Session 3: Lehman Brothers -Case Study

[Acid]

Case study -Lehman Brothers unfortunate fate.


NEW YORK - British bank Barclays PLC intends to unveil a plan to acquire all or part of Lehman Brothers Holdings Inc.'s investment banking and trading operations, a person close to the talks said Tuesday.

http://us.bc.yahoo.com/b?P=KY6SJEwNc1g4pGg0SMVNHAu0TR5zFEjQStsADp21&T=1fgr0mm8b%2fX%3d1221610203%2fE%3d8903535%2fR%3dn ews%2fK%3d5%2fV%3d2.1%2fW%3dH%2fY%3dYAHOO%2fF%3d27 75767341%2fH%3dY2FjaGVoaW50PSJuZXdzIiBjb250ZW50PSJ iYW5rO2ludmVzdG1lbnQ7YmFua2luZzt0cmFkaW5nO3JlYWwgZ XN0YXRlO2luZm9ybTtpdDtjb3VydHJvb207YnVzaW5lc3M7ZW5 2aXJvbm1lbnQ7bGlxdWlkaXR5O2xvYW5zO2ZpbGluZztob3VzZ TtGZWRlcmFsIFJlc2VydmU7QmFuaztGZWQ7SG91c2U7R292ZXJ ubWVudDtJdDtCdXNpbmVzcztyZWZ1cmxfd3d3X3lhaG9vX2Nvb SIgcmVmdXJsPSJyZWZ1cmxfd3d3X3lhaG9vX2NvbSIgdG9waWN zPSJyZWZ1cmxfd3d3X3lhaG9vX2NvbSI-%2fQ%3d-1%2fS%3d1%2fJ%3d13730D4C&U=13fkpta0b%2fN%3dntCvIkPDoH0-%2fC%3d687767.12908565.13185195.1442997%2fD%3dLREC %2fB%3d5472512%2fV%3d1
The deal, which was expected to be announced by early Wednesday, would throw a lifeline to more than 9,000 Lehman employees whose future was uncertain after Lehman filed for bankruptcy protection on Monday. Lehman collapsed from massive exposure to risky real estate holdings.
Barclays President Robert Diamond has addressed Lehman investment bankers to inform them of his company's intentions, this person said. He spoke on condition of anonymity because a final agreement had yet to be reached.
The third-biggest bank in the U.K. had withdrawn from weekend talks with Lehman Brothers about a possible outright acquisition. There have been reports that Barclays can pick up the assets it wants for about $2 billion to $3 billion. The deal must get approval from the bankruptcy court.
Lehman's first bankruptcy hearing began late Tuesday afternoon in a crowded courtroom at the U.S. bankruptcy court in Manhattan — just steps away from Wall Street's iconic bull statue.
Shai Waisman, a lawyer for Weil, Gotshal & Manges, LLP representing Lehman Brothers, in his opening statement argued that Lehman's Brothers' downfall was the result of a "chain reaction" of events that were largely out of the investment bank's control.
"Lehman operated in an extremely unfavorable business environment," Waisman said, referring to declining asset values and low levels of liquidity.
Requests to get initial approval of potential asset sales and to obtain loans to operate while in bankruptcy from a judge were postponed by one day to a hearing scheduled for Wednesday.
Judge James Peck approved a motion Tuesday confirming that "automatic stay" applies to Lehman. Automatic stay is a typical bankruptcy rule that prevents creditors from taking actions — such as filing lawsuits — to collect debt from the company in question.
Peck also approved a motion Tuesday that JPMorgan Chase & Co. will remain Lehman's clearing house through the bankruptcy proceedings. The issue arose over the past two days, during which JPMorgan advanced Lehman $138 billion to allow it to keep trading and "avoid a disruption of the financial markets," according to court filings.
JPMorgan advanced Lehman $87 billion when the market opened Monday, acting in part on a request by the Federal Reserve Bank of New York. The New York Fed later repaid JPMorgan that amount. On Tuesday, JPMorgan advanced another $51 billion.
Also on Tuesday, the House Oversight and Government Reform committee said it would hold a hearing Sept. 25 to examine the "regulatory mistakes and financial excesses" that led to Lehman's bankruptcy filing. It asked Lehman Chief Executive Richard Fuld to testify before the committee.



What business issues can you identify ? How are the the stakeholders going be effected by Lehman collapse and its current external & internal situation? What future do you see for Lehman brothers ?

[Acid]

Analysis:

So they can get out from under their present load, reopen under a new name with a fresh start, dump all their bad clients and keep all their best ones.

