LEHMAN BANKRUPTCY

BY BHAVNA FATEHCHANDANI

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INTRODUCTION…

LEHMAN BROTHERS HOLDINGS INC.

Type Public
Fate Chapter 11 Bankruptcy
Founded Montgomery, Alabama, United States (1850)
Henry Lehman
Founder(s) Emanuel Lehman
Mayer Lehman
Headquarters New York City, New York, United States
Area served Worldwide
Richard S. Fuld, Jr.
Key people
(Chairman) & (CEO)
Industry Investment services
Financial Services
Products Investment Banking
Investment management
Market cap US$130 Million (As of September 15, 2008)

Revenue ▲ US$59.003 Billion (2007)

Operating income ▲ US$6.013 Billion (2007)

Net income ▼ US$6.7 Billion (2008)
Total assets ▲ US$691.063 Billion (2007)

Total equity ▲ US$22.490 Billion (2007)

Employees 26,200 (2008)
Website www.lehman.com

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Lehman Brothers Holdings Inc, the fourth largest US investment

bank, succumbed to the sub prime mortgage crisis in the biggest
bankruptcy filing in history.

The 158 year old firm, which survived railroad bankruptcies of the
1800s, the great depression in the 1930s, & the collapse of long
term capital management a decade ago, filed a chapter 11 petition
with US bankruptcy caught in Manhattan on September, 15.The
following day, its investment banking & trading divisions were
acquired by Barclays plc along with its New York headquarters
building.

Lehman Brothers Holdings Inc, was a global financial-services

firm active prior to its bankruptcy and sale in 2008. The firm did

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business in investment banking, equity and fixed-income sales,

research and trading, investment management, private equity,
and private banking. It was a primary dealer in the U.S.
Treasury securities market. Its primary subsidiaries included
Lehman Brothers Inc., Neuberger Berman Inc., Aurora Loan
Services, Inc., SIB Mortgage Corporation, Lehman Brothers Bank,
FSB, Eagle Energy Partners, and the Crossroads Group. The
firm's worldwide headquarters were in New York .

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WHAT HAPPENED…?
In the biggest reshaping of the financial industry since the Great
Depression, Wall Street’s most storied firm, Lehman Brothers
Holdings Inc., headed towards extinction.
Lehman Brothers Holdings Inc, the fourth largest US investment
bank, succumbed to the sub prime mortgage crisis in the biggest
bankruptcy filing in history.
The 158 year old firm, which survived railroad bankruptcies of the
1800s, the great depression in the 1930s, & the collapse of long
term capital management a decade ago, filed a chapter 11 petition
with US bankruptcy caught in Manhattan on September, 15.The
following day, its investment banking & trading divisions were
acquired by Barclays plc along with its New York headquarters
building.
The collapse of Lehman, which listed more than $613 billion of
debt, dwarfs World Com Inc’s insolvency in 2002 & Drexel
Burnham Lambert’s failure in 1990.
What happened that weekend was 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.
Lehman was forced into bankruptcy after Barclay’s plc & Bank of
America Corp abandoned takeover talks on 14 September & the
company lost 94% of its market value this year. Chief Executive
Officer, Richard Fuld, who turned the New York based firm into

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the biggest underwriter of mortgage- backed securities at the top of

the US real state market, couldn’t survive this year’s credit crunch.

The Chapter 11 filing did not include Lehman's broker-dealer

operations and other units, such as asset management firm
Neuberger Berman. Those businesses will continue to operate,
although Lehman is expected to liquidate them.

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BREAKUP PROCESS
On September 20, 2008, a revised proposal to sell the brokerage
part of Lehman Brothers holdings of the deal, was put before the
bankruptcy court, with a $ 1.35 billion (£700 million) plan for
Barclays Plc to acquire the core business of Lehman Brothers
(mainly Lehman's $ 960 million Lehman's Midtown Manhattan
office skyscraper, with responsibility for 9,000 former employees),
was approved. Manhattan court bankruptcy Judge James Peck,
after a 7 hour hearing, ruled: "I have to approve this transaction
because it is the only available transaction. Lehman Brothers
became a victim, in effect the only true icon to fall in a tsunami
that has befallen the credit markets. This is the most momentous
bankruptcy hearing I've ever sat through. It can never be deemed
precedent for future cases. It's hard for me to imagine a similar
emergency."

