Drexel Burnham Ailing--Seeks Cash Infusion

Drexel Burnham Lambert Inc., the maverick Wall Street firm that created a $200-billion market for junk bonds and was once the nation’s most powerful financier of hostile corporate takeovers, said Monday that it faces a financial crisis and needs a quick infusion of cash or a merger partner.

The announcement was followed by word that traders at many rival firms had stopped doing business with Drexel because of concern that the firm might not be able to make good on its trading debts. The news prompted senior Wall Street officials to speculate that the firm may be in danger of collapse if a buyer isn’t found quickly. Although rumors circulated of possible buyers, there wasn’t any firm indication that an investor was ready to step forward.

Sources said, however, that Drexel was in talks with more than one potential investor. The firm also is believed to be negotiating with commercial banks to obtain a new line of credit worth several hundred million dollars.

There was concern that a collapse by Drexel could have wide repercussions. “It’s a very volatile situation and sensitive for the rest of the industry,” the spokesman for another large Wall Street firm said.

Among the possible effects would be a further loss of confidence in the securities industry, which is currently suffering a major downturn. Commercial banks that are big lenders to Drexel also could be hurt.

Drexel officials were said to have met in New York with senior officials of the Federal Reserve, the Treasury and the Securities and Exchange Commission, but the Fed did not take any action to bolster Drexel’s financial position. The Federal Reserve intends to monitor the markets closely today, officials said.

Officials at the New York Stock Exchange were said to have held special meetings about Drexel on Monday and were in touch with Drexel officials. A NYSE spokeswoman declined to comment, however, beyond stating that “they are a member in good standing” of the stock exchange.

A decline in Drexel’s fortunes has been evident for months. The firm has been battered by the collapse of the $200-billion market for high-risk, high-yield debt securities that it pioneered. Its reputation has been sullied by its guilty plea to six felony counts last year and by the racketeering indictment of its former star, Michael Milken.

Departures by senior staff members and customers have escalated, and the firm has had trouble for the first time completing several financings for clients. But word of an immediate crisis came only on Monday, when Drexel acknowledged that the continuing decline of the junk bond market had “adversely affected the liquidity” of its parent company, Drexel Burnham Lambert Group.

Drexel’s plunge into crisis seemed to signal that the end of an era really is at hand. The takeover craze of the 1980s has dwindled as the junk bond market, a major source of financing for raiders, has gone into decline. And now Drexel, the firm that created that market, is in a fight for its life.

Sources said the crisis evolved in recent weeks as the cost to Drexel of “rolling over” $200 million in commercial paper became prohibitive. In other words, Drexel became unable to raise the money it needs for day-to-day operations through the usual method of issuing short-term unsecured debt securities. At that point, although Drexel still met the legal minimum requirements for capital on hand, regulators are said to have expressed concern that the firm not allow its capital to run down further.

There were unconfirmed reports that top Drexel officials had made tentative, unsuccessful approaches to the Bush Administration about the possibility of a bailout.

But Drexel said Monday it still has a net worth of $800 million. In a statement, the firm asserted that it hadn’t fallen below the minimum requirements set by regulators for the amount of capital that securities broker-dealers must have on hand.

By the end of the trading day, at least 23 of the 44 primary dealers of U.S. government securities had stopped trading with Drexel, sources said. Officials at several bigWall Street trading firms said many firms also have cut Drexel out of trading in mortgage-backed securities and corporate bonds.

“People have lost their faith in Drexel being able to repay their borrowings,” an official at one top Wall Street firm said. Officials at that and other brokerages said the cutoff could be a death blow to Drexel if it doesn’t swiftly find a buyer or outside investor to restore confidence in the firm’s ability to meet its obligations.

An official at one investment house said he visited traders in various departments on his own firm’s trading floor. He said he discovered that traders of mortgage-backed securities and government and corporate bonds had all stopped trading with Drexel. He said they had stopped because “you don’t trade when you think you’re going to lose money.”

Steven Anreder, Drexel’s spokesman, declined to comment on the possibility that the firm might not find a a buyer or outside investor. “I’m not going to speculate on anything along those lines,” he said.

Drexel’s chairman, John S. R. Shad, and its chief executive, Frederick H. Joseph, held meetings with staff members in New York and Beverly Hills in recent days, explaining that the firm was in need of a large short-term loan, employees said. Drexel is privately owned, primarily by its employees and by a Belgian concern, Groupe Bruxelles Lambert, which holds about 25%.

