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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended February 28, 2001
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number 1-9466
Lehman Brothers Holdings Inc.
(Exact name of registrant as specified in its charter)
Delaware 13-3216325
(State or other jurisdiction of incorporation(I.R.S.Employer Identification No.)
or organization)
3 World Financial Center
New York, New York 10285
(Address of principal (Zip Code)
executive offices)
(212) 526-7000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
As of March 31, 2001, 246,491,672 shares of the Registrant's Common Stock, par
value $0.10 per share, were outstanding.
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED FEBRUARY 28, 2001
INDEX
Part I. FINANCIAL INFORMATION Page
Number
Item 1. Financial Statements - (unaudited)
Consolidated Statement of Income -
Three Months Ended
February 28, 2001 and February 29, 2000.............................. 3
Consolidated Statement of Financial Condition -
February 28, 2001 and November 30, 2000.............................. 4
Consolidated Statement of Cash Flows -
Three Months Ended
February 28, 2001 and February 29, 2000.............................. 6
Notes to Consolidated Financial Statements........................... 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............... 15
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................... 27
Item 4. Submission of Matters to a Vote of Security Holders......... 28
Item 6. Exhibits and Reports on Form 8-K............................ 29
Signature ..................................................... 31
EXHIBIT INDEX ..................................................... 32
Exhibits
2
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of INCOME
(Unaudited)
(In millions)
Three months ended
-------------------------------------
February 28 February 29
2001 2000
---------------- ----------------
Revenues
Principal transactions $ 998 $ 1,114
Investment banking 483 602
Commissions 278 229
Interest and dividends 4,981 4,313
Other 12 82
---------- -------------
Total revenues 6,752 6,340
Interest expense 4,869 4,138
------------ ---------------
Net revenues 1,883 2,202
------------ ---------------
Non-interest expenses
Compensation and benefits 960 1,145
Technology and communications 112 84
Brokerage and clearance 77 58
Business development 50 35
Professional fees 47 32
Occupancy 41 30
Other 23 24
------------ ---------------
Total non-interest expenses 1,310 1,408
------------ ---------------
Income from operations before taxes and
dividends on trust preferred securities 573 794
Provision for income taxes 172 239
Dividends on trust preferred securities 14 14
------------ ---------------
Net income $ 387 $ 541
============ ===============
Net income applicable to common stock $ 375 $ 482
============ ===============
Earnings per common share
Basic $ 1.52 $ 1.96
============ ===============
Diluted $ 1.39 $ 1.84
============ ===============
See notes to consolidated financial statements.
3
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION
(Unaudited)
(In millions)
February 28 November 30
2001 2000
------------------ ------------------
ASSETS
Cash and cash equivalents $ 2,535 $ 5,160
Cash and securities segregated and on deposit for regulatory and
other purposes 3,288 2,434
Securities and other financial instruments owned:
Governments and agencies 29,320 27,381
Mortgages and mortgage-backed 29,049 24,670
Corporate equities 24,583 24,042
Corporate debt and other 17,634 16,098
Derivatives and other contractual agreements 12,154 9,583
Certificates of deposit and other money market instruments 1,676 3,433
------------------ ------------------
114,416 105,207
------------------ ------------------
Collateralized short-term agreements:
Securities purchased under agreements to resell 80,521 81,242
Securities borrowed 18,801 17,618
Receivables:
Brokers, dealers and clearing organizations 2,969 1,662
Customers 9,636 7,585
Others 1,145 1,135
Property, equipment and leasehold improvements (net of
accumulated depreciation and amortization of $865 in 2001and
$855 in 2000)
755 671
Other assets 2,044 1,826
Excess of cost over fair value of net assets acquired (net of
accumulated amortization of $141 in 2001 and $138 in 2000) 177 180
------------------ ------------------
Total assets $ 236,287 $ 224,720
================== ==================
See notes to consolidated financial statements.
4
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of FINANCIAL CONDITION - (Continued)
(Unaudited)
(In millions, except share data)
February 28 November 30
2001 2000
----------------- ------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Commercial paper and short-term debt $ 4,871 $ 5,800
Securities and other financial instruments sold but not yet purchased:
Governments and agencies 14,801 14,998
Corporate equities 13,441 6,623
Derivatives and other contractual agreements 10,765 8,568
Corporate debt and other 5,749 5,096
----------------- ------------------
44,756 35,285
----------------- ------------------
Collateralized short-term financing:
Securities sold under agreements to repurchase 106,895 110,225
Securities loaned 10,139 7,242
Payables:
Brokers, dealers and clearing organizations 2,126 1,922
Customers 14,237 11,637
Accrued liabilities and other payables 8,494 8,735
Long-term debt:
Senior notes 33,374 32,106
Subordinated indebtedness 2,938 3,127
----------------- ------------------
Total liabilities 227,830 216,079
----------------- ------------------
Commitments and contingencies
Preferred securities subject to mandatory redemption 710 860
STOCKHOLDERS' EQUITY
Preferred stock 700 700
Common stock, $0.10 par value; 300,000,000 shares authorized;
Shares issued: 253,647,415 in 2001 and 251,629,126 in 2000;
Shares outstanding: 247,321,056 in 2001 and 236,395,332 in 2000 25 25
Additional paid-in capital 3,059 3,589
Accumulated other comprehensive income (net of tax) (10) (8)
Retained earnings 4,069 3,713
Other stockholders' equity, net 312 597
Common stock in treasury, at cost: 6,326,359 shares in 2001 and
15,233,794 shares in 2000 (408) (835)
----------------- ------------------
Total stockholders' equity 7,747 7,781
----------------- ------------------
Total liabilities and stockholders' equity $236,287 $224,720
================= ==================
See notes to consolidated financial statements.
5
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of CASH FLOWS
(Unaudited)
(In millions)
Three months ended
--------------------------------------
February 28 February 29
2001 2000
----------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITES
Net income $ 387 $ 541
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 38 24
Compensation payable in common stock 127 77
Other adjustments 17 12
Net change in:
Cash and securities segregated (854) (1,188)
Securities and other financial instruments owned (8,377) (3,509)
Securities borrowed (1,183) (4,542)
Receivables from brokers, dealers and clearing organizations (1,307) 181
Receivables from customers (2,051) (520)
Securities and other financial instruments sold but not yet
purchased 9,471 12,268
Securities loaned 2,897 380
Payables to brokers, dealers and clearing organizations 204 470
Payables to customers 2,600 1,810
Accrued liabilities and other payables (249) 1,208
Other operating assets and liabilities, net (128) (213)
----------------- ----------------
Net cash provided by operating activities $ 1,592 $ 6,999
----------------- ----------------
See notes to consolidated financial statements.
6
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
CONSOLIDATED STATEMENT of CASH FLOWS (Continued)
(Unaudited)
(In millions)
Three months ended
-------------------------------------
February 28 February 29
2001 2000
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITES
Proceeds from issuances of senior notes $ 2,485 $ 3,776
Principal payments of senior notes (2,059) (1,914)
Principal payments of sub debt (194) -
Net payments from commercial paper and short-term debt (929) 349
Resale agreements net of repurchase agreements (2,609) (11,317)
Payments for treasury stock purchases (679) (112)
Dividends paid (30) (73)
Issuances of common stock 26 -
Redemption of preferred stock (100) (88)
Issuances of trust preferred securities, net of issuance costs
---------------- ----------------
Net cash used in financing activities (4,089) (9,379)
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold improvements (128) (17)
---------------- ----------------
Net cash used in investing activities (128) (17)
---------------- ----------------
Net change in cash and cash equivalents (2,625) (2,397)
---------------- ----------------
Cash and cash equivalents, beginning of period 5,160 5,186
---------------- ----------------
Cash and cash equivalents, end of period $ 2,535 $ 2,789
================ ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions)
Interest paid totaled $5,006 and $4,226 for the three months ended February 28,
2001 and February 29, 2000, respectively. Income taxes paid totaled $137 and
$59 for the three months ended February 28, 2001 and February 29, 2000,
respectively.