Luc Despins, the creditors committee counsel, said: "The reason

we're not objecting is really based on the lack of a viable
alternative. We did not support the transaction because there had
not been enough time to properly review it." In the amended
agreement, Barclays would absorb $ 47.4 billion in securities and
assume $ 45.5 billion in trading liabilities. Lehman's attorney
Harvey Miller of Weil, Gotshal & Manges, said "the purchase price
for the real estate components of the deal would be $ 1.29 billion,
including $960 million for Lehman's New York headquarters and $
330 million for two New Jersey data centers. Lehman's original
estimate valued its headquarters at $ 1.02 billion but an appraisal
from CB Richard Ellis this week valued it at $900 million."
Further, Barclays will not acquire Lehman's Eagle Energy unit, but
will have entities known as Lehman Brothers Canada Inc, Lehman
Brothers Sudamerica, Lehman Brothers Uruguay and its Private
Investment Management business for high net-worth individuals.
Finally, Lehman will retain $20 billion of securities assets in
Lehman Brothers Inc that are not being transferred to Barclays.

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Barclays had a potential liability of $ 2.5 billion to be paid as

severance, if it chooses not to retain some Lehman employees
beyond the guaranteed 90 days.

On September 22, 2008, Nomura Holdings, Inc. announced it

agreed to acquire Lehman Brothers' franchise in the Asia Pacific
region including Japan and Australia. The following day, Nomura
announced it's intentions to acquire Lehman Brothers' investment
banking and equities businesses in Europe and the Middle East. A
few weeks later it was announced that conditions to the deal had
been met, and the deal will become legally effective on Monday,
13 October. In 2007, Non-US subsidiaries of Lehman Brothers
were responsible for over 50% of global revenue produced.

IMIDIATE AFTER EFFECTS-

US stocks tumbled, more than $300 billion in market value,

pummeled by the developments. Lehman plunged 95%; AIG
retreated 42% on funding concerns while Bank of America Corp
slumped 14% after agreeing to buy Merrill Lynch & Co. for $50
billion.
Stocks fell across Europe & Asia the dollar lost the most against
the yen in a decade & treasuries surged. The Standard & Poor’s
500 index declined 27.33 points, or 2.2 % , to 1224.37 at 10:18
a.m. on 15 September in New York. December futures on the
bench mark index had fallen as much as 4.4%. The Dow Jones
Industrial Average sank 300.20 to 11121.79. Seven stocks slipped
for each that rose on the New York Stock Exchange.
The Dow Jones closed down just over 500 points on September 15,
2008, at the time the largest drop by points in a single day since the
days following the attacks on September 11, 2001.This drop was
subsequently exceeded by an even larger plunge on September
29th, 2008.)

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WHY HAPPENED...?

The bankruptcy filing represents the end of a 158-year-old

company that survived world wars, the Asian financial crisis and
the collapse of hedge fund Long-Term Capital Management, but
not the global credit crunch.

Financial institutions globally have recorded more than $500

billion of write-downs and credit losses as the U.S. subprime
mortgage crisis has spread to other markets.

Bankruptcy also represents a bad end to Chief Executive Dick

Fuld's four-decade career at Lehman. Fuld, who piloted the
investment bank through prior crises with aplomb, was widely seen
as too slow to recognize Lehman's need to raise capital and shed
bad assets.

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.

SECOND, Lehman had a ton of what is called "leveraged assets".

Basically what happened (the non-basic is for another question) is

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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.

THE OVERALL PROCESS

LEADING TO THE BANKRUPTCY
In August 2007, the firm closed its subprime lender, BNC
Mortgage, eliminating 1,200 positions in 23 locations, and took an
after-tax charge of $25 million and a $27 million reduction in
goodwill. Lehman said that poor market conditions in the mortgage
space "necessitated a substantial reduction in its resources and
capacity in the subprime space".

At the end of August ‘07, Lehman had $600 billion of assets

financed with just $30 billion of equity.

Having so little capital meant that a 5 percent decline in assets

would wipe out the value of the company, which investors saw as a
real risk due to the company's billions of dollars of mortgage
securities.

In 2008, Lehman faced an unprecedented loss to the continuing

subprime mortgage crisis. Lehman's loss was apparently a result of
having held on to large positions in subprime and other lower-rated
mortgage tranches when securitizing the underlying mortgages;
whether Lehman did this because it was simply unable to sell the
lower-rated bonds, or made a conscious decision to hold them, is
unclear. In any event, huge losses accrued in lower-rated mortgage-
backed securities throughout 2008. In the second fiscal quarter,
Lehman reported losses of $2.8 billion and was forced to sell off

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$6 billion in assets. In the first half of 2008 alone, Lehman stock

lost 73% of its value as the credit market continued to tighten. In
August 2008, Lehman reported that it intended to release 6% of its
work force, 1,500 people, just ahead of its third-quarter-reporting
deadline in September.

On August 22, 2008, shares in Lehman closed up 5% (16% for the

week) on reports that the state-controlled Korea Development
Bank was considering buying the bank. Most of those gains were
quickly eroded as news came in that Korea Development Bank was
"facing difficulties pleasing regulators and attracting partners for
the deal." It culminated on September 9, when Lehman's shares
plunged 45% to $7.79, after it was reported that the state-run South
Korean firm had put talks on hold.

