A Case Study on the Lehman

Brothers
PREPARED BY:
JONAH M. MANAOIS
ANNE CLARISSE C. REYES

HISTORY
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.

While the firm prospered over the following decades as the

U.S. economy grew into an international powerhouse, Lehman

had to contend with plenty of challenges over the years.
The railroad bankruptcies of the 1800s
The Great Depression of the 1930s
Two world wars
A capital shortage when it was spun off by American Express
Co. (AXP) in 1994
The Long Term Capital Management collapse
Russian debt default of 1998.
Fortunately, Lehman Brothers have survived them all.

However, despite its ability to survive past disasters,

the collapse of the U.S. housing market

ultimately brought Lehman Brothers to its knees, as
its headlong rush into the subprime mortgage
market proved to be a disastrous step.

Achievements under CEO

Richard S. Fuld Jr.
2007 generated approximately $3.1 billion in

net revenue and almost $800 million in pretax income

Prior to going bankrupt, the firm had in
excess of $275 billion in assets under
management
The firm had increased net revenues over
600% from $2.73 billion to $19.2 billion and
had increased employee over 230% from
8,500 to almost 28,600.

THE PRIME CULPRIT

In 2003 and 2004, with the U.S. housing boom (read, bubble) well under

way, Lehman acquired five mortgage lenders, including subprime

lender BNC Mortgage and Aurora Loan Services, which specialized in AltA loans (made to borrowers without full documentation).
Lehman's acquisitions at first seemed prescient; record revenues from

Lehman's real estate businesses enabled revenues in the capital

markets unit to surge 56% from 2004 to 2006, a faster rate of growth than
other businesses in investment banking or asset management.

The firm securitized $146 billion of mortgages in

2006, a 10% increase from 2005.

Lehman reported record profits every year from
2005 to 2007.
In 2007, the firm reported net income of a record
$4.2 billion on revenue of $19.3 billion.

In August 2007,Lehman closed it

'subprime lender, BNC mortgage eliminating 1200

positions in 23 locations & took a $25million after
tax charge & $27 million reduction in goodwill.
In 2008 Lehman faced an unprecedented loss due to

subprime mortgage.

SUBPRIME MORTGAGE
A subprime mortgage is a type of mortgage that is

normally issued by a lending institution to borrowers

with low credit ratings.
As a result of the borrower's lower credit rating,
a conventional mortgage is not offered because the
lender views the borrower as having a larger-thanaverage risk of defaulting on the loan.
Lending institutions often charge interest
on subprime mortgages at a rate that is higher than a
conventional mortgage in order to compensate
themselves for carrying more risk.

Lehman's Colossal Miscalculation

February 2007 - the stock reached a record $86.18, giving Lehman

a market capitalization of close to $60 billion. However, by the first

quarter of 2007, cracks in the U.S. housing market were already
becoming apparent as defaults on subprime mortgages rose to a sevenyear high.
On March 14, 2007 - A day after the stock had its biggest one-day

drop in five years on concerns that rising defaults would affect

Lehman's profitability, the firm reported record revenues and profit for
its fiscal first quarter.

In the post-earnings conference call,

Lehman's chief financial officer (CFO) said that the

risks posed by rising home delinquencies were well
contained and would have little impact on the
firm's earnings.
He also said that he did not foresee problems in
the subprime market spreading to the rest of the
housing market or hurting the U.S. economy.

REASONS BEHIND THE COLLAPSE

Subprime boom
The Real state Bubble
Asset-backed securities (ABS)
Collateral debt obligations(CDOs)
Lehman underwrote mortage-backed securities more than any other firm,

accumulating an $85-billion portfolio, or four times its shareholders equity

Leverage levels up to 20-35 percent of their equity capital in order to invest on

securitized products using debt capital

Excessive risk-taking
Passing the investment risks through unregulated credit default swaps (CDS) where

they didnt have any adequate capital behind them.(AIG case)

Weakness of the FED to recognize the economic catastrophe that Lehman Brothers

bankruptcy would cause.

RISK MANAGEMENT
Lehman Brothers had six committees, one of them

was a Finance and Risk Committee, which consists of

the Firms Executive Committee, the CRO and the
CFO, should meet weekly to discuss all risk
exposures, position concentrations and risk taking
activities, but it only met twice in both 2006 and
2007.

The Losses :
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.
In the second quarter of 2008, Lehman reported losses of
$2.8 billion and was forced to sell off $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.
On September 10th 2008Lehman announced a loss of
$3.9 billion
On September 17, 2008, the New York Stock Exchange
delisted Lehman Brothers.

The Bankruptcy Filing

On September 13, 2008, Timothy F. Geithner, the

president of the Federal reserve bank of New York

called a meeting on the future of Lehman
On September 14, 2008, The New York Times

reported, that Barclays had ended its bid to purchase

all or part of Lehman and a deal to rescue the bank
from liquidation collapsed.

The Bankruptcy (contd)

Finally on September 15,2008 Lehman

Brothers filed for bankruptcy protection after

failing to find a buyer.

IMPACT OF THE BANKRUPTCY

The disorderly and costly nature of the LBHI

bankruptcy the largest, and still ongoing, financial

bankruptcy in U.S. history contributed to the massive
financial disruption of late 2008.
The collapse of Lehman Brothers Holdings Inc. (LEH)
had a crippling effect on the global economy with the
financial crisis escalating to other parts of the world.
In the aftermath of this event, financial institutions
froze lending activities thereby creating liquidity
problems in the shadow banking financial system.

SUMMARY OF RECOMMENDATIONS
In essence, a risk describes the probability and

consequence of a negative event. The risks identified

and defined by Lehman Brothers in their own
business represented different scenarios in which the
bank would suffer losses due to negative events
related to market, credit, liquidity, operations and
reputation respectively.

CONCLUSION
Lehman Brothers failed for many reasons
Corporate Governance Failures
Inefficient Risk Management
Creative Accounting/ Window dressing procedures
Lehman Brothers failure and other failures that
happened in the financial crisis has, in turn, spawn a
new wave of corporate governance reforms.
It has given rise to the evolution of a robust
Whistleblower policy.

FAILURE TO CONSIDER GOOD GOVERNANCE

Accountability- ensure that management is

accountable to the board and ensure that the Board is

accountable to shareholders.
Fairness- protect Shareholders rights
Transparency- ensure timely, accurate disclosure on
all material matters, including the financial situation,
performance, ownership and corporate governance.
Independence- procedures and structures are in place
so as to minimize, or avoid completely conflicts of
interest.

THE END

REFFERENCES
Case Study: The Collapse of Lehman Brothers |

Investopedia
http://www.investopedia.com/articles/economics/09/l
ehman-brothers-collapse.asp#ixzz4Vv2nHcmY
LEHMAN BROTHERS BANKRUPTCY

by Wilhelmus Irwan (2009461091)

Subprime Mortgage Definition | Investopedia
http://www.investopedia.com/terms/s/subprime_mor
tgage.asp#ixzz4Vv4nhx1u