Only the lawyers (and accountants) get rich…

The New York Federal Reserve’s excellent Liberty Street blog recently published a series of 5 posts aimed at assessing the scale of value destruction, both direct and indirect, following the bankruptcy filing of Lehman Brothers on September 15, 2008, which now seems so long ago as to belong to another era.

What many may not realize is that the Chapter 11 proceedings for Lehman Brothers Holdings Inc. (LBHI) and a number of its US subsidiaries are still continuing, a period of time which is apparently some 8 times that of the average Chapter 11 proceeding of 14 months. What may also not be appreciated is that Lehman’s US broker-dealer subsidiary, Lehman Brothers Inc. (LBI), was resolved and liquidated under a separate process under the Securities Investor Protection Act (SIPA), which took some 4 ½ years to be essentially completed in March 2013.

These separate processes have had very different outcomes in terms of creditor recovery. In the case of LBI, customers received 100% of their claims- almost USD 190BN. In the case of LBHI and its other US subsidiaries outside the SIPA process, the outcome was much more complex, protracted and unsatisfactory.

When LBHI filed, its senior bonds implied a recovery of 30%, falling to 9% a month later. In early 2011, LBHI estate estimated recovery for its creditors at 16%. In a plan filed in June 2011, allowed claims by third-party creditors totaled USD 362BN, against which recovery, net of expenses, of USD 75BN was expected, or c.21%. The total for 16 distributions made to date is c. USD 94BN against estimated allowed claims of just over USD 300BN, implying a recovery rate of c. 31%. Of course, that is in nominal dollars. Discounted at UST yields, the recovery is c.26%. That brings home just how large the financial impact of the Lehman’s bankruptcy has been, without even taking into account the human and economic costs for its then 25,000 employees, many of whom were pitched into unemployment at a time when the financial system appeared to be in meltdown.

As the blog points out (even though there had been signs of “cracks” within the financial system in 2007), Lehman’s stock reached its all-time high in January 2008, then beginning a decline which accelerated mid-year and turned into a rout after its now-infamous “pre-announcement” on September 10 of disastrous Q3/08 results. Even as late as September 10, LBHI’s senior bonds were at USD 77 (“distressed” levels, but not “bankruptcy imminent”). Interestingly, with hindsight, the proverbial “canary in the coal mine” may well have been “free credit balances” (analogous to bank deposits) in LBI, Even though such balances were supposed to be segregated from those of LBI itself, they declined 60% between May and September 19 (the day on which LBI filed for bankruptcy). Of course, most of this would have been anecdotal and not that easily visible in the timeframe involved.

So, why should anyone care about any of this? Simply because it demonstrates that not only close and predictive monitoring of all counterparties is essential; but that one should also clearly understand the nature of one’s claim, in terms of both legal and structural ranking and subordination. Just accepting what the “market” believes is far from sufficient.

At Awbury, we aim to be rigorous in all aspects of our risk analysis, and that includes legal, regulatory and recovery risks. After all, we are fundamental credit analysts.

As an aside, the professional fees for LBI’s liquidation were USD 1.18BN; while those for LBHI’s continuing Chapter 11 process so far total USD 2.56BN, both according to calculations made by the Liberty Street economists.

The Awbury Team

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