Lehman Brother Crash

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Text of Lehman Brother Crash

CRA SH

Presented By: Hitesh Dutt - 20 Kuntal Datta - 25 Poorva Bhardwaj - 32 Sameer Kalra -

The Company History2

Lehman Brothers had humble origins, tracing its roots back to a small general store that was founded by German immigrant Henry Lehman in Montgomery, Alabama, in 1844.In 1850, Henry Lehman and his brothers, Emanuel and Mayer, founded Lehman Brothers.Years 1844 1850 Early 1850s 1858 1899 1906 1930s 1975 Events Dry-goods store Lehman brothers Started to accept payment in cotton for goods and also created a secondary market for trading in cotton Trading in coffee Exchange and also the New York Stock Exchange Underwrote a public offering for the International Steam Pump Company Started underwriting some bigger public offerings. focus of Lehman went toward venture capital Firm merged with Kuhn, Loeb and Company to form at the time the 4th largest investment bank

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Operating Principles3

Demonstrating a Commitment to Excellence Ensuring That Their Organization Is a True Meritocracy Demonstrating Smart Risk Management Preserving and Strengthening the Culture Always Acting With an Ownership Mentality Building and Protecting Their Brand Maximizing Shareholder Value

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Product & Services4

Financial Services Investment Banking Equity Trading Research

Investment Management Private banking Private equity

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Subprime????.....5

Prime Lending

Subprime Lending

Issued to borrowers with highly rated credit Issued to borrowers with low incomes and histories. assets, and with troubled credit histories.

Low interest rate

High Interest rate

Called A-paper credit

Called B-paper credits

Typ i l y , i i th e p o o r a n d th e yo u n g w h o fo rm ca l t s th e b u l o f su b -p ri e b o rro w e rs k m 02/15/10

Why loans were given6

Real Estate Boom would allow even people with dodgy credit backgrounds to repay on the loans they were taking to buy or build homes. As in 1997 prices of home were almost double.

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Contd. . .7

Government encouraged to lend to subprime borrowers, arguing that this would help even the poor and young to buy houses.

Govt. want to increase the spending of people by increasing the availability of money

With stock markets booming and liquidity, many big fund investors saw sub-prime loan portfolios as attractive investment opportunities. Hence, they bought such portfolios from the original lenders.

This in turn meant the lenders had fresh funds to lend. The subprime loan market thus became a fast growing segment. 02/15/10

8

Effect of interest rate on subprime:

Rate of lending to Sub prime was 2% higher than the prime lenders

Added to high risk of defaulting. Higher interest rate meant substantially higher EMIs than for prime borrowers for same duration, further raising the risk of default. Further, lenders devised new instruments to reach out to more sub-prime borrowers. Being flush with funds they were willing to compromise on prudential norms. The repayment of the principal portion was to start after two years.02/15/10

How did this turn into crisis:9

The housing boom in the US started petering out in 2007. The boom had led to a massive increase in the supply of housing. Thus house prices started falling.

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Contd. . .10

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Contd. . .11

Default rate of sub prime borrowers increased as the housing value decreased, as well as banks were exposed to higher risk. Adjustable Rate Mortgages:- Mortgages where interest rate is adjusted periodically Slowdown in the US economy made matters worse. 02/15/10

Roadmap to subprime:12

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Impact of Subprime crisis13

$512 billion in sub-prime losses were write off by Global Banks High losses were borne by major banks like Citi, Merrill Lynch, JP Morgan chase, Freddie Mac a& Fannie Mae Till July09 end #64 US banks collapsed. FDIC said the number of "problem banks" in the US have risen to a 15-year-high of 305 in the first quarter of 2009 02/15/10 against 252 in

Subprime on Lehman14

Lehman adopted a very aggressive leverage policy in the context of a major financial crisis. The roots of this crisis have to be found in bad regulation, lack of transparency, and market complacency brought about by several years of positive returns. Lehmans bankruptcy lead to a reassessment of the risk, in particular in the market for credit default swaps.