See notes to consolidated financial statements.
7
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
The consolidated financial statements include the accounts of Lehman Brothers
Holdings Inc. ("Holdings") and subsidiaries (collectively, the "Company" or
"Lehman Brothers"). Lehman Brothers is one of the leading global investment
banks serving institutional, corporate, government and high-net-worth individual
clients and customers. The Company's worldwide headquarters in New York and
regional headquarters in London and Tokyo are complemented by offices in
additional locations in North America, Europe, the Middle East, Latin America
and the Asia Pacific Region. The Company is engaged primarily in providing
financial services. The principal U.S. subsidiary of Holdings is Lehman Brothers
Inc. ("LBI"), a registered broker-dealer. All material intercompany accounts and
transactions have been eliminated in consolidation. The Company's financial
statements have been prepared in accordance with the rules and regulations of
the Securities and Exchange Commission (the "SEC") with respect to the Form 10-Q
and reflect all normal recurring adjustments which are, in the opinion of
management, necessary for a fair presentation of the results for the interim
periods presented. Pursuant to such rules and regulations, certain footnote
disclosures which are normally required under generally accepted accounting
principles have been omitted. It is recommended that these consolidated
financial statements be read in conjunction with the audited consolidated
financial statements incorporated by reference in the Company's Annual Report on
Form 10-K for the twelve months ended November 30, 2000 (the "Form 10-K"). The
Consolidated Statement of Financial Condition at November 30, 2000 was derived
from the audited financial statements.
The nature of the Company's business is such that the results of any interim
period may vary significantly from quarter to quarter and may not be indicative
of the results to be expected for the fiscal year. Certain prior period amounts
reflect reclassifications to conform to the current period's presentation.
2. Long-Term Debt:
During the three months ended February 28, 2001, the Company issued $2,485
million of long-term debt (all of which were senior notes). Of the total
issuances during the period, $1,028 million were U.S. dollar fixed rate, $714
million were U.S. dollar floating rate, $11 million were foreign currency
denominated fixed rate, and $733 million were foreign currency denominated
floating rate. These issuances were primarily utilized to refinance current
maturities of long-term debt in 2001 and to increase total capital
(stockholders' equity, long-term debt and preferred securities subject to
mandatory redemption).
The Company's floating rate new issuances contain contractual interest rates
based primarily on London Interbank Offered Rates ("LIBOR"). All of the
Company's fixed rate new issuances were effectively converted to floating rate
obligations through the use of interest rate swaps. Of the foreign denominated
new issuances totaling $744 million, $477 million were effectively swapped to
U.S. Dollars, with the remainder match funding foreign currency denominated
capital needs.
The Company had $2,253 million of long-term debt mature during the three months
ended February 28, 2001.
3. Capital Requirements:
The Company operates globally through a network of subsidiaries, with several
being subject to regulatory requirements. In the United States, LBI, as a
registered broker-dealer, is subject to SEC Rule 15c3-1, the Net Capital Rule,
which requires LBI to maintain net capital of not less than the greater of 2% of
aggregate debit items arising from customer transactions, as defined, or 4% of
funds required to be segregated for customers' regulated commodity accounts, as
defined. At February 28, 2001, LBI's regulatory net capital, as defined, of
$2,038 million exceeded the minimum requirement by $1,895 million.
8
Lehman Brothers International (Europe) ("LBIE"), a United Kingdom registered
broker-dealer and subsidiary of Holdings, is subject to the capital requirements
of the Securities and Futures Authority ("SFA") of the United Kingdom. Financial
resources, as defined, must exceed the total financial resources requirement of
the SFA. At February 28, 2001, LBIE's financial resources of approximately
$2,361 million exceeded the minimum requirement by approximately $544 million.
Lehman Brothers Japan Inc.'s Tokyo branch, a regulated broker-dealer, is subject
to the capital requirements of the Financial Services Agency and at February 28,
2001, had net capital of approximately $348 million which was approximately $105
million in excess of the specified levels required. Lehman Brothers Bank, FSB
(the "Bank"), the Company's thrift subsidiary is regulated by the Office of
Thrift Supervision ("OTS"). The Bank exceeds all regulatory capital requirements
and is considered well capitalized by the OTS. Certain other non-U.S.
subsidiaries are subject to various securities, commodities and banking
regulations and capital adequacy requirements promulgated by the regulatory and
exchange authorities of the countries in which they operate. At February 28,
2001, these other subsidiaries were in compliance with their applicable local
capital adequacy requirements. In addition, the Company's "AAA" rated
derivatives subsidiaries, Lehman Brothers Financial Products Inc. ("LBFP") and
Lehman Brothers Derivative Products Inc. ("LBDP"), have established certain
capital and operating restrictions which are reviewed by various rating
agencies. At February 28, 2001, LBFP and LBDP each had capital which exceeded
the requirement of the most stringent rating agency by approximately $51 million
and $25 million, respectively.
The regulatory rules referred to above, and certain covenants contained in
various debt agreements may restrict Holdings' ability to withdraw capital from
its regulated subsidiaries, which in turn could limit its ability to pay
dividends to shareholders.
4. Derivative Financial Instruments:
Effective December 1, 2000, the Company adopted Statement of Financial
Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended by SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities," which requires that all
derivative instruments be reported on the consolidated statement of financial
condition at fair value and establishes criteria for designation and
effectiveness of hedging relationships. The adoption of SFAS No. 133 did not
have a material effect on the Company's consolidated statement of financial
condition or the results of operations.
Most of the Company's derivative transactions are entered into for trading
related activities for which the adoption of SFAS No. 133 had no accounting
impact. The Company's trading related derivative activities are marked-to-market
through earnings as a component of Principal Transactions revenues. The Company
also utilizes derivatives for non-trading purposes as an end user to modify the
market risk exposures of certain assets and liabilities. In this regard, the
Company primarily enters into fair value hedges utilizing interest rate swaps to
convert a substantial portion of the Company's fixed rate long-term debt and
certain term fixed rate secured financing activities to a floating interest
rate. The ineffective portion of the fair value hedges were included in
"Interest Expense" on the consolidated statement of income and were immaterial
for the three months ended February 28, 2001.
Market or fair value for trading-related instruments is generally determined by
either quoted market prices (for exchange-traded futures and options) or pricing
models (for over-the-counter swaps, forwards and options). Pricing models
utilize a series of market inputs to determine the present value of future cash
flows, with adjustments, as required for credit risk and liquidity risk. Further
valuation adjustments may be recorded, as deemed appropriate for new or complex
products or for positions with significant concentrations. These adjustments are
integral components of the mark-to-market process. Credit-related
9
valuation adjustments represent estimates of expected losses which incorporate
business and economic conditions, historical experience, concentrations, and the
character, quality and performance of credit sensitive financial instruments.
Unrealized gains and losses on derivative contracts are recorded on a net basis
in the Consolidated Statement of Financial Condition for those transactions with
counterparties executed under a legally enforceable master netting agreement and
are netted across products when such provisions are stated in the master netting
agreement. Listed in the following table is the fair value of the Company's
trading-related derivative activities. Assets and liabilities represent net
unrealized gains (amounts receivable from counterparties) and net unrealized
losses (amounts payable to counterparties), respectively.
Fair Value* Fair Value*
February 28, 2001 November 30, 2000
--------------------------------- ----------------------------------
(in millions) Assets Liabilities Assets Liabilities
- -------------------------------------------------------- -------------- -- --------------- -------------- --- ---------------
Interest rate and currency swaps and options
(including caps, collars and floors) $ 6,004 $ 4,711 $ 4,349 $ 3,390
Foreign exchange forward contracts and
options 1,195 1,401 902 1,361
Other fixed income securities contracts
(including options and TBAs) 387 350 496 418
Equity contracts (including equity swaps,
warrants and options) 4,568 4,303 3,836 3,399
-------------- -- --------------- -------------- --- ---------------
Total $ 12,154 $ 10,765 $ 9,583 $ 8,568
-------------- -- --------------- -------------- --- ---------------
* Amounts represent carrying value (exclusive of collateral) and do not
include receivables or payables related to exchange-traded futures
contracts.
