Fall Of Lehman Brother


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Fall of Lehman Brother

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  • With a long-established reputation for excellence, LehmanBrothers is one of the preeminent franchises in the globalequity markets. Our expert team of traders, salespeople andorigination specialists has built success by forming strong clientpartnerships based on our ability to provide the highest qualityexecution and distribution. Our traditional strengths infundamental, quantitative and strategic research continue toprovide the competitive advantage our clients seek. Significantgrowth and continued product innovations allowed Equitiesto set a new record in 2007, with net revenues of $6.3 billion,an increase of 76% over the prior year.
  • VAR appears to have been designed to let the traders get on with the business of making real money, while at the same time keeping the top brass from worrying too much about the risks traders were taking. ///One big problem with this approach to managing risk is that it doesn’t tell you what can happen the other 1% of the time, when the VAR limit is exceeded. /////
  • Chapter 11 is a chapter of the United States Bankruptcy Code, which permits reorganization under the bankruptcy laws of the United States. Chapter 11 bankruptcy is available to every business, whether organized as a corporation or sole proprietorship, and to individuals, although it is most prominently used by corporate entities. In contrast, Chapter 7 governs the process of a liquidation bankruptcy, while Chapter 13 provides a reorganization process for the majority of private individuals.
  • Debtors may "emerge" from a Chapter 11 bankruptcy within a few months or within several years, depending on the size and complexity of the bankruptcy. The Bankruptcy Code accomplishes this objective through the use of a bankruptcy plan. With some exceptions, the plan may be proposed by any party in interest.[3] Interested creditors then vote for a plan. Upon its confirmation, the plan becomes binding and identifies the treatment of debts and operations of the business for the duration of the plan.Debtors in Chapter 11 have the exclusive right to propose a plan of reorganization for a period of time (in most cases 120 days). After that time has elapsed, creditors may also propose plans. Plans must satisfy a number of criteria in order to be "confirmed" by the bankruptcy court. Among other things, creditors must vote to approve the plan of reorganization. If a plan cannot be confirmed, the court may either convert the case to a liquidation under Chapter 7, or, if in the best interests of the creditors and the estate, the case may be dismissed resulting in a return to the status quo before bankruptcy. If the case is dismissed, creditors will look to non-bankruptcy law in order to satisfy their claims.
  • The collapse of Lehman Brothers is confirmation that the credit crunch is far from over. Although mortgage rates have been coming down, there is now every chance they will start to rise again as banks grow nervous about lending to each other once more.Lehman Brothers is an investment bank, whose clients are institutions, not individuals. However, its collapse shows that the banking sector as a whole is still vulnerable, and it is not impossible that another retail bank finds itself in the situation that Northern Rock did. If another high-street bank went bust, savers would have the first £35,000 of their deposits guaranteed, but beyond this they could lose everything. Hence, if you're sitting on a larger amount of savings, you might want to consider spreading it around a few different banks – or putting it with Northern Rock or National Savings & Investments, both of which are fully backed by the HM Treasury.Lehman Brothers employs some 25,000 staff worldwide, of which about 5,000 are in the UK. Most if not all of these will be out of a job after yesterday. On a wider scale, the collapse of another bank will create a further drain on liquidity in the capital markets, meaning that banks remain reluctant to lend to individuals. Britain's economy had already ground to a halt by the end of the second quarter this year, and looks increasingly likely to record its first quarter of negative growth in 18 years between July and the end of this month.A prolongation of the credit crunch can only mean more bad news for house prices. Lehman's collapse is certain to reduce the amount of capital available to banks, which in turn will reduce the amount of money which lenders are willing to advance to UK homebuyers. Although house prices have fallen by about 10 per cent over the past year, the sharper drop in mortgage approvals since the start of the year would suggest this is only the beginning. Some economists are predicting that prices will fall by more than a third from the top of the market last year.For the small number of British individuals that held shares in Lehman Brothers, their investment will now be all but worthless. For most people, however, the effects of Lehman's collapse will be felt in a less direct manner. Global stock markets fell sharply in reaction to the news yesterday. If you are investing for the long term, make sure your portfolio is well diversified, and sit out the storm. If the market continues to fall in the short term, you can take comfort that by continuing to make your monthly contributions, you are buying more shares for your money.
