================================================================================
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 AUGUST 31, 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 SEPTEMBER 30, 2001, 238,305,895 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 AUGUST 31, 2001
INDEX
PAGE
PART I. FINANCIAL INFORMATION NUMBER
-------------
Item 1. Financial Statements - (unaudited)
Consolidated Statement of Income -
Three and Nine Months Ended
August 31, 2001 and August 31, 2000................................ 3
Consolidated Statement of Financial Condition -
August 31, 2001 and November 30, 2000.............................. 5
Consolidated Statement of Cash Flows -
Nine Months Ended
August 31, 2001 and August 31, 2000................................ 7
Notes to Consolidated Financial Statements......................... 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......................... 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk............. 33
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 34
Item 6. Exhibits and Reports on Form 8-K................................. 35
SIGNATURE ........................................................................... 37
EXHIBIT INDEX........................................................................ 38
EXHIBITS
2
LEHMAN BROTHERS HOLDINGS AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE DATA)
Three months ended
----------------------
August 31 August 31
2001 2000
--------- ---------
Revenues
Principal transactions $ 637 $1,071
Investment banking 491 582
Commissions 253 234
Interest and dividends 3,657 5,461
Other 19 11
------ ------
Total revenues 5,057 7,359
Interest expense 3,429 5,307
------ ------
Net revenues 1,628 2,052
------ ------
Non-interest expenses
Compensation and benefits 830 1,067
Technology and communications 131 80
Brokerage and clearance 82 68
Business development 43 51
Professional fees 38 53
Occupancy 53 35
Other 16 25
------ ------
Total non-interest expenses 1,193 1,379
------ ------
Income from operations before taxes and
dividends on trust preferred securities 435 673
Provision for income taxes 112 202
Dividends on trust preferred securities 14 14
====== ======
Net income $ 309 $ 457
====== ======
Net income applicable to common stock $ 298 $ 444
====== ======
Earnings per common share
Basic $ 1.24 $ 1.83
====== ======
Diluted $ 1.14 $ 1.68
====== ======
See notes to consolidated financial statements.
3
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE DATA)
Nine months ended
-----------------------
August 31 August 31
2001 2000
---------- ---------
Revenues
Principal transactions $ 2,619 $ 3,055
Investment banking 1,539 1,664
Commissions 827 690
Interest and dividends 13,070 14,512
Other 38 113
------- -------
Total revenues 18,093 20,034
Interest expense 12,560 14,025
------- -------
Net revenues 5,533 6,009
------- -------
Non-interest expenses
Compensation and benefits 2,822 3,125
Technology and communications 376 249
Brokerage and clearance 232 188
Business development 147 126
Professional fees 126 128
Occupancy 138 97
Other 59 71
------- -------
Total non-interest expenses 3,900 3,984
------- -------
Income from operations before taxes and
dividends on trust preferred securities 1,633 2,025
Provision for income taxes 466 607
Dividends on trust preferred securities 42 42
------- -------
Net income $ 1,125 $ 1,376
======= =======
Net income applicable to common stock $ 1,041 $ 1,293
======= =======
Earnings per common share
Basic $ 4.28 $ 5.27
======= =======
Diluted $ 3.91 $ 4.91
======= =======
See notes to consolidated financial statements.
4
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
(UNAUDITED)
(IN MILLIONS)
August 31 November 30
2001 2000
--------- ---------
ASSETS
Cash and cash equivalents $ 3,488 $ 5,160
Cash and securities segregated and on deposit for regulatory
and other purposes 2,531 2,434
Securities and other financial instruments owned:
Governments and agencies 26,221 27,381
Mortgages and mortgage-backed 32,908 24,670
Corporate equities 22,261 24,042
Corporate debt and other 18,274 16,098
Derivatives and other contractual agreements 13,269 9,583
Certificates of deposit and other money market instruments 2,190 3,433
-------- --------
115,123 105,207
-------- --------
Collateralized short-term agreements:
Securities purchased under agreements to resell 86,944 81,242
Securities borrowed 22,084 17,618
Receivables:
Brokers, dealers and clearing organizations 1,898 1,662
Customers 7,200 7,585
Others 985 1,135
Property, equipment and leasehold improvements (net of
accumulated depreciation and amortization of $809 in 2001
and $855 in 2000) 893 671
Other assets 2,020 1,826
Excess of cost over fair value of net assets acquired (net of
accumulated amortization of $148 in 2001 and $138 in 2000) 171 180
-------- --------
Total assets $243,337 $224,720
======== ========
See notes to consolidated financial statements.