On September 17, 2008 Swiss Re estimates its overall net exposure

approximately CHF 50 million to Lehman Brothers.

Investor confidence continued to erode as Lehman's stock lost

roughly half its value and pushed the S&P 500 down 3.4% on
September 9. The Dow Jones lost 300 points the same day on
investors' concerns about the security of the bank. The U. S.
government did not announce any plans to assist with any possible
financial crisis that emerged at Lehman.

The next day, Lehman announced a loss of $3.9 billion and their
intent to sell off a majority stake in their investment-management
business, which includes Neuberger Berman. The stock slid 7
percent that day. Lehman, after earlier rejecting questions on the
sale of the company, was reportedly searching for a buyer as its
stock price dropped another 40 percent on September 11, 2008.

Just before the collapse of Lehman Brothers, executives at

Neuberger Berman sent e-mail memos suggesting, among other
things, that the Lehman Brothers' top people forgo multi-million
dollar bonuses to "send a strong message to both employees and

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investors that management is not shirking accountability for recent

performance."

Lehman Brothers Investment Management Director George

Herbert Walker IV, second cousin to U. S. President George
Walker Bush, dismissed the proposal, going so far as to actually
apologize to other members of the Lehman Brothers executive
committee for the idea of bonus reduction having been suggested.
He wrote, "Sorry team. I am not sure what's in the water at
Neuberger Berman. I'm embarrassed and I apologize."

In its Chapter 11 filing, Lehman named Citibank and Bank of New

York Mellon as trustees for about $138 billion of senior Lehman
bonds. It said Citi's Hong Kong affiliate had made a $275 million
bank loan to Lehman.

Among Lehman's other unsecured creditors are Japanese banks

Aozora Bank, Mizuho Financial Group Inc, Shinsei Bank and UFJ
Bank.

France's BNP Paribas is also on Lehman's list of its 30 largest

unsecured creditors.

The firm said that as of May 31, it owed about $110.5 billion on
account of senior unsecured notes, $12.6 billion on account of
subordinated unsecured notes, and $5 billion on account of junior
subordinated notes.

Lehman also disclosed that it owned stakes of 10 percent or more

in a number of companies, including Imperial Sugar Co , Lpath
Inc, Derma Services, Flagstone Reinsurance, GLG Partners, Ronco
Corp , Pacific Energy Partners, Blount International , Pemstar Inc
and Transmontaigne Inc.

The investment bank, once the fourth-largest in the United States,

had hoped to raise capital by selling off a stake in its investment

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unit, and use that capital as well as other funds to spin off some of
its toxic assets to shareholders.

But that plan did not satisfy investors, who punished Lehman's
share price, or rating agencies, who pressed the company to find a
stronger partner.

Lehman said the uncertainty, particularly among banks through

which it clears securities trades, ultimately made it impossible for
it to continue to operate its business.

The bankruptcy filing comes after a weekend of heated

negotiations among regulators and Wall Street firms about
Lehman's fate.

The U.S. government refused to backstop Lehman's worst assets

the way it backstopped Bear Stearns Cos Inc's sale to JPMorgan
Chase.

Government officials told banks to support Lehman or else be

prepared for more investment banks to lose investor confidence
and fail.

But prospective bidders refused to buy Lehman without

government support, people briefed on the matter said.

In the end, Lehman was allowed to fail, and Bank of America Corp
agreed to buy what was seen as the next weakest U.S. investment
bank, Merrill Lynch & Co Inc.

For many of Lehman's 26,000 employees the outlook is likely to

be gloomy, with job losses expected to be substantial even if
significant parts of the business can be sold.

At Lehman's headquarters in midtown Manhattan on Sunday

afternoon, men dressed in suits came and went, while some

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employees entered the building with what appeared to be empty

duffel bags, then left with them full.

Others emerged with accordion files, binders stuffed with papers

and full valises.

On Sunday night, hundreds of Lehman employees were still in the

office to clear their desks and pack personal belongings, according
to an employee.

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WORLD-WIDE IMPACT

Lehman's bankruptcy was expected to cause some depreciation in

the price of commercial real estate. The prospect for Lehman's $4.3
billion in mortgage securities getting liquidated sparked a selloff in
the commercial mortgage-backed securities (CMBS) market.
Additional pressure to sell securities in commercial real estate is
feared as Lehman gets closer to liquidating its assets. Apartment-
building investors are also expected to feel pressure to sell as
Lehman unloads its debt and equity pieces of the $22 billion
purchase of Archstone, the third-largest United States Real Estate
Investment Trust (REIT). Archstone's core business is the
ownership and management of residential apartment buildings in
major metropolitan areas of the United States. Jeffrey Spector, a
real-estate analyst at UBS said that in markets with apartment
buildings that compete with Archstone, "there is no question that if
you need to sell assets, you will try to get ahead" of the Lehman
selloff, adding "Every day that goes by there will be more pressure
on pricing."