  • The bankruptcy filing by Lehman Brothers Holdings Inc. (LBHI), the largest among financial institutions in U.S.has shown that billion dollar companies can collapse overnight. Companies must take a realistic valuation of it positions at any point of time.Investors need to look into the fundementals of the company and the risk it is taking.This sub-prime mess raises……..banks lend money willy-nilly to people without properly checking their credentials.Lehman entered the real estate market ,2001 through its products like credit default swap cds & collateralised debtobligation (CDO) contract. In 2004 there were only $157.4 billion of CDO being issued, but by 2007 theamount grew to $481.6 billion.Lehman quickly put its capital to work in real estate and soon was a dominant force in the subprime-mortgage market, which catered to borrowers with shaky financial backgrounds. An even more significant engine of profit for the firm was commercial real estate. The next five years saw the bank borrowing billions of dollars to invest in the housingmarket. It worked. The housing market boom had turned Lehman Brothers from a modest firm into theworld's fourth largest investment bank. ……put in all its money in the real estate market …...end result …the real estate collapse brought down the company.absolutely pathetic rating process used by the rating agencies. Raises issues of moral hazard because the rating agencies profited massively from rating. In the wake of Lehman's bankruptcy filing, Lehman was rated A and most of its instruments were rated AAA. Post crisis …..Standard & Poor's Ratings Services lowered the ratings on the debt ofLehman's U.S. broker-dealer subsidiary to 'BB-/CreditWatch Developing' and its holding company ratings to 'D'. Hence one needs to be cautious wliquidity can provide some form of short-term life support to an institution under severestress, it is either real or perceived capital inadequacy that can precipitate a company's failureLeverage was the way to supercharge revenues. At one point, it was said that Lehman had borrowed $32 for every $1 in its coffers. (Compare that to home buying. Usually a buyer must put down 20 percent of the total price. Lehman, in effect, made a down payment of about 3 percent.) By comparison, at Merrill Lynch and Goldman Sachs, the ratio was roughly 25 to one. For all of the firms, a small dip in the value of collateral could prove calamitous.Short term borrowing - More stringent regulations for derivatives and allowing , transparency , Stringent regulations must be imposed when it comes to govt sponsored agencies in getting exposure to derivatives,contracts or exotic instruments. Puch for greater transparency in corporates.Leverage………all eggs in one basket///A strong and well-regulated financial system should be the first line of defense against financial shocks …. [T]he more free-market oriented we want our economies to be, the more we need official supervision and oversight of our financial institutions and markets. That’s because truly free-market economies involve a high risk of business failure, and corresponding high risks to the financial institutions and investors that lend to and invest in those businesses. A key lesson from this crisis is that competition among lenders breeds innovation, but also instability
  • 1. How Is The Lehman Brothers Holdings Inc. Bankruptcy Progressing? – S&P report
  • Fall Of Lehman Brother

    1. 1. The Downfall of LEHMAN BROTHERS<br />Presented By<br />Group 6<br />
    2. 2. United States Housing Bubble<br />Was marked by a sudden increase in housing prices followed by a downfall<br />In the year 2006-2007 foreclosure rates increased drastically<br />Dec 30, 2008 : Case-shiller home price index recorded largest dip<br />Resulted in Mortgage <br />debt higher than the actual<br /> value of the property.<br />
    3. 3.
    4. 4.
    5. 5.
    6. 6. United States Housing Bubble contd…<br />A combination of very low interest rates and a loosening of credit underwriting standards can bring borrowers into the market, fuelling demand. <br />A rise in interest rates and a tightening of credit standards can lessen demand, causing a housing bubble to burst.<br />
    7. 7. Mortgage classification<br />Subprime Mortgage<br /> Tarnished credit records <br /> Low Credit scoring<br /> Pay Higher Mortgage Rates<br />Prime Mortgages<br />Less than 45% debt-to-income ratio<br /> Good record from credit bureau<br /> At least 10% margin<br /> Good Credit Scoring<br />
    8. 8. Players in Subprime<br />Financial Institutions<br />Subprime lenders<br />Subprime borrowers (buying home)<br />mortgage-market players<br />Investors(Banks, Hedge funds, Insurance Co.s, Pension funds)<br />
    9. 9. New Model of Mortgage Lending<br />Source: BBC News<br />
    10. 10.