Assets included in the table above represent the Company's net
receivable/payable for derivative financial instruments before consideration of
collateral. Included within the $12,154 million fair value of assets at February
28, 2001 was $10,348 million related to swaps and other OTC contracts and $1,806
million related to exchange-traded option and warrant contracts. Included within
the $9,583 million fair value of assets at November 30, 2000 was $8,643 million
related to swaps and other OTC contracts and $940 million related to
exchange-traded option and warrant contracts.
With respect to OTC contracts, including swaps, the Company views its net credit
exposure to be $7,566 million at February 28, 2001, representing the fair value
of the Company's OTC contracts in an unrealized gain position, after
consideration of collateral. Presented below is an analysis of the Company's net
credit exposure at February 28, 2001 for OTC contracts based upon actual ratings
made by external rating agencies or by equivalent ratings established and
utilized by the Company's Credit Risk Management Department.
Counterparty S&P/Moody's Net Credit
Risk Rating Equivalent Exposure
----------- ---------- --------
1 AAA/Aaa 18%
2 AA-/Aa3 or higher 29%
3 A-/A3 or higher 31%
4 BBB-/Baa3 or higher 15%
5 BB-/Ba3 or higher 6%
6 B+/B1 or lower 1%
10
The Company is also subject to credit risk related to its exchange-traded
derivative contracts. Exchange-traded contracts, including futures and certain
options, are transacted directly on the exchange. To protect against the
potential for a default, all exchange clearinghouses impose net capital
requirements for their membership. Additionally, exchange clearinghouses require
counterparties to futures contracts to post margin upon the origination of all
contracts and for any changes in the market value of the contracts on a daily
basis (certain foreign exchanges provide for settlement within three days).
Therefore, the potential for losses from exchange-traded products is limited.
For a further discussion of the Company's derivative related activities, refer
to "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Off-Balance Sheet Financial Instruments and Derivatives" and Notes
1 and 12 to the Consolidated Financial Statements, incorporated by reference in
the Form 10-K.
5. Other Commitments and Contingencies:
In connection with its financing activities, the Company had outstanding
commitments under certain lending arrangements of approximately $3.2 billion at
February 28, 2001 and November 30, 2000. These commitments require borrowers to
provide acceptable collateral, as defined in the agreements, when amounts are
drawn under the lending facilities. Advances made under the above lending
arrangements are typically at variable interest rates and generally provide for
over-collateralization based upon the borrowers' creditworthiness.
In addition, the Company, through its high grade and high yield sales, trading
and underwriting activities, makes commitments to extend credit in loan
syndication transactions and then participates out a significant portion of
these commitments. The Company had lending commitments to high grade borrowers
of $5.4 billion and $4.4 billion at February 28, 2001 and November 30, 2000,
respectively. In addition, lending commitments to high yield borrowers totaled
$1.1 billion and $1.3 billion at February 28, 2001 and November 30, 2000,
respectively. All of these commitments and any related draw downs of these
facilities are typically secured against the borrowers' assets, have fixed
maturity dates, and are generally contingent upon certain representations,
warranties and contractual conditions applicable to the borrower. Total
commitments are not indicative of actual risk or funding requirements, as the
commitments may not be drawn or fully utilized, and the Company will continue to
syndicate and/or sell these commitments.
At February 28, 2001 and November 30, 2000, the Company had commitments to
invest up to $609 million and $357 million, respectively, directly and through
partnerships in private equity related investments. These commitments will be
funded as required through the end of the respective investment periods,
principally expiring in 2004.
In the normal course of its business, the Company has been named a defendant in
a number of lawsuits and other legal proceedings. Although there can be no
assurances as to the ultimate outcome, the Company has denied, or believes it
has a meritorious defense and will deny, liability in all significant cases
pending against it, and intends to defend vigorously each such case, and based
on information currently available and established reserves, the Company
believes that the eventual outcome of the actions against it will not, in the
aggregate, have a material adverse effect on the consolidated financial position
or results of operations of the Company.
As a leading global investment bank, risk is an inherent part of all of the
Company's businesses and activities. The extent to which the Company properly
and effectively identifies, assesses, monitors and manages each of the various
types of risks involved in its trading (including derivatives), brokerage, and
investment banking activities is critical to the success and profitability of
the Company. The principal types
11
of risks involved in the Company's activities are market risk, credit or
counterparty risk and transaction risk. Management has developed a control
infrastructure throughout the Company to monitor and manage these risks on a
global basis. For further discussion of these matters, refer to Note 14 to the
Consolidated Financial Statements, incorporated by reference in the Form 10-K.
6. Segments
The Company operates in three segments: Investment Banking, Capital Markets and
Client Services.
The Investment Banking Division provides advice to corporate, institutional and
government clients throughout the world on mergers, acquisitions and other
financial matters. The Division also raises capital for clients by underwriting
public and private offerings of debt and equity securities.
The Capital Markets Division includes the Company's institutional sales,
trading, research and financing activities in equity and fixed income cash and
derivatives products. Through the Division, the Company is a global market-maker
in numerous equity and fixed income products, including U.S., European and Asian
equities, government and agency securities, money market products, corporate
high grade, high yield and emerging market securities, mortgage- and
asset-backed securities, municipal securities, bank loans, foreign exchange and
derivatives products. The Division also includes the Company's risk arbitrage
and secured financing businesses, as well as, realized and unrealized gains and
losses related to the Company's direct private equity investments. The financing
business manages the Company's equity and fixed income matched book activities,
supplies secured financing to institutional clients and customers, and provides
secured funding for the Company's inventory of equity and fixed income products.
Client Services revenues reflect earnings from the Company's private client and
private equity businesses. Private client revenues reflect the Company's
high-net-worth retail customer flow activities as well as asset management fees
earned from these clients. Private equity revenues include the management and
incentive fees earned in the Company's role as general partner for twenty-four
private equity partnerships.
Certain prior period segment information has been reclassified to conform to the
current period presentation.
The Company's segment information for the first quarter of 2001 and 2000 is
presented below and was developed consistent with the accounting policies used
to prepare the Company's consolidated financial statements.
(in millions) Investment Capital Client
Banking Markets Services Total
------------------ -------------- ----------------- ------------------
February 28, 2001
Net revenue $ 471 $ 1,208 $ 204 $ 1,883
================== ============== ================= ==================
Earnings before taxes (1) $ 75 $ 451 $ 47 $ 573
================== ============== ================= ==================
Segment assets (billions) $1.4 $ 226.8 $ 8.1 $ 236.3
================== ============== ================= ==================
February 29, 2000
Net revenue $ 593 $ 1,339 $ 270 $ 2,202
================== ============== ================= ==================
Earnings before taxes (1) $ 179 $ 506 $ 109 $ 794
================== ============== ================= ==================
Segment assets (billions) $0.8 $ 204.9 $ 8.2 $ 213.9
================== ============== ================= ==================
(1) And before dividends on preferred securities.
12
The following are net revenues by geographic region:
February 28 February 29
(in millions) 2001 2000
------------------ -------------------
Americas $ 1,232 $ 1,245
Europe 519 704
Asia Pacific and other 132 253
------------------ -------------------
Total $ 1,883 $ 2,202
================== ===================
The following information describes the Company's methods of allocating
consolidated net revenues to geographic regions. Net revenues, if syndicate,
trading or sales related, have been distributed based upon the location where
the primary or secondary position was fundamentally risk managed; if
fee-related, by the location of the senior coverage banker. In addition, certain
revenues associated with domestic products and services which resulted from
relationships with international clients and customers have been reclassified as
international revenues using an allocation consistent with the Company's
internal reporting.
7. Incentive Plans:
In February of 2001, the Company transferred 16.0 million shares of its common
stock held in treasury into the RSU Trust. The RSU Trust is included in the
Consolidated Statement of Financial Condition as a component of other
stockholders' equity. The transfer had no impact on the total stockholders'
equity of the Company, as the decrease in treasury stock was offset by a
corresponding decrease in additional paid-in capital and other stockholders'
equity. At February 28, 2001 and November 30, 2000, 57.5 million and 42.4
million outstanding shares, respectively, were held in the RSU Trust.