Several money-market funds and institutional cash funds had

significant exposure to Lehman with the institutional cash fund run
by The Bank of New York Mellon and the Primary Reserve Fund,
a money-market fund, both falling below $1 per share, called
"breaking the buck", following losses on their holdings of Lehman
assets. In a statement The Bank of New York Mellon said its fund
had isolated the Lehman assets in a separate structure. It said the
assets accounted for 1.13% of its fund. The drop in the Primary
Reserve Fund was the first time since 1994 that a money-market
fund had dropped below the $1-per-share level.

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Putnam Investments, a unit of Canada's Great-West Lifeco, shut a

$12.3 billion money-market fund as it faced "significant
redemption pressure" on September 17, 2008. Evergreen
Investments said its parent Wachovia Corporation would "support"
three Evergreen money-market funds to prevent their shares from
falling. This move to cover $494 million of Lehman assets in the
funds also raised fears about Wachovia's ability to raise capital.

About 100 hedge funds used Lehman as their prime broker and
relied largely on the firm for financing. As administrators took
charge of the London business and the U. S. holding company filed
for bankruptcy, positions held by those hedge funds at Lehman
were frozen. As a result the hedge funds are being forced to de-
lever and sit on large cash balances inhibiting chances at further
growth.

In Japan, banks and insurers announced a combined 249 billion

yen ($2.4 billion) in potential losses tied to the collapse of
Lehman. Mizuho Trust & Banking Co. cut its profit forecast by
more than half, citing 11.8 billion yen in losses on bonds and loans
linked to Lehman. The Bank of Japan Governor Masaaki
Shirakawa said "Most lending to Lehman Brothers was made by
major Japanese banks, and their possible losses seem to be within
the levels that can be covered by their profits," adding "There is no
concern that the latest events will threaten the stability of Japan's
financial system." During bankruptcy proceedings a lawyer from
The Royal Bank of Scotland Group said the company is facing
between $1.5 billion and $1.8 billion in claims against Lehman
partially based on an unsecured guarantee from Lehman and
connected to trading losses with Lehman subsidiaries, Martin
Bienenstock.

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After Constellation Energy was reported to have exposure to

Lehman, its stock went down 56% in the first day of trading
having started at $67.87. The massive drop in stocks led to the
New York Stock Exchange halting trade of Constellation. The next
day, as the stock plummeted as low as $13 per share, Constellation
announced it was hiring Morgan Stanley and UBS to advise it on
"strategic alternatives" suggesting a buyout. While rumors
suggested French power company Électricité de France would buy
the company or increase its stake, Constellation ultimately agreed
to a buyout by MidAmerican Energy, part of Berkshire Hathaway
(headed by billionaire Warren Buffett).

The Federal Agricultural Mortgage Corporation or Farmer Mac

said it would have to write off $48 million in Lehman debt it
owned as a result of the bankruptcy. Farmer Mac said it may not be
in compliance with its minimum capital requirements at the end of
September.

In Hong Kong more than 40,000 individuals in the city have

invested in HK$12.7 billion of "guaranteed mini-bonds" from
Lehman. Many claim that banks and brokers mis-sold them as low-
risk. Conversely, bankers note that minibonds are indeed low-risk
instruments since they were backed by Lehman Brothers, which
until just months before its collapse was a venerable member of
Wall Street with high credit and investment ratings. The default of
Lehman Brothers was a low probability event, which was totally
unexpected. Indeed, many banks accepted minibonds as collateral
for loans and credit facilities. Another HK$3 billion has been
invested in similar like derivatives. The Hong Kong government
proposed a plan to buy back the investments at their current
estimated value, which will allow investors to partially recover
some of their loss by the end of the year. HK Chief executive

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Donald Tsang insisted the local banks respond swiftly to the

government buy-back proposal as the Monetary Authority received
more than 9,300 complaints. On Oct 17 He Guangbe, chairman of
the Hong Kong Association of Banks, agreed to buy back the
bonds, which will be priced using an agreed upon methodology
based on its estimated current value. This episode has deep
repercussions on the banking industry, where misguided investor
sentiments have become hostile to both wealth management
products as well as the banking industry as a whole. Under intense
pressure from the public, all political parties have come out in
support of the investors, further fanning distrust towards the
banking industry

