Sell Side

Lehman Files Chapter 11; Liquidation Looms

Storied brokerage firm Lehman Brothers filed for Chapter 11 bankruptcy protection Monday, the latest casualty of a credit crisis that has rocked Wall Street firms to their core. It is one of the nation's largest corporate bankruptcies ever and is Wall Street's most dramatic failure since Drexel Burnham Lambert in the late 1980s.

The petition was filed in New York's Southern District Bankruptcy Court, the site of numerous high-profile bankruptcy cases. The judge overseeing the case is James Peck.

Lehman is the fourth-largest bank in the U.S. and employs more than 25,000 people. The company said its board of directors decided to opt for court protection on Sunday after attempts to find a buyer for its business fell through. Barclays Capital, which has been eager to expand its footprint in the U.S., and Bank of America were among the firms to consider Lehman, but ultimately backed off.

Lehman said in court documents that its bankruptcy was brought about by problems in global financial markets and worldwide economic conditions.

"For most of 2008, Lehman Brothers operated in an extremely unfavorable global business environment," the firm said in court filings. "Conditions were characterized by a continued lack of liquidity in the credit markets, significantly depressed volumes in most equity markets, a widening in certain fixed-income credit spreads compared to the end of the 2007 fiscal year, and declining asset spreads."

Lehman's shares were recently trading at 19 cents each; a year ago, they were changing hands at $58.62. News of the bankruptcy Monday sank share prices of other financials and weighed on global stock indexes.

The bankruptcy comes six months after the Federal Reserve and Treasury orchestrated the purchase of Bear, Stearns & Co. by JPMorgan, an action that many hoped would reinvigorate U.S. financial markets. Market observers say Lehman's decision to petition for court protection was also a message from regulators that government bailouts of other ailing financial giants would not be forthcoming.

Lehman's bankruptcy comes days after it announced a preliminary third-quarter loss of about $3.9 billion, or $5.92 a share. A year ago, just as the credit storm began encroaching on Wall Street, it earned $887 million, or $1.54 a share, in the third quarter.

Chris Low, chief economist at FTN Financial, said Lehman's bankruptcy and the planned purchase of Merrill Lynch & Co. by Bank of America may be the first step in shoring up the credit picture.

"To get out of the recession we are in now we need a recovery in credit. To get a recovery in credit we need to restore confidence in our financial system. To do that we first need to take companies whose balance sheets are at risk out of the picture one way or another - through a merger, bankruptcy, or capital injections," Low said.

Lehman's bankruptcy, meanwhile, has enormous ramifications. According to court documents, Lehman says it has more than 100,000 creditors. Its assets total $639 billion and liabilities total $613 billion. The firm is a major participant in debt and equity markets, investment banking, asset management, and private equity. It is a major force in Europe, the U.S., and Asia. Half of its revenues last year came from overseas business operations.

Among the 30 largest unsecured claims for the bankruptcy are Citibank NA, the Bank of New York, AOZORA, Mizuho Corporate Bank Ltd., Shinsei Bank Ltd., UFJ Bank Ltd., Sumitomo Mitsubishi, Svenska Handelsbanken, Bank of China, Lloyds Bank, and Bank of Taiwan. The largest owners of the firm are AXA, ClearBridge Advisors, and FMR LLC along with all their related parties, according to court documents.

A creditors meeting or any hearings related to the Lehman bankruptcy were not scheduled as of mid-day Monday. But the case is sure to attract throngs of investors and bankruptcy and restructuring professionals to the Southern District's lower Manhattan courthouse.

While Lehman filed for a Chapter 11 bankruptcy protection, some attorneys believe that the firm will end up being liquidated. Chapter 11 is usually used to restructure a company and keep it alive as a "going concern." In the case of Lehman, the use of a Chapter 11 filing may more likely aid in an orderly liquidation of the business.

None of Lehman's broker-dealer subsidiaries will be included in the Chapter 11 and will continue to operate. The firm said customers of its Neuberger Berman Holdings money management business also will be able to continue to trade.

Broker-dealer firms are not allowed to petition for Chapter 11 and can only petition for a Chapter 7 filing, according to a attorney who declined to be named because he is representing creditors in the Lehman case. "A securities broker in Chapter 7 will be liquidated by a trustee appointed by the SIPC [Securities Investor Protection Corp.], a quasi-SEC agency designed to protect investors," he said.

Customers of Lehman's broker-dealer unit have the right to move accounts elsewhere and if another Wall Street firm wants to buy the broker-dealer business it can do so.

Lehman said in court documents it tried to sell its investment management division, which it believed would bring it over $4 billion. It also considered selling its commercial loan assets to a new company that would be owned by its shareholders.

Lehman Brothers may be a name long associated with Wall Street, but its roots are actually in Alabama. The company was founded by three brothers who left their family cattle business in Bavaria. In Montgomery, they set up a trading and dry goods business called Lehman Brothers. Three years after the end of the Civil War, they moved their headquarters to lower Manhattan where they instrumental in setting up the New York Cotton Exchange

In recent decades, Lehman was a prominent force in the residential and commercial mortgage finance markets as well as investment-grade and high-yield corporate debt financings.

On a global basis, in the first half of 2008 Lehman was the seventh-ranked financial adviser on mergers and acquisitions, the fifth-ranked underwriter of mortgage debt, and the sixth-ranked equity underwriter, with a market share of just over 6% according to Thomson Reuters.


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