Fall Of Lehman Brother

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Fall Of Lehman Brother

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Fall Of Lehman Brother

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Fall Of Lehman Brother Lehman Brothers fall

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Fall Of Lehman Brother

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1. The Downfall of LEHMAN BROTHERSPresented ByGroup 6 2. United States Housing BubbleWas marked by a sudden increase in housing prices followed by a downfallIn the year 2006-2007 foreclosure rates increased drasticallyDec 30, 2008 : Case-shiller home price index recorded largest dipResulted in Mortgage debt higher than the actual value of the property. 6. United States Housing Bubble contdA combination of very low interest rates and a loosening of credit underwriting standards can bring borrowers into the market, fuelling demand.A rise in interest rates and a tightening of credit standards can lessen demand, causing a housing bubble to burst. 7. Mortgage classificationSubprime Mortgage Tarnished credit records Low Credit scoring Pay Higher Mortgage RatesPrime MortgagesLess than 45% debt-to-income ratio Good record from credit bureau At least 10% margin Good Credit Scoring 8. Players in SubprimeFinancial InstitutionsSubprime lendersSubprime borrowers (buying home)mortgage-market playersInvestors(Banks, Hedge funds, Insurance Co.s, Pension funds) 9. New Model of Mortgage LendingSource: BBC News 11. From the pages of history 12. Down the years

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15. The rising numbers 16. Stock performance till 2007 17. Product portfolio of LehmanLIQUID MARKETSSingle-Stock TradingProgram TradingTransition ManagementListed OptionsExchangeTraded FundsQuantitative TradingElectronic TradingEvent-DrivenDesk-Based AnalyticsSTRUCTURED PRODUCTSStructured InvestmentsConvertiblesEquity SolutionsProduct ManagementRESEARCHFundamental Analysis> Basic Industries> Consumer> Emerging Markets> Energy and Power> Financial Services> Real Estate> Retail> Technology> TelecomEquity-Linked StrategiesEnterprise

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http://www.slideshare.net/rakeshsancheti/fall-of-lehman-brother[17-02-2013 20:42:20]

Fall Of Lehman Brother

ValuationEconomicsGlobal Equity Strategy 18. Failure of Risk Management 19. 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. In its 2008 Annual Report, Lehman boasted of having a culture of risk management at every level of the firm. They took risk management measures but it mostly used the Value at Risk system invented by JPMorgan Chase & Co. (JPM) in the early 1990s. 20. Problem with VaRVaR 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% didnt matter.Since VAR was calculated from daily price movements, that 1% accounted to a significant value.The other problem with VAR is that, in most cases, it depends on an assessment of the volatility of the security concerned.Volatility is by definition low in quiet markets and much higher in turbulent markets. So the systems 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. 21. Causes of downfall 22. Causes of Downfall 23. Market Complacency 24. Market ComplacencyDrop in delinquency ratesAvailability of innovative mortgage optionsInterest onlyNegative amortization, etcDeterioration in lending standardsPoor Monitoring by Capital marketpooled mortgages were resold in tranches that had different senioritymassive amount of issuance made by a limited number of players 25. Massive amount of issuances - by limited number of players changed the fundamental nature of the relationship between credit rating agencies and the investment banks. In the past each customer, issuing only a couple of securities, had no market power over the rating agencies.In their sample of 1,257 mortgage securitization deals Nadauld and Sherlund (2008) find that Lehman alone had 128 deals.With the diffusion of collateralized debt obligations, the major investment banks were purchasing hundreds of rating services a year.Instead of submitting an issue to rating agencys judgment, investment banks shopped around for the best ratings. 26. Importance of Structured Finance Products for Credit Rating Agencies (Rating revenues by business unit: Structured Finance (in Millions of Dollars)) Source: Moddys Annual Report 27. Bad RegulationRegulatory constraints created inflated demandGoals Government Sponsored Entities (GSE) as percentages of the total number of

Essay_CRISIL_Young Though Leader

Big Ideas Essay Rakesh Sancheti

http://www.slideshare.net/rakeshsancheti/fall-of-lehman-brother[17-02-2013 20:42:20]

Fall Of Lehman Brother

mortgages purchasedMoney market funds loved these instrumentssatisfied the regulatory requirementsboosted their yieldsAllow banks to allocate zero capital to loans which are hedged with credit default swapsPressure on credit-rating agenciesAccounting of subprime mortgages 28. Lack of TransparencyUnregulated growth in the market for credit default swaps (CDS)Low level of collateral generating the possibility of a systemic failuremortgage-backed security market issued under the 144A rule, with limited disclosure 29. Credit Default Swap (CDS)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.The most widely traded derivative product. 30. In the event of a defaultThe buyer typically delivers the defaulted asset to the seller for a payment of the par value. (physical settlement) OrThe seller pays the buyer the difference between the par value and the market price of a specified debt obligation. (cash settlement) 31. Usage Typically as contracts to insure against the default of financial instruments like bonds or corporate debtButAlso bought and sold as bets against bond defaults; a buyer doesnt necessarily have to own a bond to buy the credit default swap that insures itBanks and other institutions use CDSs to cover the risk of default in mortgage and other debt securities they hold 32. Disclosure?The CDS contract is over-the-counter i.e. it is not regulated by a formal exchangeMeans -- > no one knows what the exposures of specific financial institutions to specific credit defaults are.Only the institutions themselves knew, there was no mandatory disclosure law, and.not in the institutions best interest to disclose. 33. Illiquid nature of the marketNot very liquid, because the contracts not standardizedTwo-party negotiations, often with very specific terms Not interchangeable with other contracts, even for the same company/debt issuance 34. Size of the market.Notional amount on outstanding worldwide OTC CDSs$13.9 trillion in December 2005$28.9 trillion in December 2006$42.6 trillion in June 2007 $58 trillion in September, 2008Remember (2007) was $13.8 trillion 36. When Lehman became a layman!!!Triggered the transfer of large sums in the CDS market to buyers of Lehman credit default risk protection against all losses from that eventSellers 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 bondsThe final auction price U.S. GDP