13
8. Earnings Per Common Share:
Earnings per share was calculated as follows (in millions, except for per share
data):
Three Months Ended
--------------------------------------
February 28 February 29
2001 2000
Numerator:
Net income $387 $541
Preferred stock dividends (12) (59)
----------------- -----------------
Numerator for basic earnings per share-income available to common
stockholders 375 482
Convertible preferred stock dividends - 2
----------------- -----------------
Numerator for diluted earnings per share-income available to common
stock-holders (adjusted for assumed conversion of preferred stock) $375 $484
================= =================
Denominator:
Denominator for basic earnings per share - weighted-average shares 246.2 246.1
Effect of dilutive securities:
Employee stock options 17.3 9.8
Employee restricted stock units 7.2 4.1
Preferred shares assumed converted into common - 2.4
----------------- -----------------
Dilutive potential common shares 24.5 16.3
----------------- -----------------
Denominator for diluted earnings per share - adjusted weighted-average
shares 270.7 262.4
================= =================
Basic earnings per share $1.52 $1.96
================= =================
Diluted earnings per share $1.39 $1.84
================= =================
For February 29, 2000, Convertible Voting Preferred shares were convertible into
common shares at a conversion price of approximately $61.50 per share. However,
for purposes of calculating diluted earnings per share, preferred shares were
assumed to be converted into common shares when basic earnings per share exceeds
preferred dividends per share obtainable upon conversion (approximately $0.77 on
a quarterly basis). During December 2000, the Company redeemed all outstanding
Convertible Voting Preferred shares.
14
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS
Business Environment
The principal business activities of Lehman Brothers Holdings Inc. ("Holdings")
and subsidiaries (collectively, the "Company" or "Lehman Brothers") are
investment banking and securities trading and sales, which by their nature are
subject to volatility, primarily due to changes in interest and foreign exchange
rates and security valuations, global economic and political trends and industry
competition. As a result, revenues and earnings may vary significantly from
quarter to quarter and from year to year.
The marketplace uncertainties experienced in the second half of 2000 continued
into the first quarter of 2001 as slower consumer spending and recessionary
fears resulted in generally weak market conditions. In response to these
conditions and to stimulate growth, the Federal Reserve lowered interest rates
during the first week of January by half of a percentage point and by a further
half of a percentage point during the last week of January. Subsequent to
quarter-end, interest rates were again lowered an additional half of a
percentage point on March 20, 2001.
In U.S. equity markets, weak earnings reported by corporations across most
market sectors led to significantly lower returns during the fiscal first
quarter of 2001 when compared to the same period a year ago. The Standard &
Poor's 500 Index was down 9% from the end of the fiscal first quarter of 2000
and 6% from the end of fiscal year 2000. The NASDAQ experienced even greater
volatility, closing the fiscal first quarter of 2001 at its lowest level in 26
months, down 54% from a year ago and 17% from November 30, 2000.
Internationally, world markets experienced the same slowing of growth as well as
intervention by the major regional central banks. The Bank of England cut
interest rates during the period by a quarter of a percentage point, the first
reduction in almost two years. In addition, the Bank of Japan cut key interest
rates at the end of February 2001 in response to continued slow growth and a
declining stock market, which closed the quarter at a 28-month low.
Global equity new issuances felt the impact of the market downturns during the
quarter. Only nine initial public offerings ("IPO") were priced during the
quarter, the lowest number in almost 10 years. IPO proceeds for the fiscal first
quarter of 2001 were $3.9 billion, with two deals accounting for more than 75%
of the amount, according to Thomson Financial Securities Data Corp. ("TFSD").
This compares with 57 companies that raised $7.5 billion during the same period
a year ago.
U.S. fixed income markets were strong during the fiscal first quarter of 2001,
as falling stock markets and lower interest rates led investors to interest rate
based and credit sensitive products. Yields on all U.S. Treasury maturities,
which move inversely to price, were at or near two-year lows. Credit spreads
generally tightened during the quarter. Spreads at first widened during the
quarter, then narrowed across most sectors as the quarter progressed, even as
higher defaults loomed.
European fixed income market activity experienced mixed trading conditions
during the first fiscal quarter of 2001. Markets began the quarter weak as
credit spreads widened on continued market weakness but rebounded later in the
quarter as the European economy experienced much steadier growth than the U.S.
and Japan. Although analysts predicted the European Central Bank (ECB) would
reduce rates during the first quarter, no action was actually taken, as Europe's
economy was steady and inflation remained above the ECB's short-term target of
2%.
Global debt new issuances were very strong during the quarter. Activity was
bolstered by the Federal Reserve's aggressive rate cuts, as absolute interest
rates for borrowing companies were very attractive.
15
Reflecting this improving market, investment grade debt new issuances and high
yield new issuances for the quarter were up 16% and 19%, respectively, versus
prior year first quarter activity.
The value of merger and acquisition advisory "deal completions" increased during
the fiscal first quarter of 2001 when compared to the same period a year ago.
These results did not reflect the significant deterioration that occurred in the
marketplace for "deal announcements" during the quarter. The value of worldwide
announced mergers and acquisitions fell 57% from the year-earlier period,
according to TFSD, primarily as a result of the deteriorating equity markets.
- --------------------------------------------------------------------------------
Some of the statements contained in this Management's Discussion and Analysis of
Financial Condition and Results of Operations, including those relating to the
Company's strategy and other statements that are predictive in nature, that
depend upon or refer to future events or conditions or that include words such
as "expects," "anticipates," "intends," "plans," "believes," "estimates" and
similar expressions, are forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. These statements are not
historical facts but instead represent only the Company's expectations,
estimates and projections regarding future events. These statements are not
guarantees of future performance and involve certain risks and uncertainties
that are difficult to predict, which may include market, credit or counterparty,
liquidity, legal and operational risks. Market risks include changes in interest
and foreign exchange rates and securities valuations, global economic and
political trends and industry competition. The Company's actual results and
financial condition may differ, perhaps materially, from the anticipated results
and financial condition in any such forward-looking statements. The Company
undertakes no obligation to update any forward-looking statements, whether as a
result of new information, future events or otherwise.
16
Results of Operations
For the Three Months Ended February 28, 2001 and February 29, 2000
The Company reported net income of $387 million for the quarter ended February
28, 2001, representing a decrease of 29% from record net income of $541 million
for the quarter ended February 29, 2000. Earnings per common share (diluted) was
$1.39 for the first quarter of 2001 compared to $1.84 for the first quarter of
2000. Net revenues of $1,883 million represented the Company's 3rd highest
quarterly revenues ever reported.
The Company believes these results are relatively strong, given the very
difficult market environment experienced during the quarter, and demonstrates
the growing breadth of the franchise. During the first quarter of 2001, the
Company continued to selectively grow its high margin investment banking and
equities businesses through increased headcount and product offerings. In
addition, through the Company's continued emphasis on expense discipline,
non-personnel expenses increased only 4% compared to the fourth quarter of 2000
versus an 11% in net revenues over the same period.
The Company is segregated into the following three business segments (each of
which is described below): Investment Banking, Capital Markets and Client
Services. Each segment represents a group of activities and products with
similar characteristics. These business activities result in revenues from both
institutional and high-net-worth retail clients which are recognized across the
different revenue categories contained in the Company's Consolidated Statement
of Income. (Net revenues by segment also contain certain internal allocations,
including funding costs, which are centrally managed.)
Three Months Ended February 28, 2001 and February 29, 2000
(in millions) Net Revenues
for the
Three Months Ended
----------------------------------
Feb 28 Feb 29
2001 2000
--------------- ---------------
Investment Banking $ 471 $ 593
Capital Markets 1,208 1,339
Client Services 204 270
--------------- ---------------
Total $ 1,883 $ 2,202
=============== ===============
17
The following discussion provides an analysis of the Company's net revenues for
the periods above.