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Impact on Asian EMEs

In contrast to the previous episodes of global turmoil, EMEs have
exhibited relative resilience, though equity market and exchange
rate pressures have intensified in recent days. So far, the
investment sentiment is positive for the Asian EMEs reflecting
their strong economic performance and, for some countries,
favourable investment opportunities associated with elevated
commodity prices, though they have adjusted downwards in recent
times, while being somewhat volatile. Credit policy reforms, better
structuring of banking sector debt and improved fiscal positions
have also played their role making the EMEs resilient from the
crisis. In addition, large foreign exchange reserves, particularly in
Asia, also provide a degree of protection against possible sudden
stops. Another factor that could be of relevance for this favourable
situation is the relatively smaller presence of foreign banks in the
Asian banking sector. This is evident from the fact that the share of
banking assets held by foreign banks in these economies generally
lies between 0 and 10 percent (Global Development Finance,
2008).
The spillovers to the EMEs from the current global financial
market crisis have occurred mainly in and through financial
markets, reflecting the relatively high level of integration of such
markets in the global financial system. In this respect, there have
been four major spillovers, viz., (i) a rise in the price of risk; (ii) a
reduction in international bond issuance; (iii) a sell-off in equity
markets; and (iv) some unwinding of carry-trade positions. The
major EMEs in Asia have been recording surpluses on the current
account in recent years, with the exception of Korea and India.
Thus, the vulnerability of Asia, other than Korea and India, is
relatively contained to that extent. It is in this context the foreign

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exchange markets in India and Korea have experienced greater

pressure in recent times.
Despite the fact that no significant macroeconomic disruption has
taken place in EMEs, some vulnerabilities exist. There are
indications that the current crisis will have some implications in
terms of higher funding costs and raising external finance,
particularly, for lower rated firms. Further, countries with
significant foreign bank presence, mostly in East European
economies, might be vulnerable to financial stress faced by a
parent bank. Similarly, slowdown in advanced countries might
impact the remittances to EMEs.
As regards the impact of financial turbulence on the real sector,
Asian EMEs may not be entirely immune to slowing growth in
developed economies. For East Asian economies, since most of
these economies are small and their trade sector (export plus
imports) as proportion of GDP varies at a significantly higher level
between over 200 percent and 60 per cent as opposed to the weight
of domestic demand as in India, it could be an area of concern for
these countries. Therefore, for these set of countries, the crises
could be transmitted through the trade channel. While strong
regional sources of growth within EMEs may be a mitigating
factor, most EMEs still retain substantial trade linkages with
developed economies. In Asia, while intra-regional trade has been
growing rapidly over recent years, much of this activity is still
driven by developed economies as a major destination for final
goods.

According to the analysis contained in the IMF’s latest Global

Financial Stability Report (October 2008) (IMF, 2008a), both
domestic and global factors are important in explaining the
movement in equity prices in the EMEs. Correlation of equity
markets in EMEs with those in the advanced economies has risen,
suggesting a growing transmission channel for equity price
movements. Amongst the three group of EMEs (Latin America,
Asia and Emerging Europe), the spillover from global factors is

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found to be strongest in Latin American EMEs followed by

Emerging Europe and Asia. The wealth effect of stock market
changes on consumption and investment, although statistically
significant, is found to be weaker in EMEs vis-à-vis the advanced
economies. Furthermore, such wealth effects tend to play out
gradually.
During the financial turmoil, commodity prices may have been
pushed higher to some extent by increased demand for
commodities as a hedge against a depreciating US dollar and
possibly also as a hedge against higher inflation. As global growth
slows, a fall in commodity prices represents a downside risk to
commodity-exporting EMEs, which is particularly relevant for
some Latin American EMEs. In an extreme scenario,
where commodity prices fall dramatically, this could have
significant implications for economies that have had a heavy
reliance on the performance of commodities in recent years, and
might furthermore pose some risks to the financial stability in these
countries. On the other hand, Asian EMEs which are commodity
importers may benefit from the correction in global commodity
prices. This may alleviate inflationary pressures in these economies
and may provide the necessary flexibility to monetary policy in
these countries. However, the beneficial impact of softening
commodity prices is getting partly eroded by the depreciation
pressures in some of the EMEs, thus, limiting to some extent the
manoeuvrability available to the monetary policy. Overall, while
the real sector in the major Asian EMEs has held up relatively
well, it needs to be recognised that the financial crisis in the US
has deepened significantly over the past couple of months and
there are signs of its spreading to the mature economies in Europe.
The deepening and widening of the financial crisis is already
getting reflecting in elevated volatility in the financial markets of
key EMEs and widening of spreads of the EME assets. Although a
large amount of liquidity has been injected by the central banks of
the major advanced economies, short-term market rates remain
well above policy rates. Financing costs for the EMEs have

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increased over the past few weeks and could thus deteriorate in the
coming months. If the financial crisis were to linger longer and the
economic activity in these regions slows down significantly, the
adverse impact on the real economies in the major EMEs could
turn out to be stronger than that has been observed so far.
According to the IMF’s latest World Economic
Outlook (October 2008) (IMF, 2008b), major advanced economies
are already in or close.

