Lehman Brothers (LEH) said Wednesday morning that it expects to lose $3.9 billion in the third quarter, a loss of $5.92 per share, the largest quarterly loss in company history. Driving the loss are $5.6 billion in net write-downs on residential mortgage and commercial real estate positions, the company said in a press statement. That's the bad news. The good news is that Lehman isn't facing some sort of imminent failure, as some investors had begun to fear earlier this week after talks with Korea Development Bank over a 25 percent stake in the Wall Street firm fell apart on Tuesday, sending shares plummeting 45 percent. The company confirmed as well that it will pursue a good bank/bad bank strategy for its commercial real estate assets, saying it will spin CRE assets into a new, separate public company called REI Global; the spinoff is expected to be complete by the end of the first fiscal quarter in 2009, Lehman said. It also will cut its dividend and sell a majority interest in its asset-management division at an auction; the company did not identify potential bidders Wednesday. Lehman also said it had pulled back dramatically on both residential and commercial mortgages during the third quarter. Residential mortgage exposure tumbled 47 percent from Q2 levels to $13.2 billion, the company said, while it cut its CRE exposure by 18 percent during the quarter, as well. "This is an extraordinary time for our industry, and one of the toughest periods in the firm’s history," CEO Dick Fuld said. "The strategic initiatives we have announced today reflect our determination to fundamentally reposition Lehman Brothers by dramatically reducing balance sheet risk, reinforcing our focus on our client-facing businesses and returning the Firm to profitability." Which is all, generally speaking, good news. And shares in Lehman had spiked up more than 10 percent when this story was published, as a result. But for the good and the bad, the really ugly is still out there: in particular, accomplishing the spin-off and sales will require additional capital. And finding that capital will prove to be a steep challenge for the Wall Street firm. "They are saying 'we are fine now,' and that's buying them time to negotiate for that additional capital," Brad Hintz, an analyst at Sanford C. Bernstein in New York and former Lehman finance chief, said in a Bloomberg Television interview. "They will need capital as part of the spinoff." "It's still this incrementalism that I think ultimately Wall Street's not going to be very satisfied with,'' Chuck Carlson, a portfolio manager at Horizon Investment Services said in the same Bloomberg interview. "Lehman is trying to cling to the fact that they can come out of this independent and I'm not so sure that that's going to be the case." Lehman has one thing going for it that Bear Stearns & Cos. did not when it saw its shares take a similar dive in March: access to the Fed' Primary Dealer Credit Facility, or PDCF. The program was put into place after the Bear Stearns failure to allow Wall Street banks to have access to funds in the event of a collapse in stock prices, giving Lehman time to search for a longer-term solution. The longer it relies on the PDCF, however, the more likely speculation will mount that a Federal takeover is imminent. And after what had taken place with the GSEs this past week, is that sort of move really out of the question? "Given what was done with Freddie and Fannie and Bear Stearns, it's hard to distinguish why Lehman is not too big to fail as well," Robert Eisenbeis, chief monetary economist at Cumberland Advisors, and a former research director at the Atlanta Fed, told Bloomberg Wednesday. "My guess is that everyone will blink again and Lehman too will be saved. We are in for a rough ride." Disclosure: The author held no relevant positions when this story was published; indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.