    11. 11. From the pages of history…<br />
    12. 12. Down the years…<br />
    13. 13. Down the years…<br />
    14. 14. The rising numbers<br />
    15. 15. The rising numbers<br />
    16. 16. Stock performance till 2007<br />
    17. 17. Product portfolio of Lehman<br />LIQUID MARKETS<br />Single-Stock Trading<br />Program Trading<br />Transition Management<br />Listed Options<br />Exchange-Traded Funds<br />Quantitative Trading<br />Electronic Trading<br />Event-Driven<br />Desk-Based Analytics<br />STRUCTURED PRODUCTS<br /><ul><li>Structured Investments
    18. 18. Convertibles
    19. 19. Equity Solutions
    20. 20. Product Management</li></ul>RESEARCH<br />Fundamental Analysis<br /><ul><li>> Basic Industries
    21. 21. > Consumer
    22. 22. > Emerging Markets
    23. 23. > Energy and Power
    24. 24. > Financial Services
    25. 25. > Real Estate
    26. 26. > Retail
    27. 27. > Technology
    28. 28. > Telecom
    29. 29. Equity-Linked Strategies
    30. 30. Enterprise Valuation
    31. 31. Economics
    32. 32. Global Equity Strategy</li></li></ul><li>Failure of Risk Management…<br />
    33. 33. <ul><li>Of the five big investment banks that were in operation at the outset of 2008, The Bear Stearns Cos. has already failed and been taken over and Lehman Brothers was trying to avoid a similar fate.
    34. 34. In its 2008 Annual Report, Lehman boasted of having “a culture of risk management at every level of the firm.”
    35. 35. They took risk management measures but it mostly used the “Value at Risk” system invented by JPMorgan Chase & Co. (JPM) in the early 1990s.</li></li></ul><li>Problem with VaR<br />VaR assesses the “99% confidence limit” of the loss that may be incurred by each trading position at most 1% of the time. But the top managers of the investment banks were led to believe that this 1% didn’t matter.<br />Since VAR was calculated from daily price movements, that 1% accounted to a significant value.<br />The other problem with VAR is that, in most cases, it depends on an assessment of the “volatility” of the security concerned.<br />Volatility is by definition low in quiet markets and much higher in turbulent markets. So the system’s assessment of risk is low when markets are quiet, allowing traders to pile on positions like madmen, and then zooms upward when things go wrong. At that point positions cannot be unwound.<br />
    36. 36. Causes of downfall…<br />
    37. 37. Causes of Downfall<br />
    38. 38. Market Complacency<br />
    39. 39. Market Complacency<br />Drop in delinquency rates<br />Availability of innovative mortgage options<br />Interest only<br />Negative amortization, etc<br />Deterioration in lending standards<br />Poor Monitoring by Capital market<br />pooled mortgages were resold in tranches that had different seniority<br />massive amount of issuance made by a limited number of players<br />
    40. 40. Massive amount of issuances - by limited number of players changed the fundamental nature of the relationship between credit rating agencies and the investment banks. <br /> In the past each customer, issuing only a couple of securities, had no market power over the rating agencies.<br />In their sample of 1,257 mortgage securitization deals<br /> Nadauld and Sherlund (2008) find that Lehman alone had 128 deals.<br />With the diffusion of collateralized debt obligations, the major investment banks were purchasing hundreds of rating services a year.<br />Instead of submitting an issue to rating agency’s judgment, investment banks shopped around for the best ratings.<br />
    41. 41. Importance of Structured Finance Products for Credit Rating Agencies<br /> (Rating revenues by business unit: Structured Finance (in Millions of Dollars)) Source: Moddy’s Annual Report<br />
    42. 42. Bad Regulation<br />Regulatory constraints created inflated demand<br />Goals Government Sponsored Entities (GSE) as percentages of the total number of mortgages purchased<br />Money market funds loved these instruments<br />satisfied the regulatory requirements<br />boosted their yields<br />Allow banks to allocate zero capital to loans which are hedged with credit default swaps<br />Pressure on credit-rating agencies<br />Accounting of subprime mortgages<br />
    43. 43. Lack of Transparency<br />Unregulated growth in the market for credit default swaps (CDS)<br />Low level of collateral generating the possibility of a systemic failure<br />mortgage-backed security market issued under the 144A rule, with limited disclosure<br />