http://www.slideshare.net/rakeshsancheti/fall-of-lehman-brother[17-02-2013 20:42:20]

Fall Of Lehman Brother

of Lehmans debt was $8.625; i.e. for each $100 initial par value, the debt was worth $8.625 onlySellers 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 38. Collateralized Debt Obligations (CDOs)CDOsare a type ofstructuredasset-backed security (ABS) whose value and payments are derived from a portfolio of fixed-incomeunderlying assets. Different risk classes, ortranches, whereby "senior" tranches are considered the safest securities. Interest and principal payments are made in order of seniority, so that junior tranches offer highercouponpayments (and interest rates) or lower prices to compensate for additionaldefault risk. 39. To create a CDO, acorporate entityis constructed to hold assets ascollateraland to sell packages ofcash flowsto investors.Aspecial purpose entity(SPE) acquires aportfolioof underlying assets (mortgage-backed securities, commercial real estate bonds and corporate loans)The SPE issuesbonds(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 juniorsecuritiesand equity securities. 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. 40. Issuer reward.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. 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. 41. Classification of CDOs based on fundingCash v/s Synthetic CDOsCash CDOsinvolve a portfolio of cash assets, such as loans,corporate bonds,ABSorMBS. 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. 42. Synthetic CDOsdont 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.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.Each tranche receives a periodic payment (the swap premium), with the junior tranches offering higher premiums. 43. Reluctance of market to lendLacking 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. Measure of this reluctance is the spread

http://www.slideshare.net/rakeshsancheti/fall-of-lehman-brother[17-02-2013 20:42:20]

Fall Of Lehman Brother

between Libor and the overnight indexed swap (OIS) rate of the same maturity. Before the beginning of the crisis the multi-year average of this spread was 11 basis points. In August 2007 it was over 50 basis points and it was over 90 basis points by September 2008. 44. Lehmans Financial PolicyThe extremely high level of leverageThe strong reliance on short-term debt financing 45. Lehman Brothers Liabilities and Shareholders Equity 46. Filed Bankruptcy under Chapter 11 47. Chapter 11When 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. In Chapter 7 the business ceases operations, a trustee sells all of its assets, and then distributes the proceeds to its creditors. Any residual amount is returned to the owners of the company. 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. 48. Features of Chapter 11 bankruptcyIt retains many of the features present in all, or most bankruptcy proceedings in the United StatesIt also provides additional tools for debtorsIt empowers the trustee to operate the debtor's business.Chapter 11 is reorganization, as opposed to liquidation. 49. Effect of Lehman Brother Collapse 50. Lehman Brother Collapse and EffectLets analyze the effect on each of the Stakeholders:BorrowersSaversInvestorsEconomyHouse Prices 51. Lessons from the Lehman Case 52. Lessons from Lehman.Big need not mean mighty..Subprime loans .toxic debtCredit ratingare they credible???Capital adequacy Relook regulations..Stay humbleStay realistic.Stay cautious 53. Lehman Post Crisis.Nomura & Barclays 54. Lehman brothers - Post CrisisBarclays: Date Sept. 17, 2008:North American investment banking and capital markets businessesThree real estate properties, including LBHI's Manhattan headquarters.Nomura Holdings Inc. of Japan : Date Sept. 22, 2008Equities and investment-banking operations in Asia, Europe, and the Middle EastPrivate Equity Firms:Principal investment management unitNeuberger Berman--and the fixed-income and certain alternative asset management. 56. Consideration : assumed liabilities, $250 million in cash and certain contingent considerations. Also real estate properties :$1.45 billionBarclays Capital also has agreed to provide debtor-in-possession (DIP) financing to

http://www.slideshare.net/rakeshsancheti/fall-of-lehman-brother[17-02-2013 20:42:20]

Fall Of Lehman Brother

Lehman Brothers Holdings Inc. of $500 million and a substantial interim credit facility to LehmanBrothers 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.Barclays Capital 57. International workforce increase by 3000 from 1700 to 4700Total Acquisition cost approx. $2bnPre Tax Income of $5bn (net of one time losses such as subprime lossesBusiness Synergies:Nomura Securities 58. 1. How Is The Lehman Brothers Holdings Inc. Bankruptcy Progressing? S&P report2. Nomura holdings acquistion of lehman's operations3. 0916_barclays_acquisition Press Release by Lehman Brothers4."Causes and Effects of the Lehman Brothers Bankruptcy- Luigi ZingalesReferences 59. Lets look at the One of the Best Video of Ex-Lehman Brother Employeehttp://widerimage.reuters.com/timesofcrisis/

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