Investment Banking This segment's net revenues result from fees earned by the
Company for underwriting public and private offerings of fixed income and equity
securities, and advising clients on merger and acquisition activities and other
services.
Investment Banking's net revenues decreased 21% during the Investment Banking
Net Revenues first quarter to $471 million from $593 million in the first
quarter of 2000, reflecting the weak market conditions for equity origination,
partially offset by stronger fixed income underwriting activity.
Equity origination revenues were significantly down compared to the year-ago
period, consistent with an overall decline in common stock underwriting in the
global marketplace as a result of the deterioration in the equity markets.
Investment Banking Net Revenues
----------------------- ------------------------------
(in millions) Three Months Ended
February 28 February 29
2001 2000
----------------------- --------------- --------------
Equity Underwriting $ 105 $ 261
Debt Underwriting 183 153
Merger and Acqui-
sition Advisory 183 179
----------------------- --------------- --------------
$ 471 $ 593
----------------------- --------------- --------------
Much of the equity capital raised during the quarter was in the form of
convertible securities, which is a more conservative investment class and
generally carries smaller underwriting fees. However, the benefits of the
Company's growth strategy in investment banking and equities were evidenced by a
higher global equity origination volume share which increased during the
quarter.
Debt underwriting revenues totaled $183 million for the first quarter of 2001, a
20% increase over the prior year's comparable period as fees from high grade and
high yield originations were both up compared to last year's first quarter.
Fixed income origination benefited this quarter from the actions of the Federal
Reserve, tightening credit and swap spreads, a steepening of the yield curve to
a more normal shape and issuers' move to raise lower-coupon long-term debt to
replace some of their short-term debt. In addition, contributing to these
results was the increase in the Company's global market share for high yield
underwriting, which grew significantly as compared to full year 2000, from 5.0%
for calendar-year 2000 to 7.2% for the fiscal first quarter of 2001, combined
with a 19% increase in market volume during the period, according to TFSD.
Merger and acquisition advisory revenues for the first quarter of 2001 were $183
million, up slightly versus the first quarter of 2000. Contributing to these
results were record European merger and acquisition advisory revenues, which
more than doubled from last year's first quarter, reflecting the success of the
Company's growth initiative in this region.
Capital Markets This segment's net revenues reflect institutional flow
activities and secondary trading and financing activities related to fixed
income and equity products. These products include a wide range of cash,
derivative, secured financing and structured instruments.
Capital Markets' net revenues were $1,208 million for the first quarter of 2001,
down 10% from the first quarter of 2000. Excluding a $150 million realized gain
from a single private equity related principal investment during the first
quarter of 2000 net revenues increased slightly, during a quarter which
experienced volatile markets and a broad devaluation of equity securities.
Capital Market Net Revenues
---------------------- ---------------------------------
(in millions) Three Months Ended
February 28 February 29
2001 2000
---------------------- -------------- ------------------
Equities $ 685 $ 868
Fixed Income 523 471
---------------------- -------------- ------------------
$ 1,208 $ 1,339
---------------------- -------------- ------------------
18
The overall consistency of Capital Markets' revenues during these difficult
market conditions demonstrates the strength of the Company's institutional
"customer flow" business. This customer flow business provides the Company with
a relatively stable form of revenues as customers rebalance their portfolio
across market cycles with the full array of capital market products that are
provided by the Company.
Net revenues from the equity component of Capital Markets were $685 million in
the first quarter of 2001, relatively unchanged from the first quarter of 2000,
after adjusting first quarter 2000 results for the private equity gain described
above. Despite significant declines in the major market indices, the Company's
institutional market volumes were up versus the year-ago period. This activity
led to strong returns from equity cash businesses both in the U.S. and Europe,
convertible securities and equity derivative activities.
Net revenues from the fixed income component of Capital Markets increased 11%
from the first quarter of 2000 as the yield curve began to return to a more
normal slope and credit spreads tightened. Increases were driven by improved
institutional flow in credit products, particularly high grade and high yield
bonds, and municipals. Given the heightened level of global uncertainty, foreign
exchange revenues from customer flow activities also increased.
Client Services Client Services net revenues reflect earnings from the Company's
private client and private equity businesses. Private client net revenues
reflect the Company's high-net-worth retail customer flow activities as well as
asset management fees. Private equity net revenues include the management and
incentive fees earned in the Company's role as general partner for twenty-four
private equity partnerships.
Client Services' net revenues were $204 million in the
first quarter of 2001 compared to $270 million in the first
quarter of 2000. Excluding a special performance-based
asset management fee of $73 million, from the year-ago
period, Client Services' results improved slightly as the
Company's high-net-worth retail sales force had its
strongest production quarter ever.
Client Service Net Revenues
(in millions) Three Months Ended
February 28 February 29
2001 2000
---------------------- -------------- ------------------
Private Client $ 192 $ 260
Private Equity 12 10
---------------------- -------------- ------------------
$ 204 $ 270
---------------------- -------------- ------------------
Non-Interest Expenses Non-interest expenses were $1,310 million for the first
quarter of 2001 compared to $1,408 million for the first quarter of 2000.
Compensation and benefits expense as a percentage of net revenues decreased to
51.0% for the quarter compared to the prior year first quarter of 52.0%. The
compensation accrual percentage is consistent with the Company's fiscal 2000
level and reflects the Company's continued expansion of its investment banking,
equities and European franchises. Nonpersonnel expenses were $350 million for
the first quarter of 2001, $338 million for the fourth quarter of 2000 and $263
million for the first quarter of 2000. The increase in nonpersonnel expenses
from the first quarter of 2000 is consistent with a 32% increase in headcount
and also reflects the Company's continued investment in technology. Compared to
the fiscal fourth quarter of 2000, nonpersonnel expenses grew by only 4% as
revenues increased by 11%.
Income Taxes The Company's income tax provision was $172 million for the first
quarter of 2001 versus $239 million for the first quarter of 2000. The effective
tax rate was 30% for the first quarter of 2001, unchanged from the first quarter
of 2000.
19
Liquidity, Funding and Capital Resources
Liquidity Risk Management Liquidity risk management is of critical importance to
the Company, providing a framework which seeks to ensure that the Company
maintains sufficient liquid financial resources to continually fund its balance
sheet and meet all of its funding obligations in all market environments. The
Company's liquidity framework has been structured so that even in a severe
liquidity event the balance sheet does not have to be reduced purely for
liquidity reasons (although we may choose to do so for risk reasons). This
allows the Company to continue to maintain its customer franchise and debt
ratings during a liquidity event.
The Company's liquidity management philosophy incorporates the following
principles:
o Liquidity providers are credit and market sensitive. Consequently, firms
must be in a state of constant liquidity readiness.
o Firms should not rely on asset sales to generate cash or believe that they
can increase unsecured borrowings or funding efficiencies in a liquidity
crisis.
o During a liquidity event, certain secured lenders may require higher
quality collateral. Firms must therefore not over-estimate the availability
of secured financing, and must fully integrate their secured and unsecured
funding strategies.
o A firm's legal entity structure may constrain liquidity. Regulatory
requirements can restrict the flow of funds between regulated and
unregulated group entities and this must be accounted for in liquidity
planning.
The Company's Funding Framework incorporates these principles and mitigates
liquidity risk whenever possible. This Framework comprises four major
components:
(1) The Cash Capital Model - which evaluates the amount of long-term
liabilities - with remaining maturities of over one year - that are
required to fund the Company.
(2) The Reliable Secured Funding Model - which forecasts the reliable sources
of overnight secured funding available to the Company.
(3) The Maximum Cumulative Outflow - which estimates the size of the added
liquidity requirement necessary to fund contingent cash outflows expected
from a stress environment.
(4) The Contingency Funding Plan - which represents a detailed action plan
to manage a stress liquidity event within the Company.
For further discussion of these principles refer to the Liquidity, Funding and
Capital Resources section of Management's Discussion and Analysis of Financial
Condition and Results of Operations incorporated by reference in the Form 10-K.
