Wednesday, September 17, 2008

Lehman Bros. Administration scenario

Lehman Brothers (with $41.8 billion of land & condos + $40 billion of "toxic" assets exposure) filed for Chapt11 in US (and in Tokyo under the Civil Rehabilitation Law, where Lehmans has over $32bn in liabilities).
In the UK, PwC's administration (advised by Linklaters who I suspect may recruit some of 50 redundent Lehman lawyers) protects a British company from creditors while attempts are made to reorganize Lehman Brothers International (Europe) + Lehman Brothers Ltd., LB Holdings PLC and LB UK RE Holdings Ltd. Some group companies remain solvent and continue to trade. LBAM (Europe) and Lehman's SPE/SIVs managing p/fs of residential & commercial real estate & non-performing loans MBS/ABS also continue operating (but only if the management of the underlying assets remains functioning and auditable).
In the UK ‘Bankruptcy’ is only for individuals and partnerships. Companies and corporations enter into legal insolvency procedures called liquidation or administration. Administration is initiated by the debtor (Lehman) & protects companies from creditors while undergoing a restructuring plan. During administration control of the business is handed to a licensed insolvency practitioner (PwC supported by Linklaters) appointed by the courts.
PwC do not yet have a fully worked out plan & expect this process of administration and firming up the plan and executing it to take at least 6 months.
Basically, PwC will examine what can be saved and sold as a "going concern" or marketable asset while stripping out costs.
In the case of structured products exposures it is unlikely CDS and related products will be made freely marketable. Lehmans CD swaps are OTC (standard 30, 60, 90 days) as counterparty for many in Europe such as HBOS, Britannia or Nationwide (i.e. major mortgage lenders). For swaps over corporate loans (12 months 24, 36) the counterparties may also include firms such as Britannia, Nationwide, or any building society etc.
The failure of AIG or HBOS and publicly discussed possible failures and weaknesses of others such as WAMU suggests Lehman was a major c/p for these too? JPM is also thought to be a dominant CDS counterparty.
What can PwC do? Its first job will be to mark to model existing contracts within Lehman EMEA (the London operation), possibly using third party specialist firms. PwC may not find buyers to take up swap contracts unless for discounts well over 50%? Buyers may be found in the mutual fund industry willing to buy cheap. I suspect that the accounting records will be good, if expert staff are retained to run Lehman's proprietary inhouse analytics system.
Barclays may be involved following purchase of Lehman Investment banking division, although it seems least interested in the London end. All counterparties are reviewing and reporting their exposures, and PwC will meet to agree with them how assets & liabilities will be handled.
(Note that Neuberger Berman and Lehman Brothers Asset Management will continue to conduct business as usual and will not be subject to the bankruptcy case of its parent.)
PWC partner Tony Lomas (appointed as lead administrator alongside Steven Pearson, Dan Schwarzmann and Mike Jervis) says: “The last 48 hours has seen a period of intense activity. We have been working to understand the operating position of the company with a view to identifying how its various holdings can be wound-down in an orderly manner. A priority has been establishing arrangements to retain staff to ensure the orderly disposal of assets and we have taken steps to achieve this. We are currently reviewing various proposals to transact and over the last 24 hours we have resolved trading issues with the London Clearing House to ensure that customers begin to transfer trades to third parties."
One of the best pre-administration newspaper articles on Lehman is undoubtedly:

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