    44. 44. Credit Default Swap (CDS)<br />ACDS is a credit derivative contract between two counterparties, whereby the “buyer” makes periodic payments to the “seller” in exchange for the right to a payoff if there is a default or credit event in respect of a third party or “reference entity”.<br />The most widely traded derivative product.<br />
    45. 45. In the event of a default……<br />The buyer typically delivers the defaulted asset to the seller for a payment of the par value. (“physical settlement”) <br />Or<br />The seller pays the buyer the difference between the par value and the market price of a specified debt obligation. <br /> (“cash settlement”) <br />
    46. 46. Usage …<br />Typically as contracts to insure against the default of financial instruments like bonds or corporate debt<br />But<br />Also bought and sold as bets against bond defaults; a buyer doesn’t necessarily have to own a bond to buy the credit default swap that insures it<br />Banks and other institutions use CDSs to cover the risk of default in mortgage and other debt securities they hold<br />
    47. 47. Disclosure…?<br />The CDS contract is over-the-counter i.e. it is not regulated by a formal exchange<br />Means -- > no one knows what the exposures of specific financial institutions to specific credit defaults are….<br />Only the institutions themselves knew, there was no mandatory disclosure law, and….not in the institutions’ best interest to disclose.<br />
    48. 48. Illiquid nature of the market…<br />Not very liquid, because the contracts not standardized<br />Two-party negotiations, often with very specific terms <br />Not interchangeable with other contracts, even for the same company/debt issuance<br />
    49. 49. Size of the market….<br />Notional amount on outstanding worldwide OTC CDSs<br />$13.9 trillion in December 2005<br />$28.9 trillion in December 2006<br />$42.6 trillion in June 2007 <br />$58 trillion in September, 2008<br />Remember U.S. GDP (2007) was $13.8 trillion<br />
    50. 50.
    51. 51. When Lehman became a layman…!!!<br />Triggered the transfer of large sums in the CDS market to buyers of Lehman credit default risk protection against all losses from that event<br />Sellers of these contracts received Lehman debt and in return were obligated to pay the contract buyers (the insured parties) enough money to make them “whole” i.e. to give them their full investment in the bonds back as if they never bought Lehman bonds<br />The final auction price of Lehman’s debt was $8.625; i.e. for each $100 initial par value, the debt was worth $8.625 only<br />Sellers of Lehman CDSs are obligated to pay the insured party 91.375% of the bonds’ face value and, in return, receive the bonds. Of course …!!! Lehman had hundreds of billions of dollars of debt outstanding<br />
    52. 52.
    53. 53. Collateralized Debt Obligations (CDOs)<br />CDOs are a type of structured asset-backed security (ABS) whose value and payments are derived from a portfolio of fixed-income underlying assets. <br />Different risk classes, or tranches, whereby "senior" tranches are considered the safest securities. Interest and principal payments are made in order of seniority, so that junior tranches offer higher coupon payments (and interest rates) or lower prices to compensate for additional default risk.<br />
    54. 54. To create a CDO, a corporate entity is constructed to hold assets as collateral and to sell packages of cash flows to investors.<br />A special purpose entity (SPE) acquires a portfolio of underlying assets (mortgage-backed securities, commercial real estate bonds and corporate loans)<br />The SPE issues bonds (CDOs) in different tranches and the proceeds are used to purchase the portfolio of underlying assets. The senior CDOs are paid from the cash flows from the underlying assets before the junior securities and equity securities. <br />Risk and return for a CDO investor depends directly on how the CDOs and their tranches are defined, and only indirectly on the underlying assets.<br />
    55. 55. Issuer … reward….<br />Issuer of the CDO, typically an investment bank, earns a commission at time of issue and earns management fees during the life of the CDO. <br />The ability to earn substantial fees from originating and securitizing loans, coupled with the absence of any residual liability, skews the incentives of originators in favor of loan volume rather than loan quality.<br />
    56. 56. Classification of CDOs based on funding<br />Cash v/s Synthetic CDOs<br />Cash CDOs involve a portfolio of cash assets, such as loans, corporate bonds, ABS or MBS.<br /> Ownership of the assets is transferred to the legal entity (known as a special purpose vehicle) issuing the CDOs tranches. The risk of loss on the assets is divided among tranches in reverse order of seniority. <br />