As a consequence of implementing its Funding Framework, the Company has
generally shifted to longer-term funding over the past several years. As a
result, the Company has reduced its reliance on short-term unsecured debt, which
represents only 3% of adjusted total assets and less than 12% of total debt.
20
Total Capital Total Capital (defined as long-term debt, preferred securities
subject to mandatory redemption and stockholders' equity) was $44.8 billion at
February 28, 2001 compared to $43.9 billion at November 30, 2000. The net
increase in Total Capital resulted from a net increase in long-term debt, the
retention of earnings, and amortization associated with RSU awards. These were
partially offset by repurchases of common stock (to fund restricted stock units
and option awards) and the redemption of the Cumulative Convertible Voting
Preferred Stock for $150 million.
February 28 November 30
(in millions) 2001 2000
- ---------------------------------------- -------------------------------------- -------------------------------
Long-term Debt
Senior Notes $ 33,374 $ 32,106
Subordinated Indebtedness 2,938 3,127
-------- --------
36,312 35,233
Preferred Securities 710 860
Stockholders' Equity
Preferred Equity 700 700
Common Equity 7,047 7,081
-------- --------
7,747 7,781
- ---------------------------------------- -------------------------------------- --------------------------------------
Total Capital $ 44,769 $ 43,874
- ---------------------------------------- -------------------------------------- --------------------------------------
During the first quarter of 2001, the Company issued $2.5 billion in long-term
debt, which was $200 million in excess of maturing debt. Long-term debt
increased to $36.3 billion at February 28, 2001 from $35.2 billion at November
30, 2000, with a weighted-average maturity of 3.9 years at February 28, 2001 and
3.8 years at November 30, 2000.
Back-Up Credit Facilities Holdings maintains a Revolving Credit Agreement (the
"Credit Agreement") with a syndicate of banks. Under the terms of the Credit
Agreement, the banks have committed to provide up to $2 billion (at quarter end)
for up to 364 days. Any loans outstanding on the commitment termination date may
be extended for up to an additional year at the option of Holdings. The Credit
Agreement contains covenants that require, among other things, that the Company
maintain a specified level of tangible net worth. Subsequent to quarter end, the
Company elected to reduce the committed amount under the Credit Agreement to $1
billion. The reduction reflects the Company's belief that its liquidity position
is stronger as a result of the implementation of the Funding Framework, and the
Company's desire to utilize its credit in forms that are more suitable to its
needs.
In July 2000, the Company entered into a $1 billion Committed Securities
Repurchase Facility (the "Facility") for LBIE, the Company's major operating
entity in Europe. The Facility provides secured multi-currency financing for a
broad range of collateral types. Under the terms of the Facility, the bank group
will agree to provide funding for up to one year on a secured basis. Any loans
outstanding on the commitment termination date may be extended for up to an
additional year at the option of LBIE. The Facility contains covenants which
require, among other things, that LBIE maintain specified levels of tangible net
worth.
There are no borrowings outstanding under either the Credit Agreement or the
Facility. The Company may use the Credit Agreement and the Facility for general
corporate purposes from time to time. The
21
Company has maintained compliance with the applicable covenants for both the
Credit Agreement and the Facility at all times.
Balance Sheet The Company's total assets increased to $236.3 billion at February
28, 2001 from $224.7 billion at November 30, 2000. The Company's adjusted total
assets, defined as total assets less the lower of securities purchased under
agreements to resell or securities sold under agreements to repurchase, were
$155.8 billion at February 28, 2001 compared to $143.5 billion at November 30,
2000. The Company believes adjusted total assets is a more effective measure of
evaluating balance sheet usage when comparing companies in the securities
industry. The increase in adjusted total assets reflects higher levels of
securities owned associated with increased customer flow activities across the
Capital Markets businesses.
The Company's balance sheet consists primarily of cash and cash equivalents,
securities and other financial instruments owned, and collateralized short-term
financing agreements. The liquid nature of these assets provides the Company
with flexibility in financing and managing its business. The majority of these
assets are funded on a secured basis through collateralized short-term financing
agreements.
Financial Leverage Balance sheet leverage ratios are one measure used to
evaluate the capital adequacy of a company. Leverage ratios are commonly
calculated using either total assets or adjusted total assets divided by total
stockholders' equity and preferred securities subject to mandatory redemption.
The Company believes that the adjusted leverage ratio is a more effective
measure of financial risk when comparing companies in the securities industry.
The Company's adjusted leverage ratio based on adjusted total assets was 18.4x
and 16.6x as of February 28, 2001 and November 30, 2000, respectively.
Consistent with maintaining a single A credit rating, the Company targets an
adjusted leverage ratio of approximately 20.0x. The Company operated below this
level at February 28, 2001 due to the sub-optimal market environment during the
quarter. Due to the nature of the Company's sales and trading activities, the
overall size of the Company's balance sheet fluctuates from time to time and at
specific points in time may be higher than the fiscal quarter ends or the
quarterly average.
Credit Ratings
The Company, like other companies in the securities industry, relies on external
sources to finance a significant portion of its day-to-day operations. The
Company's access to and cost of funding is generally dependent upon its short-
and long- term debt ratings. As of February 28, 2001 the short- and long-term
debt ratings of Holdings and LBI were as follows:
Holdings LBI
----------------------------------- -----------------------------------
Short-term Long-term Short-term Long-term**
- ------------------------------------------- ---------------- ------------------ --- --------------- -------------------
Fitch IBCA, Inc. F-1 A F-1 A/A-
Moody's P-1 A2 P-1 A1*/A2
Standard & Poor's Corp. A-1 A A-1 A+*/A
Thomson BankWatch TBW-1 A TBW-1 A+/A
* Provisional ratings on shelf registration
** Senior/subordinated
22
Other
The Company underwrites, trades, invests and makes markets in high yield
corporate debt securities. The Company also syndicates, trades and invests in
loans to below investment grade-rated companies. For purposes of this
discussion, high yield debt instruments are defined as securities or loans to
companies rated BB+ or lower, or equivalent ratings by recognized credit rating
agencies, as well as non-rated securities or loans which, in the opinion of
management, are non-investment grade. Non-investment grade securities generally
involve greater risks than investment grade securities due to the issuer's
creditworthiness and the liquidity of the market for such securities. In
addition, these issuers have higher levels of indebtedness, resulting in an
increased sensitivity to adverse economic conditions. The Company recognizes
these risks and aims to reduce market and credit risk through the
diversification of its products and counterparties. High yield debt instruments
are carried at fair value, and unrealized gains or losses for these securities
are recognized in the Company's Consolidated Statement of Income. Such
instruments at February 28, 2001 and November 30, 2000 included long positions
with an aggregate market value of approximately $3.6 billion and $3.5 billion,
respectively, and short positions with an aggregate market value of
approximately $840 million and $745 million, respectively. The Company mitigates
its aggregate and single-issuer net exposure through the use of derivatives,
sole-recourse securitization financing and other financial instruments.
Additional information about the Company's high yield securities and lending
activities, including related commitments, can be found in Note 5 to the
Consolidated Financial Statements (Other Commitments and Contingencies).
The Company has investments in twenty-four private equity partnerships, for
which the Company acts as general partner, as well as related direct
investments. At February 28, 2001, the Company's private equity related
investments were $838 million. The Company's policy is to carry its investments,
including the appreciation of its general partnership interests, at fair value
based upon the Company's assessment of the underlying investments. Additional
information about the Company's private equity activities, including related
commitments, can be found in Note 5 to the Consolidated Financial Statements
(Other Commitments and Contingencies).
For a discussion of the Company's use of derivative instruments and the risks
related thereto, see Note 4 to the Consolidated Financial Statements (Derivative
Financial Instruments) and the Off-Balance Sheet Financial Instruments and
Derivatives section of Management's Discussion and Analysis of Financial
Condition and Results of Operations incorporated by reference in the Form 10-K.
