail seeking comment.

When Bear Stearns Cos. collapsed earlier this year and was snatched by J.P. Morgan Chase & Co. (JPM), J.P. Morgan got Bear's existing prime brokerage business.

-By Joseph Checkler, Dow Jones Newswires; 201-938-4297; joseph.checkler@ dowjones.com

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