5
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF FINANCIAL CONDITION - (CONTINUED)
(UNAUDITED)
(IN MILLIONS, EXCEPT SHARE DATA)
August 31 November 30
2001 2000
--------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Commercial paper and short-term debt $ 4,502 $ 5,800
Securities and other financial instruments sold but not yet purchased:
Governments and agencies 28,498 14,998
Corporate equities 6,177 6,623
Derivatives and other contractual agreements 11,401 8,568
Corporate debt and other 6,366 5,096
--------- ---------
52,442 35,285
--------- ---------
Collateralized short-term financing:
Securities sold under agreements to repurchase 103,418 110,225
Securities loaned 12,834 7,242
Payables:
Brokers, dealers and clearing organizations 910 1,922
Customers 11,475 11,637
Accrued liabilities and other payables 9,599 8,735
Long-term debt:
Senior notes 36,402 32,106
Subordinated indebtedness 2,934 3,127
--------- ---------
Total liabilities 234,516 216,079
--------- ---------
Commitments and contingencies
Preferred securities subject to mandatory redemption 710 860
STOCKHOLDERS' EQUITY
Preferred stock 700 700
Common stock, $0.10 par value; 600,000 shares authorized; Shares issued
255,510,055 in 2001 and 251,629,126 in 2000; Shares outstanding:
239,046,975 in 2001 and 236,395,332 in 2000 25 25
Additional paid-in capital 3,399 3,589
Accumulated other comprehensive income (net of tax) (9) (8)
Retained earnings 4,698 3,713
Other stockholders' equity, net 496 597
Common stock in treasury, at cost: 16,463,080 shares in 2001 and 15,233,794
shares in 2000 (1,198) (835)
--------- ---------
Total stockholders' equity 8,111 7,781
--------- ---------
Total liabilities and stockholders' equity $ 243,337 $ 224,720
========= =========
See notes to consolidated financial statements.
6
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
Nine Months Ended
----------------------
August 31 August 31
2001 2000
--------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,125 $ 1,376
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 143 72
Compensation payable in common stock 300 203
Other adjustments (13) 54
Net change in:
Cash and securities segregated (97) (1,070)
Securities and other financial instruments owned (9,021) (18,640)
Securities borrowed (4,466) (3,056)
Receivables from brokers, dealers and clearing organizations (236) 64
Receivables from customers 385 (115)
Securities and other financial instruments sold but not yet purchased 17,157 1,791
Securities loaned 5,592 4,560
Payables to brokers, dealers and clearing organizations (1,012) (74)
Payables to customers (162) 2,329
Other operating assets and liabilities, net 1,235 1,443
-------- --------
Net cash provided by (used in) operating activities 10,930 (11,063)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of senior notes $ 8,817 $ 11,874
Principal payments of senior notes (5,461) (6,331)
Principal payments of subordinated indebtedness (204) --
Net proceeds from (payments for) commercial paper and short-term debt (1,298) 191
Resale agreements net of repurchase agreements (12,509) 5,620
Payments for treasury stock purchases (1,498) (470)
Dividends paid (137) (122)
Issuances of common stock 54 68
(Redemption) issuance of preferred stock (100) 162
-------- --------
Net cash provided by (used in) financing activities (12,336) 10,992
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, equipment and leasehold improvements (266) (148)
-------- --------
Net cash used in investment activities (266) (148)
-------- --------
Net change in cash and cash equivalents (1,672) (219)
-------- --------
Cash and cash equivalents, beginning of period 5,160 5,186
-------- --------
Cash and cash equivalents, end of period $ 3,488 $ 4,967
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS)
Interest paid totaled $12,659 and $14,075 for the nine months ended August 31,
2001 and August 31, 2000, respectively. Income taxes paid totaled $570 and $308
for the nine months ended August 31, 2001 and August 31, 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 nine months ended August 31, 2001, the Company issued $8,817 million
of long-term debt (all of which were senior notes). Of the total issuances
during the period, $3,252 million were U.S. dollar fixed rate, $3,245 million
were U.S. dollar-floating rate, $970 million were foreign currency denominated
fixed rate, and $1,350 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"). Of the fixed rate
new issuances totaling $4,222 million, $3,693 million were effectively converted
to floating rate obligations through the use of interest rate swaps. Of the
foreign denominated new issuances totaling $2,320 million, $969 million were
effectively swapped to U.S. Dollars, with the remainder match funding foreign
currency denominated capital needs.
The Company had $5,665 million of long-term debt mature during the nine months
ended August 31, 2001. Long-term debt at August 31, 2001, scheduled to mature
within one year totaled $7,883 million.
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 August 31, 2001, LBI's regulatory net capital, as defined, of $1,618
million exceeded the minimum requirement by $1,512 million.