India has by-and-large been spared of global financial contagion

due to the subprime turmoil for a variety of reasons. India’s growth
process has been largely domestic demand driven and its reliance
on foreign savings has remained around 1.5 per cent in recent
period. It also has a very comfortable level of forex reserves. The
credit derivatives market is in an embryonic stage; the originate-to-
distribute model in India is not comparable to the ones prevailing
in advanced markets; there are restrictions on investments by
residents in such products issued abroad; and regulatory guidelines
on securitisation do not permit immediate profit recognition.
Financial stability in India has been achieved through perseverance
of prudential policies which prevent institutions from excessive
risk taking, and financial markets from becoming extremely
volatile and turbulent.

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IMPACT ON
INDIAN MARKETS !!!

• LEHMAN’S INDIA INVESTMENTS-

The 158 year old Lehman Brothers’ move to file for bankruptcy
wiped off more than Rs2000 crore from the market valuation of
those Indian companies in which the US financial major made
equity investments.
Major stocks held through participatory notes issued by Lehman
Brothers Investment Management, a SEBI- registered foreign
institutional investor, saw their prices nosedive. Participatory notes
are derivative instruments through which foreign investors that are
not registered in India can trade on the Indian markets.
In addition to its equity holdings in listed companies, Lehman had
also invested in various projects of Indian companies, especially in
real estate. In India, Lehman also acquired BRICS Institutional
Equities business of research analysts and sales and trading
professionals and bought a 26% stake in Edelweiss Capital Finance
, a non banking financial company, recently.
The investment banking major has also been involved in several
Indian initial public offers.

•IT SECTOR-

The meltdown in US had a huge impact on indian IT & IT

companies as a large chunk of their revenues is from US. Thus, the
crisis had definitely delayed various new projects.
Market sources revealed that the companies affected by the crisis
such as Lehman Brothers, Merill Lynch and AIG have been
outsourcing work to wipro, Tata Consultancy Services & Infosys.
There was a direct impact on the revenues of this companies.
As more & more consolidation, acquisition & mergers took place

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in the US, the number of companies in this space came down &
shrunk the addressable market for the Indian IT services
companies. Consolidation also led to consolidated IT resources &
reduction in IT spending, which had negative effect on the IT
companies.
The slowdown also had an jmpact on the hiring practices of Indian
IT services companies, who had to now focus on just-in-time
hiring, rather than advanced hiring practices like campus
recruitment.
Thus, w.r.t. Lehman, as much as 60% of the revenue of India’s
software firms comes from the global financial sector, so the
fallout of Lehman’s bankruptcy on India’s IT sector cn be well
imagined.

•REAL ESTATE-

The collapse of Lehman Brothers and the bailout of Merrill Lynch,

the global financial behemoths, affected Indian realty companies
that were in the process of raising fresh funds. Many leading
realtors, already facing a paucity of funds due to a slowdown or a
correction in prices, found it more difficult to raise resources even
at the project level. Merrill Lynch & Lehman Brothers had
exposure to more than a dozen realty companies, including, Ansal
Housing, Anant Raj Industries, Unity Infrastructure, the
Puravankara group and J Kumar Infrastructure, among others. The
Indian companies are not only unable to raise fresh capital but they
are also finding it difficult to sell the inventory of housing stock as
demand & prices both have fallen.

•BANKING-

ICICI Bank said that it might need to make an additional provision

of $28 million (Rs.188 crore) on its exposure to bonds issued by
Lehman. It had already made provisions of $12 million on these

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bonds.

• LEHMAN’S BPO UNIT-

Indian IT major Wipro Technologies has expressed interest in

bidding for the Indian back office business of Lehman. The
bankrupt investment banking firm is expected to close its captive
unit in Mumbai by the end of this month. The unit’s 1200
employees, who work on equity research and analytics support for
the mergers and acquisitions business, have been asked to quit by
September end. Unlike employees in Lehman’s investment
banking business who have been receiving feelers from domestic
banks, employees in the captive BPO are unlikely to find alternate
jobs quickly because the IT and IT- enabled services industries
have already begun downsizing, owing to the global financial
crisis.

• COST OF CREDIT-

The RBI had moved quickly to improve liquidity. Still there could
be some impact on credit availability. That implies more expensive
credit (even public sector banks are said to be raising money at
11.5%, so that lending rates will inch up to 16 % and higher).
For companies looking to raise capital, the alternative of funding
through fresh equity is not cheap, either, since stock valuations
have suffered in the wake of the FII pull out.
Capital has suddenly become more expensive. There is a risk that
projects underway will suffer from delays and cost overruns as cost
of credit shoots up. Real estate could be most affected sector.
Builders may have to resort to dropping prices to find customers
for housing projects nearing completion.
Another worry is impact on job creation in the country. There
could be downsizing in companies in sectors impacted by high cost

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of credit and fall in demand. The layoffs in IT sector may be a fair

portent of things to come.