    57. 57. Synthetic CDOs don’t own cash assets like bonds or loans; instead they gain credit exposure to a portfolio of fixed income assets without owning those assets through the use of CDSs.<br />Risk of loss on the CDO's portfolio is divided into tranches. Losses will first affect the equity tranche, next the mezzanine tranches, and finally the senior tranche.<br />Each tranche receives a periodic payment (the swap premium), with the junior tranches offering higher premiums.<br />
    58. 58. Reluctance of market to lend<br />Lacking information on the nature and hence the value of banks’ assets, the market grew reluctant to lend to them, for fear of losing out in case of default. <br />Measure of this reluctance is the spread between Libor and the overnight indexed swap (OIS) rate of the same maturity. <br />Before the beginning of the crisis the multi-year average of this spread was 11 basis points. <br />In August 2007 it was over 50 basis points and it was over 90 basis points by September 2008. <br />
    59. 59. Lehman’s Financial Policy<br />The extremely high level of leverage<br />The strong reliance on short-term debt financing<br />
    60. 60. Lehman Brothers Liabilities and Shareholders’ Equity<br />
    61. 61. Filed Bankruptcy under Chapter 11<br />
    62. 62. Chapter 11<br />When a business is unable to service its debt or pay its creditors, the business or its creditors can file with a federal bankruptcy court for protection under either Chapter 7 or Chapter 11. <br />In Chapter 7 the business ceases operations, a trustee sells all of its assets, and then distributes the proceeds to its creditors. <br />Any residual amount is returned to the owners of the company. <br />In Chapter 11, in most instances the debtor remains in control of its business operations as a debtor in possession, and is subject to the oversight and jurisdiction of the court.<br />
    63. 63. Features of Chapter 11 bankruptcy<br />It retains many of the features present in all, or most bankruptcy proceedings in the United States<br />It also provides additional tools for debtors<br />It empowers the trustee to operate the debtor's business.<br />Chapter 11 is reorganization, as opposed to liquidation.<br />
    64. 64. Effect of Lehman Brother Collapse<br />
    65. 65. Lehman Brother Collapse and Effect<br />Lets analyze the effect on each of the Stakeholders:<br />Borrowers<br />Savers<br />Investors<br />Economy<br />House Prices<br />
    66. 66. Lessons from the Lehman Case…<br />
    67. 67. Lessons from Lehman…….<br />Big need not mean mighty..<br />Subprime loans ….toxic debt<br />Credit rating…are they credible???<br />Capital adequacy <br />Relook regulations…..<br />Stay humble…Stay realistic….Stay cautious<br />
    68. 68. Lehman Post Crisis….Nomura & Barclays<br />
    69. 69. Lehman brothers - Post Crisis<br /><ul><li>Barclays: Date Sept. 17, 2008:</li></ul>North American investment banking and capital markets businesses<br />Three real estate properties, including LBHI's Manhattan headquarters.<br /><ul><li>Nomura Holdings Inc. of Japan : Date Sept. 22, 2008</li></ul>Equities and investment-banking operations in Asia, Europe, and the Middle East<br /><ul><li>Private Equity Firms:</li></ul>Principal investment management unit—Neuberger Berman--and the fixed-income and certain alternative asset management.<br />
    70. 70.
    71. 71. <ul><li>Consideration : assumed liabilities, $250 million in cash and certain contingent considerations.
    72. 72. Also real estate properties :$1.45 billion
    73. 73. Barclays Capital also has agreed to provide debtor-in-possession (DIP) financing to Lehman Brothers Holdings Inc. of $500 million and a substantial interim credit facility to Lehman
    74. 74. Brothers Inc. to fund Lehman Brothers Inc.’s ongoing operations. Barclays has also entered into an agreement to provide information technology, operational and other support services.</li></ul>Barclays Capital<br />
    75. 75. <ul><li>International workforce increase by 3000 from 1700 to 4700
    76. 76. Total Acquisition cost approx. $2bn
    77. 77. Pre Tax Income of $5bn (net of one time losses such as subprime losses
    78. 78. Business Synergies:</li></ul>Nomura Securities<br />
    79. 79. 1. How Is The Lehman Brothers Holdings Inc. Bankruptcy Progressing? – S&P report<br />2. Nomura holdings acquistion of lehman's operations<br />3. 0916_barclays_acquisition – Press Release by Lehman Brothers<br />4."Causes and Effects of the Lehman Brothers Bankruptcy”- Luigi Zingales<br />References<br />
    80. 80. Lets look at the One of the Best Video of Ex-Lehman Brother Employee<br />http://widerimage.reuters.com/timesofcrisis/<br />