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Reason for failure15

H i h R i g sk D e ri ti s C o m p l Pro d u cts H i h R e tu rn va ve ex g A g g re ssi ve S tra te g y W ro n g Fo re ca sti g nM o rtg a g e s02/15/10

Reason for failure16

End product purchased by Lehman brothers were embedded by these types of risk : Credit

Risk Asset Price Risk Liquidity Risk

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Reason for failure17

q

C re d i R i a n d R e tu rn t sk

LowReturn position Loss position Risk positionAAA Portfolio

High02/15/10

Reason for failure18

q

U S cre d i u p g ra d e s a n d t d o w n g ra d e sUS credit upgrades & downgrades

2007,Q1

2007,Q2

2007,Q3

2007,Q4

2008,Q1

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Reason for failure19

q

M a rke t C ra shDow Jones Industrial Average

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Reason for failure20

Lehman Brothers had massive exposure to property derivatives. Lehman had a ton of what is called "leveraged assets". (D/E ratio of 30:1 where as industrial is 15:1) Lehmann was exposed to a lot of Subprime Mortgage Backed Securities.02/15/10 Lehman's Colossal Miscalculation.

Why AIG not Lehman ???21

Bailout was provided depending on financial markets. AIG insured millions not just of individuals but of institutions as well.

It is also the insurer of million dollars worth of securities issued by institutional lenders and borrowers. The collapse of AIG would have surely brought down these companies too. Federal Reserve had conducted assessments which showed, collapse of Lehman wont bring much chaos to the markets as opposed to the collapse of AIG or Bear Stearns or Fannie Mae or Freddie Mac.02/15/10

Contd. . .22

Lehmans financial troubles have been plaguing the company for more than a year prior to bankruptcy filing. The Fed decided not to help these investors, probably because it thought Lehmans investors could have saved themselves by managing investment risks in a company already suffering from poor financial health. The Fed may have wiped out what credibility it won resisting Lehman's rescue pleas and may have opened the door to countless other companies to come calling for help

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Filing bankruptcy23

On September 15, 2008, the firm filed for Chapter 11 bankruptcy protection. The filing marked the largest bankruptcy in U.S. history. British bank Barclays announced its agreement to purchase, subject to regulatory approval, Lehman's North American investment-banking and trading divisions along with its New York headquarters building. On September 22, 2008, Nomura Holdings announced that it had agreed to acquire Lehman Brothers' franchise in the Asia Pacific region, including Japan, Hong Kong and Australia.02/15/10 Lehman Brothers' Investment Management business, including Neuberger Berman, was sold to its management

Impact of Lehman failure24

Exposure to debt in (selective) default.

LBHI had outstanding long-term debt of approximately $110 billion as of Aug. 30, 2008. Short-term commercial paper outstanding was around $8 billion at the end of May. Money market funds managed by banks were holding some Lehman debt, leading to potential compensation to clients.

Counterparty exposure:

More significant is counterparty exposure to the various companies within the Lehman Bros. group. These exposures were largely confined to the biggest banks and broker-dealers, but smaller institutions had some as well. Given the probable movements in the value of the collateral, potential future exposure rose materially and were subjected to considerable volatility. 02/15/10

Contd. . .25

Market price impact. Even

entities active in the capital markets that have negligible direct exposure to Lehman suffered, to a potentially greater extent. resulted in further downward pressure on a wide range of assets. in turn, forced highly leveraged institutions to liquidate to meet margin calls, putting further pressure on assets.02/15/10

This

That

Lessons Learnt26

When a company attacks short-sellers, run. Good management teams embrace criticism, address it and move on. Lehman attacked the messenger. Lots of banks have downplayed their write downs by stressing net figures that include gains on so-called economic hedges, or as Lehman called them, "economic risk-mitigation strategies. Gains on declining debt values mean something. When the fair value of a company's debt slips, the market is telling you the company's assets must be deteriorating, too. If you had guessed from the ratio at Lehman that its asset values had further to fall, you wound up with the right answer. 02/15/10

Conclusion27

Some companies are indeed not too big to fail While the availability of liquidity can provide some form of short-term life support to an institution under severe stress, it is either real or perceived capital inadequacy that can precipitate a company's failure The impact from a regulatory action or inaction can have unintended consequences through indirect exposures and linkages that sometimes are only known to direct market participants. 02/15/10

Questions28