ANY BENEFITS-

The crisis does have a silver lining. The falling rupee(against the
dollar) will mean that exporters affected by the earlier rise of the
currency can breathe easy. However importers would be at the
receiving end. Importers of oil and other commodities’ prices will
neutralize the impact of the dollar’s decline against the rupee.

Prices of stocks and real estate, which had appreciated by too

much, will come down to realistic levels.

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OVERALL ANALYSIS
The Lehman Brothers bankruptcy filing indicate that as of their
May 31, 2008 financial statement that the firm has $639 billion of
assets and $613 billion of debt. At that time the firm had about
$110 billion in ordinary bonds, and about $17.6 billion in
subordinated bonds. The composition of the other debts is hard to
determine, in part, because of a bad cross reference in that part of
the filing.

As of the last financial statement, accounts payable were about $71

billion, short term debt was $163 billion, other current liabilities
were about $29 billion, and long term debt was about $350 billion.

As of the filing date, the listing of the top 30 outsider creditors of

the firm mentioned $138 billion of ordinary bonds (managed by
two bond trustees), $17 billion of subordinated bonds (managed by
one of the two ordinary bond trustees), and about 3 billion in bank
loans and letters of credit ranging in size from $463 million to $10
million from 23 different institutions (a few of whom appear to be
related entities of each other). This leaves about $485 million of
debts owed to creditors in amounts less than $10 million and
insider debtors.

This would suggest that $71 billion+ is made up of trade credit in

small amounts per creditor, while $414 billion is made up of
financial creditors in amounts less than $10 million and insider
debt, with insider debt probably making up the bulk of the debts, as
investment banks don't generally take deposits from millions of
households the way that commercial banks do.

There don't appear to be any significant (i.e. more than $10

million) secured creditors or trade creditors, although this might
not include financial rights of setoff.

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There are more details in an Affidavit of the CFO, which is

honestly rather dubious and unsatisfying. I find it very hard to
believe that Lehman Brothers is incapable of providing much,
much more information than it has to date with only modest effort.
While it might not be able to provide ever single creditor in a
matter of weeks, it ought to be able to publicly account for more
than a third of its outstanding debt. These folks are in the financial
analysis business and live and die on their own ability to be highly
leveraged without becoming insolvent.

Equity

The most recent financial statement listed the aggregate value of

preferred stock at $7 billion (and did not include it as a debtor in
the petition).
The aggregate redemption value of the preferred stock based upon
the rights of each class of preferred stock, the number of preferred
shares identified in the petition (presumably the number of
authorized preferred shares in each class), and assuming that
preferred stock dividends aren't grossly in arrears, is about $237
billion. This is calculated as follows:

 5 million shares, $500 each, $2.5 billion

 4 million shares, $5000 each, $2.0 billion
 12 million shares, $2500 each, $30 billion
 5.2 million shares, $2500 each, $12.5 billion
 66 million shares, $2500 each, $165 billlion
 12 million shares, $25 each, $0.3 billion
 12 million shares, $25 each, $0.3 billion
 16 million shares, $25 each, $0.4 billion
 8 million shares, $25 each, $0.2 billion
 4 million shares, $1000 each, $4 billion
 2 million shares, $1000 each, $2 billion

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But, this appears to grossly overstate the amount of preferred stock

shares outstanding.
There are 694,401,926 common shares outstanding according to
the petition.

Assets

The source balance statement listed the company's assets as $314

billion in cash, $42 billion in net receivables, $4.3 billion in fixed
assets, and $279 billion in non-current assets.
Presumably, this number is lower now, due to market losses,
particularly in mortgage based securities.
Some breakdown on the nature of those assets is available:

Sanford Bernstein analyst Brad Hintz estimates that 55% of

Lehman's balance sheet can be quickly liquidated, particularly such
assets as receivables and short-term loans known as repurchase
agreements. There are about $269 billion in securities that are
"another story," Hintz wrote in a report released Monday. He
estimates 27% of the $269 billion is in mortgages, 17% in
derivatives, and 8% in real estate.

ANALYSIS
The two primary bond trustees seem likely to be the dominant
voice on behalf of creditors in this bankruptcy on the creditor's
committee.

This could be a 100% payout liquidity failure bankruptcy, and

failing that, could be one in which common stock shareholders,
preferred stock shareholders, and perhaps subordinated debtors
bear the brunt of the impact, while general creditors are held
harmless or nearly so.

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Indeed, if the company adopts a plan that holds harmless all

preferred and general unsecured creditors, and all secured
creditors, then only the holders of subordinated debt would have
any right to object. Since all of the subordinated debt appears to be
represented by a single bond trustee, this might mean that the plan
could be confirmed in a one on one negotiation with the
representative of that bank.