The above is speculative and unspecific. Lehman Brothers filed for bankruptcy because they failed to raise enough capital to secure their debts. The next logical question is why did they have so much debt? This is a two-fold answer: First, Lehman Brothers had massive exposure to property derivatives. These are investments that are tied to the value of properties such as homes and mortgages. Due to the recent housing crash (the biggest part of which is falling property values), the value of the investments that Lehman had fell significantly.


The second part is slightly more complex. Lehman had a ton of what is called "leveraged assets". Basically what happened (the non-basic is for another question) is Lehman took their assets and took out loans secured by those assets (for instance, using their on-hand cash as down payments on loans) and then invested those loans in the aforementioned property derivatives. So, not only did those investments lose value, but Lehman had to pay the interest on the money they borrowed (and subsequently lost). In short, Lehman was a casualty of the credit crunch due to exposure to bad debt.
What happened this weekend is that the Fed got a bunch of bank presidents together and asked them to invest in Lehman (basically loan Lehman money). The bank CEOs, knowing the risk of such a loan (they could see Lehman's finances), refused to do so without some kind of assistance from the government (whether it be loss-protection, the government paying half of the loan, etc etc). Hank Paulson, the Secretary of Treasury, refused to do this, saying that he didn't want to saddle the taxpayers with paying to save a private company that screwed up.

**** ****

People went to traditional banks and mortgage brokers and bought
mortgages. All of these mortgages carry different amounts (e.g.
$100,000 mortgage vs. a $500,000 mortgage) and different risk levels.
The ones that are more likely to default have a higher interest rate,
so the bank stands to gain more money...but at a greater risk of the
home owner defaulting on the mortgage.

The problem with this is it is very difficult to balance your risk-
reward ratio. So they created an investment vehicle called a mortgage-
backed security (MBS). This is reffered to as a "derivative" because
it is based off of the mortgage. The way it works is the banks
chopped up all these different mortgages into different securities
that were worth different amounts and different risk levels. They
then sold these to other banks and investments firms. The firms who
bought these MBS then received a payment based off of the mortgages.
For the banks selling MBS, it helped them pool risk and generate
capital, and for the firms who bought the MBS, it provided a source of
cash flow with what was thought to be a very safe,secure underlying
commodity: real estate.

Since real estate was so "safe," these banks used huge amounts of
leverage (borrowed money to buy the securities) because they didn't
think they were that risky. Some firms, like Lehman, were leveraged
30:1, meaning that for every $30 they borrowed, they had $1 of
underlying assets. That would be like you making $1000 a year but
taking out a loan of $30,000.

While all this is going on, people are buying up adjustable interest
rate mortgages (ARMs). They offer a cheap introductory rate, but then
skyrocket. So all of a sudden, all these people discovered they
couldn't make their monthly payments. The default rate shot through
the roof. The firms that had purchased MBS did so based on certain
calculations of default. In other words, X number of people could
default on their mortgages, but they could still make a profit and
have a positive cash-flow. However, when the default rate shot up,
this threw all of their calculations off.

Now the firms faced a real problem. They had HUGE amounts of debt on
their balance sheets, and the assets that were supposed to balance
that debt were becoming worth less and less because of the rising
default rate and the drop in housing prices. These are the "write-
downs" that you hear about. The firms had to pay interest on that
debt, but they did not have the corresponding cash flow to be able to
pay the debt. Lehman, for example, had $5.4B of debt obligations last
quarter, but only had $2.3B in income.

When you can't pay your debt obligations, that's called being
insolvent. Many people think that bankruptcy is caused by having more
liabilities than assets, but that's not true. It's caused when you
can't make good on your debts, so the repo man comes and claims your
assets in order to make up for it. When that happens, you have to
file for bankruptcy in order to make sure that people get paid in the
correct order because otherwise different creditors are going to be
suing you to make sure they get what you owe them.

So that's where we are now with Lehman. They couldn't pay their
debts, so they had to file for bankruptcy.

[Frost]

One of the reasons being is that Lehman Bros has the same ceo's who screwed up in previous institutions hence a firms strategy should be to ensure that the human resources have the best intrest of the company in mind and not their pockets, these people who have created the mess were involved in previous co's that went bust example being Saloman co which was a financal institution it went down like Lehamn Bros and it was saved and renamed Citi bank. What is ironic is that Lehamn Bros is and its associate institutions are incharge of the rating system and have put themselves convinently in the A++ rating :p

[Acid]

What ? Really ? How can the lehman group look over this fact??

[andiey]

To frost: Are you sure for that - I mean ratings