Tightening credit is hurting more than just Wall Street (see BusinessWeek article). As of September 9 of this year, 57 companies had defaulted on a total of $45.3 billion of debt, up from 22 total companies defaulting in all of 2007. For the 57 that have defaulted, 45 are not in the financial industry. Unfortunately, the trend may get worse as approximately 70 percent of non-financial companies carry a junk credit rating, with the default rate possibly rising to levels not seen since 1981. Companies that are feeling the impact of the credit crunch include automakers (in particular GM), airlines (UAL Corporation - UAUA), franchisees (such as some at McDonald's, MCD, who may not default, but are having problems getting loans for coffee bar expansions), and entertainment (Boyd Gaming - BYD, Trump Entertainment - TRMP, and Six Flags - SIX). The S&P list of "weakest links," or companies that could default in the next 12 months, is now at 162 firms and growing.

Lehman Brothers (LEH) is considering shifting approximately $32 billion of commercial mortgages and real estate to a new company, nicknamed Spinco, using a good-bank, bad-bank model of the 1980s (see a recent SeekingAlpha article on the good bank, bad bank debate). Lehman would fund the bank with $8 billion of equity coming from Lehman (Korea Development Bank is in discussions to purchase 25 percent of Lehman for $6 billion), with the remaining $24 billion borrowed from Lehman or outside investors (see Bloomberg article). The Spinco option would allow Lehman to off-load 80 percent of its commercial mortgages, establishing a company capitalized and managed by outside investors. One benefit of spinning off the mortgages to its own shareholders is that Lehman can allow existing shareholders to benefit from any recovery in asset prices, thereby eliminating the need to sell at fire sale prices. If the plan fails, Lehman may be forced to seek out private equity funds and sell parts of the company, such as their asset management business Neuberger Berman (see previous post here and here).

While Lehman brothers certainly seems to be getting hit from every direction (see comments on Opsraie's problems here, of which Lehman has a 25 percent stake), they are certainly trying to be creative in how they pull the company out of potential failure. While taking the Merrill Lynch route of selling assets for 22 cents on the dollar (and financing much of the sale themselves) may have not even been a possibility for Lehman, current actions do indicate the they seem to think the worst is behind them, at least as far as the credit crisis is concerned. Maybe they have no other alternatives. Liquidity and confidence issues remain, but if they can get the needed capital, and keep from selling the entire company and its assets on the cheap, Lehman may in fact come out stronger, or at least be able to survive. Of course, this really depends first on staying afloat and not becoming the next Bear Stearns. Fortunately for Lehman, so far they have appeared to have a little less panic from their nervous investors (not much), a few more options available to them, and a little more time than a weekend to get something done. But as they say, paraphrasing, "act now - while 'capital' supplies last."

A recent Financial Times article highlights some research it has done on the impact of the housing and credit crisis on Merrill Lynch. We all know of the problems and losses with Merrill and others, but when you add up the numbers the FT finds that in the past 18 months the losses have amounted to roughly one-fourth of the profits the company has made over its 36 years as a public company. The recent credit problems have caused Merrill to report after-tax losses of more than $14 billion during a time when the company took nearly $52 billion in write-down on its balance sheet. Looking at historical data, the FT calculates that the company's total inflation-adjusted profits between 1971 and 2006 were close to $56 billion. More near-term, the $14 billion in losses also amounts to half of Merrill's profits since 2000. Amazing. If this is not an advertisement for better risk management, I am not sure what is. Securitization and leveraged loans have certainly seen better days. To add insult to injury, it also turns out that Merrill Lynch had the highest ratio of credit related losses to historical profits when compared against ten large U.S. and European financial institutions. UBS had the dubious honor of having the second highest ratio.