Equity and subordinated debt together are capable of absorbing a

$43 billion loss between May 31, 2008 and the bankruptcy filing,
and pre-bankruptcy loss estimates had been in the vicinity of $7
billion.

Barclays Bank is discussing buying the brokerage and investment

banking operations including the headquarters out of bankruptcy
for about $8 billion (presumably the usually highly profitable brick
and mortar part of the operation which probably also counts for
most accounts payable and accounts receivable), and assuming that
this is a market value for that operation by some reasonable
measure, the market losses that other creditors would have to bear
would remain unchanges, but greater liquidity could speed up the
payout.

The bankruptcy filing covers only Lehman’s holding company. Its

brokerage and money-management units are not in Chapter 11 –
employees still have their jobs, customers still execute transactions
on accounts, and portfolio managers still manage mutual funds.

The relative independence of these subsidiaries from the

bankruptcy process is what enables Barclays, the U.K.-bank that
walked away from a Lehman rescue over the weekend, to consider
purchasing part of Lehman.

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Another interesting possibility would be a plan that allocated good,

short term assets to outsider creditors as payment in full, while
allocating securities of uncertain value, like the mortgage backed
securities, to the insiders. Outsiders can't object if they get quick
cash in exchange of the debts owed to them, so this plan could be
imposed on them, leaving insiders with any windfalls resulting
from market undervaluation of Lehman Brothers' complex
financial assets.

The biggest overall risk is that the derivatives market, and in

particular, the credit default market, will be screwed up by the
freezing of the positions of a major market player, although recent
bankruptcy law reforms are designed to minimize this impact.

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CONCLUSION
Financial crises are terrifying when underlying economic
fundamentals are out of line with established theory, leading to
bursts of unjustified optimism and/or pessimism. It is the
responsibility of the powers that be to bring sense to the market.
Every financial crisis is different, but they do all end. The Lehman
Brothers bankruptcy and Merrill Lynch’s acquisition by Bank of
America is yet another stage in the progression of the financial
crisis that had its roots in the US sub-prime mortgage market.

The initial stage of the crisis took a toll on direct mortgage lenders
like Countrywide Financial. In a subsequent stage, guarantors of
mortgage-backed securities like Freddie Mac and Fannie Mae
came under attack.

This culminated in their going into US government ‘receivership’

(effectively nationalization) a few weeks ago before the
bankruptcy was actually filed. Lehman’s demise marks the stage
where banks with indirect but large exposures to the US mortgage
market, principally through derivative instruments, bear the brunt.
This is not necessarily the final stage and the worst is perhaps not
over.

A key feature of this crisis that started in the middle of 2007 has
been the lack of clarity on both the nature and number of financial
institutions that have indirect exposure to subprime assets, as well
as, cross-product problems involving movement from subprime to
prime mortgages with final spillover into derivatives, structured
products and counterparty risks.

We could see another set of intermediaries coming under severe

pressure. The decision by the US Treasury and the Fed not to

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guarantee Lehman’s financial liabilities is a clear signal to the

market that they believe that no institution is ‘too big to fail’.
Going forward, a government-funded bailout is likely to be the
exception, not the norm. Besides, with Lehman’s bankruptcy, the
fate of its counterparties hangs in balance.

It is not clear whether a fire-sale of Lehman’s assets will be

adequate to pay off its creditors. Besides, apprehensions of other
banks meeting Lehman’s fate will keep inter-bank lenders on edge.
This could lead to a huge squeeze on inter-bank liquidity and
trigger another bout of turbulence in credit markets. Finally, the
Lehman episode has ramped up the level of risk-aversion in the
global financial system.

These are days of extreme and often irrational pessimism. The way
to survive this crisis is to stay focused on the fundamentals. From a
fundamental perspective, India’s financial system has a lot going
for it. Indian banks have no direct exposure to G-7 mortgage
markets and their indirect exposure is minuscule relative to the size
of their balance sheet. This has protected us in the past and will
continue to insulate us to a significant degree from the turmoil in
global markets. As this phase of extreme pessimism abates a bit,
global investors are likely to reward India for the robustness of its
system.

Thus, at last, the bankruptcy of Lehman Brothers Holdings Inc,

was mainly caused by the fall in house prices & the easy finance
provided for housing at vary low interest rates which made the
Dow Jones Industrial Average to fall 500 points. The treasury
secretary Henry M. Paulson Jr. had been sending warning signals
to Lehman Brothers ever since the firm announced its second
quarter losses of $2.8 billion. Experts were also quoted as saying
that the 158-year-old bank was just living off the brand name that
it had nurtured over the years.

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The Lehman bankruptcy had a great impact on INDIA. The

undercapitalization of financial houses that was at the core of the
financial meltdown in the US & developed markets became a
problem in Indian Financial System, too.

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