One source close to Drexel said the Belgian company a few months ago was prepared to inject between $50 million and $75 million in capital into the firm. But, apparently scared off by the worsening downturn in the junk bond market, the Belgians backed off. Groupe Bruxelles Lambert officials failed to return several phone calls to their offices on Monday.

Drexel’s reputation has been hurt in recent months as the firm that once seemed invincible was unable to complete several deals for clients, and there were signs that longtime loyal customers, such as Saul Steinberg of Reliance Group Holdings and Ronald O. Perelman, chairman of MacAndrews & Forbes, had begun to go elsewhere for their investment banking needs.

The firm had long been viewed as being extremely dependent on the abilities of a single key employee--Michael Milken--and when he was forced to resign last year, many analysts predicted a long, slow decline for Drexel. In addition, analysts said the negative publicity from the firm’s criminal and civil legal problems might eventually put Drexel in a position where it would have to merge with another firm to survive.

But most analysts interviewed Monday said they were surprised by how rapidly Drexel’s fortunes had turned. Anreder, Drexel’s spokesman, blamed the recent downturn almost entirely on events in the junk bond market. The market has been battered by bankruptcies and defaults by some large junk-bond financed companies, such as the retailing units of Campeau Corp., and by new federal law requiring the troubled savings and loan industry to divest itself of its junk bond holdings.

Drexel, long a second-tier firm, grew to preeminence in the late 1970s through Milken’s pioneering use of junk bonds. After Milken moved the firm’s junk bond headquarters to Beverly Hills, he turned the securities into a tool for rapidly raising huge amounts of money from investors to finance corporate takeovers and leveraged buyouts. Milken’s ability to find almost instant financing for corporate raiders made Drexel in many ways the most feared--and envied--firm on Wall Street.

But the investment house that Milken built began to crumble in late 1986, when he and Drexel came under suspicion for insider trading and securities fraud. After agonizing internal discussions that left a great deal of bitterness among Milken loyalists, Drexel decided to plead guilty to six felony counts and pay $650 million in financial penalties. The firm also settled an SEC lawsuit, agreeing to the strictest supervision ever imposed on a Wall Street investment house. Milken himself was indicted last March, although he denies violating any laws.

In addition, to get big deals done, Drexel over the past year has had to agree to buy back bonds that customers didn’t want. When Drexel last year carried out the biggest junk bond financing ever, of RJR Nabisco, the investment firm reportedly agreed to buy back from customers a huge quantity of bonds of other companies. These bonds have since declined substantially in value, adding to Drexel’s woes.

An official at a competing Wall Street firm noted that Milken had been able to maintain liquidity in the junk bond market by always seeming to have a buyer ready--often Drexel itself--when an investor wanted to unload junk bonds. And when client companies were raising money through the sale of junk bonds, Milken often had them raise more than they needed. Then they could, in turn, buy the junk bonds of other Drexel clients. The official said of Drexel’s crisis: “This is the end of Mike’s musical chairs.”

A spokesman for Milken declined to make any comment on the firm’s current problems.

In recent months, the defection of employees has accelerated. Staff members have been angered by a requirement that they take part of their compensation in Drexel stock, which has been steadily declining in value. Large salary increases were given out last year in exchange for promises that employees would remain for a year. But those agreements are expiring.

Among those to depart recently were Robert A. Davidow, the head of junk bond research; Larry Post, a junk bond trader, and Lorraine Spurge, a top assistant to Milken who left Drexel to join him at a new company that he founded. Peter Ackerman, another former top figure in the Beverly Hills office, asked to be transfered to London, where his duties are expected to be considerably reduced.

And the government has been threatening to bring a new, expanded indictment against Milken that also would name Warren Trepp, Drexel’s current head of junk bond trading. Trepp, through his lawyer, has denied any wrongdoing.

The firm has eliminated its retail brokerage operation and in cost-cutting moves laid off staff in other departments. As a result, the firm employs about 5,400, roughly half the number employed two years ago. And as a result of the extremely rigid supervision imposed under the SEC settlement, employees complain that the firm has become bureaucratic and slow-moving.

A number of officials at other firms argued that Drexel should have acted far more swiftly to find an outside buyer or investor to shore up its finances and help it overcome its tarnished reputation. An investment banker at another firm said the negative publicity has hurt other Drexel businesses that could have helped the firm survive the current downturn in the junk bond market, businesses such as trading in mortgage-backed securities and municipal bonds.

“They waited too long,” he said. “They’re stuck in so many bad deals. Their reputation got clobbered and now their capital has gotten clobbered.”

Staff writers Paul Richter in New York, Jane Applegate in Los Angeles and Art Pine in Washington contributed to this story.

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