Risk Management
As a leading global investment banking company, risk is an inherent part of the
Company's businesses. Global markets, by their nature, are prone to uncertainty
and subject participants to a variety of risks. The Company has developed
policies and procedures to identify, measure and monitor each of the risks
involved in its trading, brokerage and investment banking activities on a global
basis. The principal risks of Lehman Brothers are market, credit, liquidity,
legal and operational risks. Risk Management is considered to be of paramount
importance. Consequently, the Company devotes significant resources across all
of its worldwide trading operations to the measurement, management and analysis
of risk, including investments in personnel and technology.
The Company seeks to reduce risk through the diversification of its businesses,
counterparties and activities in geographic regions. The Company accomplishes
this objective by allocating the usage of capital to each of its businesses,
establishing trading limits for individual products and traders and setting
23
credit limits for individual counterparties, including regional concentrations.
The Company seeks to achieve adequate returns from each of its businesses
commensurate with the risks that they assume.
Overall risk management policy is established by a Risk Management Committee
(the "Committee") comprised of the Chief Executive Officer, the Global Risk
Manager, the Chief Financial Officer, the Chief Administrative Officer, and the
Heads of Capital Markets and Investment Banking. The Committee brings together
senior management with the sole intent of discussing risk-related issues and
provides an effective forum for managing risk at the highest levels within the
Company. The Committee meets on a monthly basis, or more frequently if required,
to discuss, among other matters, significant market exposures, concentrations of
positions (e.g., counterparty, market risk), potential new transactions or
positions and risk limit exceptions.
The Global Risk Management Group (the "Group") supports the Committee, is
independent of the trading areas and reports directly to the Chief Executive
Officer. The Group combines two departments, credit risk management and market
risk management, into one unit. This facilitates the analysis of counterparty
credit and market risk exposures and leverages personnel and information
technology resources in a cost-efficient manner. The Group maintains staff in
each of the Company's regional trading centers and has daily contact with
trading staff at all levels within the Company. These discussions include a
review of trading positions and risk exposures.
Credit Risk Credit risk represents the possibility that a counterparty will be
unable to honor its contractual obligations to the Company. Credit risk
management is therefore an integral component of the Company's overall risk
management framework. The Credit Risk Management Department ("CRM Department")
has global responsibility for implementing the Company's overall credit risk
management framework.
The CRM Department manages the credit exposure related to trading activities by
giving initial credit approval for counterparties, establishing credit limits by
counterparty, country and industry group and by requiring collateral in
appropriate circumstances. In addition, the CRM Department strives to ensure
that master netting agreements are obtained whenever possible. The CRM
Department also considers the duration of transactions in making its credit
decisions, along with the potential credit exposure for complex derivative
transactions. The CRM Department is responsible for the continuous monitoring
and review of counterparty credit exposure and creditworthiness and recommending
valuation adjustments where appropriate. Credit limits are reviewed periodically
to ensure that they remain appropriate in light of market events or the
counterparty's financial condition.
Market Risk Market risk represents the potential change in value of a portfolio
of financial instruments due to changes in market rates, prices and
volatilities. Market risk management also is an essential component of the
Company's overall risk management framework. The Market Risk Management
Department ("MRM Department") has global responsibility for implementing the
Company's overall market risk management framework. It is responsible for the
preparation and dissemination of risk reports, developing and implementing the
firmwide Risk Management Guidelines and evaluating adherence to these
guidelines. These guidelines provide a clear framework for risk management
decision-making. To that end the MRM Department identifies and quantifies risk
exposures, develops limits, and reports and monitors these risks with respect to
the approved limits. The identification of material market risks inherent in
positions includes, but is not limited to, interest rate, equity and foreign
exchange risk exposures. In addition to these risks, the MRM Department also
evaluates liquidity risks, credit and sovereign concentrations.
24
The MRM Department utilizes qualitative as well as quantitative information in
managing trading risk, believing that a combination of the two approaches
results in a more robust and complete approach to the management of trading
risk. Quantitative information is developed from a variety of risk methodologies
based upon established statistical principles. To ensure high standards of
qualitative analysis, the MRM Department has retained seasoned risk managers
with the requisite experience and academic and professional credentials.
Market risk is present in cash products, derivatives, and contingent claim
structures that exhibit linear as well as non-linear profit and loss
sensitivity. The Company's exposure to market risk varies in accordance with the
volume of client-driven market-making transactions, the size of the Company's
proprietary and arbitrage positions and the volatility of financial instruments
traded. The Company seeks to mitigate, whenever possible, excess market risk
exposures through the use of futures and option contracts and offsetting cash
market instruments.
The Company participates globally in interest rate, equity, and foreign exchange
markets. The Company's Fixed Income division has a broadly diversified market
presence in U.S. and foreign government bond trading, emerging market
securities, corporate debt (investment and non-investment grade), money market
instruments, mortgages and mortgage-backed securities, asset-backed securities,
municipal bonds, and interest rate derivatives. The Company's Equities division
facilitates domestic and foreign trading in equity instruments, indices and
related derivatives. The Company's foreign exchange businesses are involved in
trading currencies on a spot and forward basis as well as through derivative
products and contracts.
The Company incurs short-term interest rate risk when facilitating the orderly
flow of customer transactions through the maintenance of government and
high-grade corporate bond inventories. Market-making in high yield instruments
exposes the Company to additional risk due to potential variations in credit
spreads. Trading in international markets exposes the Company to spread risk
between the term structure of interest rates in differing countries. Mortgages
and mortgage-related securities are subject to prepayment risk and changes in
the level of interest rates. Trading in derivatives and structured products
exposes the Company to changes in the level and volatility of interest rates.
The Company actively manages interest rate risk through the use of interest rate
futures, options, swaps, forwards and offsetting cash market instruments.
Inventory holdings, concentrations and agings are monitored closely and used by
management to selectively hedge or liquidate undesirable exposures.
The Company is a significant intermediary in the global equity markets through
its market-making in U.S. and non-U.S. equity securities, including common
stock, convertible debt, exchange-traded and OTC equity options, equity swaps
and warrants. These activities expose the Company to market risk as a result of
price and volatility changes in its equity inventory. Inventory holdings are
also subject to market risk resulting from concentrations and liquidity that may
adversely impact market valuation. Equity market risk is actively managed
through the use of index futures, exchange-traded and OTC options, swaps and
cash instruments.
The Company enters into foreign exchange transactions in order to facilitate the
purchase and sale of non-dollar instruments, including equity and interest rate
securities. The Company is exposed to foreign exchange risk on its holdings of
non-dollar assets and liabilities. The Company is active in many foreign
exchange markets and has exposure to the euro, Japanese yen, British pound,
Swiss franc, and Canadian dollar as well as a variety of developed and emerging
market currencies. The Company hedges its risk exposures primarily through the
use of currency forwards, swaps, futures and options.
25
Value at Risk For purposes of Securities and Exchange Commission ("SEC") risk
disclosure requirements, the Company discloses an entity-wide value-at-risk for
virtually all of its trading activities. In general, value-at-risk measures the
potential loss of revenues at a given confidence level over a specified time
horizon. Value-at-risk over a one-day holding period measured at a 95%
confidence level implies that potential loss of daily trading revenue will be at
least as large as the value-at-risk amount on one out of every 20 trading days.
The Company's methodology estimates a reporting day value-at-risk using actual
daily trading revenues over the previous 250 trading days. This estimate is
measured as the loss, relative to the median daily trading revenue. The Company
also estimates an average value-at-risk measure over 250 rolling reporting days,
thus looking back a total 500 trading days.
Average value-at-risk computed in this manner was $22.2 million and $20.8
million for the periods ended February 28, 2001 and November 30, 2000,
respectively. Value-at-risk at February 28, 2001 and November 30, 2000 was $24.7
million and $23.7 million, respectively.
Value-at-risk is one measurement of potential loss in trading revenues that may
result from adverse market movements over a specified period of time with a
selected likelihood of occurrence. As with all measures of value-at-risk, the
Company's estimate has substantial limitations due to its reliance on historical
performance, which is not necessarily a predictor of the future. Consequently,
this value-at-risk estimate is only one of a number of tools the Company
utilizes in its daily risk management activities.
As discussed throughout Management's Discussion and Analysis, the Company seeks
to reduce risk through the diversification of its businesses and a focus on
customer flow activities. This diversification and focus, combined with the
Company's risk management controls and processes, helps mitigate the net revenue
volatility inherent in the Company's trading activities. Although historical
performance is not necessarily indicative of future performance, the Company
believes its focus on business diversification and customer flow activities
should continue to help mitigate the volatility of future net trading revenues.
New Accounting Developments
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities--a replacement
of FASB No. 125" ("SFAS 140"). SFAS 140 carries over the fundamental control
premise of SFAS No. 125, which requires an entity to recognize only assets it
controls and to derecognize assets only when control has been surrendered. SFAS
140 amends the control framework of SFAS 125 by revising the criteria to be used
for evaluating whether a financial asset is controlled and providing new
criteria necessary to meet the definition of a Qualifying Special Purpose Entity
("QSPE"). A QSPE is a limited-purpose vehicle often used for asset
securitizations.
SFAS 140 will also change the accounting for collateral. SFAS 140 will no longer
require entities to recognize controlled collateral as an asset on the balance
sheet. Rather, SFAS 140 will require entities to separately classify financial
assets owned and pledged. SFAS 140 also requires new disclosures for collateral
and retained interests in securitizations.
SFAS 140 has multiple effective dates. The accounting for new transfers of
financial assets will begin March 31, 2001 unless grandfathering provisions have
been met. The new collateral accounting rules will be effective for the Company
as of November 30, 2001. The adoption of SFAS 140 is not expected to have a
material impact to the Company's financial position or results of operations.
26
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1 Legal Proceedings
The Company is involved in a number of judicial, regulatory and arbitration
proceedings concerning matters arising in connection with the conduct of its
business. Such proceedings include actions brought against the Company and
others with respect to transactions in which the Company acted as an underwriter
or financial advisor, actions arising out of the Company's activities as a
broker or dealer in securities and commodities and actions brought on behalf of
various classes of claimants against many securities and commodities firms,
including the Company.
Although there can be no assurance as to the ultimate outcome, the Company has
denied, or believes it has a meritorious defense and will deny, liability in
all significant cases pending against it including the matters described below,
and intends to defend vigorously each such case, and based on information
currently available and established reserves, the Company believes that the
eventual outcome of the actions against it, including the matters described
below, will not, in the aggregate, have a material adverse effect on the
consolidated financial position or results of operations of the Company.
McNamara et al. v. Bre-X Minerals Ltd. et al. (Reported in Holdings' 2000 Annual
Report on Form 10-K)
On March 30, 2001, the Court filed a Memorandum Opinion and Order,
dismissing the claims against LBI with prejudice.
Harold Gillet, et al. v. Goldman Sachs & Co., et al.; Yakov Prager, et al. v.
Goldman, Sachs & Co., et al.; David Holzman, et al. v. Goldman, Sachs & Co., et
al. (Reported in Holdings' 2000 Annual Report on Form 10-K)
On March 15, 2001, another related class action was filed in the United
States District Court for the Southern District of New York. That case,
captioned Equalnet Communications Corp. v. Goldman Sachs Group, Inc., et al., is
brought by a bankrupt issuer of securities. The complaint in Equalnet names over
25 underwriter defendants, including LBI, and is substantially identical to the
Gillet complaint.
27
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 4 Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders of the Company held on April 3, 2001, the
following matters were submitted to a vote of security holders:
A) A proposal was submitted for the election of all Class II Directors.
The results for the nominees were: Roger S. Berlind - 223,925,117
votes for, 3,529,591 votes withheld; and Dina Merrill - 223,809,774
votes for, 3,644,934 votes withheld. Mr. Berlind and Ms. Merrill were
elected to serve until the Annual Meeting in 2004 and until a
successor is elected and qualified.
B) A proposal was submitted for the ratification of the Company's
selection of Ernst & Young LLP as the Company's independent auditors
for the 2001 fiscal year. The results were 226,094,088 votes for,
237,395 against and 1,123,225 abstaining, and the proposal was
adopted.
C) A proposal was submitted for the adoption of an amendment to the
Company's Restated Certificate of Incorporation to increase the
aggregate number of authorized shares of Common Stock, par value $0.10
per share, from 300 million to 600 million. The results were
211,106,018 votes for, 14,969,185 against and 1,379,505 abstaining,
and the proposal was adopted.
28
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6 Exhibits and Reports on Form 8-K
(a) Exhibits:
The following exhibits are filed as part of this Quarterly Report, or
where indicated, were heretofore filed and are hereby incorporated by
reference:
3.1 Restated Certificate of Incorporation of the Registrant dated
May 27, 1994 (Incorporated by reference to Exhibit 3.1 to the
Registrant's Transition Report on Form 10-K for the eleven
months ended November 30, 1994)
3.2 Certificate of Designations with respect to the Registrant's
5.94% Cumulative Preferred Stock, Series C (Incorporated by
reference to Exhibit 4.1 to the Registrant's Current Report on
Form 8-K filed with the Commission on May 13, 1998)
3.3 Certificate of Designations with respect to the Registrant's
5.67% Cumulative Preferred Stock, Series D (Incorporated by
reference to Exhibit 4.2 to the Registrant's Current Report on
Form 8-K filed with the Commission on July 23, 1998)
3.4 Certificate of Designations with respect to the Registrant's
Fixed/Adjustable Rate Cumulative Preferred Stock, Series E
(Incorporated by reference to Exhibit 4.2 to the Registrant's
Current Report on Form 8-K filed with the Commission on March
30, 2000)
3.5 Certificate of Amendment of the Restated Certificate of
Incorporation of the Registrant, dated April 9, 2001 (Filed
herewith)
3.6 By-Laws of the Registrant, amended as of March 26, 1997
(incorporated by reference to Exhibit 3 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended February
28, 1997)
10.1 Amended and Restated Lehman Brothers Holdings Inc. 1994
Management Ownership Plan, as of April 3,2001 (including
amendment to Section 9.4) (Filed herewith)
11.1 Computation of Per Share Earnings (Omitted in accordance with
section (b)(11) of Item 601 of Regulation S-K. The calculation
of per share earnings is set forth in Part I, Item 1, in Note
8 to the Consolidated Financial Statements (Earnings Per
Common Share).)
12.1 Computation of Ratios of Earnings to Fixed Charges and to
Combined Fixed Charges and Preferred Stock Dividends (Filed
herewith)
29
LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART II - OTHER INFORMATION
(b) Reports on Form 8-K:
The following reports on Form 8-K were filed during the quarter for
which this Quarterly Report is filed:
1. Form 8-K dated February 26, 2001, Item 7.
2. Form 8-K dated January 5, 2001, Item 7.
3. Form 8-K dated January 4, 2001, Items 5 and 7.
Financial Statements:
Exhibit 99.2 Consolidated Statement of Income
(Three Months Ended November 30, 2000)
(Preliminary and Unaudited)
Exhibit 99.3 Consolidated Statement of Income
(Twelve Months Ended November 30, 2000)
(Preliminary and Unaudited)
Exhibit 99.4 Segment Net Revenue Information
(Three and Twelve Months Ended November
30, 2000)
(Preliminary and Unaudited)
Exhibit 99.5 Selected Statistical Information
(Preliminary and Unaudited)
30
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEHMAN BROTHERS HOLDINGS INC.
(Registrant)
Date: April 16, 2001 By: /s/ David Goldfarb
-------------------------------------------------
Chief Financial Officer and Senior
Vice President
(principal financial and accounting
officer)
31
EXHIBIT INDEX
Exhibit No. Exhibit
Exhibit 3.5 Certificate of Amendment of the Restated Certificate
of Incorporation of the Registrant, dated April 9,
2001
Exhibit 10.1 Amended and Restated Lehman Brothers Holdings Inc.
1994 Management Ownership Plan, as of April 3, 2001
(including amendment to Section 9.4)
Exhibit 12.1 Computation of Ratios of Earnings to Fixed Charges
and to Combined Fixed Charges and Preferred Stock
Dividends (filed herewith)
32