8
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 August 31, 2001, LBIE's financial resources of approximately $2,168
million exceeded the minimum requirement by approximately $847 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 August 31, 2001,
had net capital of approximately $357 million which was approximately $174
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 August 31, 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 August
31, 2001, LBFP and LBDP each had capital which exceeded the requirement of the
most stringent rating agency by approximately $58 million and $26 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, as of
December 1, 2000, 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 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 not material
to the Company's results for the three and nine months ended August 31, 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 valuation
adjustments represent estimates of expected losses which incorporate business
and economic
9
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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*
AUGUST 31, 2001 NOVEMBER 30, 2000
---------------- --------------- ----------------- ---------------
(in millions) ASSETS LIABILITIES ASSETS LIABILITIES
---------------- --------------- ----------------- ---------------
Interest rate and currency swaps and
options (including caps, collars and
floors) $ 5,121 $ 4,235 $ 4,349 $ 3,390
Foreign exchange forward contracts and
options 886 1,393 902 1,361
Other fixed income securities contracts
(including options and TBAs) 808 857 496 418
Equity contracts (including equity swaps,
warrants and options) 6,454 4,916 3,836 3,399
------- ------- ------- -------
TOTAL $13,269 $11,401 $ 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 $13,269 million fair value of assets at August
31, 2001 was $10,894 million related to swaps and other OTC contracts and $2,375
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 $6,662 million at August 31, 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 August 31, 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 16 %
2 AA-/Aa3 or higher 26 %
3 A-/A3 or higher 35 %
4 BBB-/Baa3 or higher 18 %
5 BB-/Ba3 or higher 3 %
6 B+/B1 or lower 2 %
10
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. SECURITIZATIONS:
The Company is a market leader in the mortgage- and asset-backed securitization
market. In connection with these activities, the Company securitizes commercial
and residential mortgages, home equity loans, government and corporate bonds,
and lease and trade receivables. Lehman Brothers may retain an interest in the
financial assets it securitizes ("Retained Interests") which may include assets
in the form of residual interests or one or more subordinate tranches. The
Company records its Securities and Other Financial Instruments Owned, including
Retained Interests, at fair value, with changes in fair value reported in
earnings. Fair value is determined based upon listed market prices, if
available. Where listed market prices are not available, fair value is
determined based on other relevant factors, including broker or dealer price
quotations and valuation pricing models which take into account time value and
volatility factors underlying the financial instruments, among other factors.
Retained interests in securitized assets were not material as of August 31,
2001. During the third quarter of 2001, the Company securitized approximately
$21.6 billion of financial assets.
6. OTHER COMMITMENTS AND CONTINGENCIES:
In connection with its financing activities, the Company had outstanding
commitments under certain collateralized lending arrangements of approximately
$2.6 billion, $3.5 billion and $3.2 billion at August 31, 2001, May 31, 2001 and
November 30, 2000, respectively. 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 $5.9 billion, $5.6 billion and $4.4 billion at August 31, 2001, May 31, 2001
and November 30, 2000, respectively. In addition, lending commitments to high
yield borrowers totaled $1.5 billion, $1.3 billion and $1.3 billion at August
31, 2001, May 31, 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.
11
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At August 31, 2001 and November 30, 2000, the Company had commitments to invest
up to $569 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, 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.
At August 31, 2001, the net fair value of securities received as collateral that
have not been sold or repledged totaled approximately $5 billion. The gross fair
value of securities received as collateral where the Company was permitted to
sell or repledge the securities was approximately $225 billion. Of this
collateral, approximately $220 billion has been sold or repledged, generally as
collateral under repurchase agreements or to cover securities and other
financial instruments sold but not yet purchased.
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 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.
7. 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. 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 derivative
products. The Capital Markets 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 interests in private equity
investments. The financing businesses manage the Company's equity and fixed
income matched book activities, supply secured financing to institutional
clients and customers, and provide 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
12
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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-five private equity partnerships.
The Company's segment information for the three and nine months ended August 31,
2001 and August 31, 2000 is presented below and was developed consistent with
the accounting policies used to prepare the Company's consolidated financial
statements.
Three Months Ended Nine Months Ended
------------------------------- -------------------------------
August 31 August 31 August 31 August 31
(in millions) 2001 2000 2001 2000
------------- -------------- -------------- --------------
Investment Banking:
Net Revenue $ 460 $ 571 $1,482 $1,635
====== ====== ====== ======
Earnings before taxes (1) $ 79 $ 143 $ 272 $ 381
====== ====== ====== ======
Segment assets (billions) $ 1.4 $ 1.1 $ 1.4 $ 1.1
====== ====== ====== ======
Capital Markets:
Net Revenue $ 965 $1,282 $3,447 $3,703
====== ====== ====== ======
Earnings before taxes (1) $ 298 $ 471 $1,214 $1,412
====== ====== ====== ======
Segment assets (billions) $237.1 $219.0 $237.1 $219.0
====== ====== ====== ======
Client Services:
Net Revenue $ 203 $ 199 $ 604 $ 671
====== ====== ====== ======
Earnings before taxes (1) $ 58 $ 59 $ 147 $ 232
====== ====== ====== ======
Segment assets (billions) $ 4.8 $ 5.6 $ 4.8 $ 5.6
====== ====== ====== ======
Total:
Net Revenue $1,628 $2,052 $5,533 $6,009
====== ====== ====== ======
Earnings before taxes (1) $ 435 $ 673 $1,633 $2,025
====== ====== ====== ======
Segment assets (billions) $243.3 $225.7 $243.3 $225.7
====== ====== ====== ======
(1) And before dividends on preferred securities.
The following are net revenues by geographic region:
Three Months Ended Nine Months Ended
------------------------------- -------------------------------
August 31 August 31 August 31 August 31
(in millions) 2001 2000 2001 2000
------------- -------------- -------------- --------------
Americas $ 1,084 $ 1,274 $ 3,618 $ 3,416
Europe 430 630 1,498 1,900
Asia Pacific and other 114 148 417 693
------- ------- ------- -------
Total $ 1,628 $ 2,052 $ 5,533 $ 6,009
======= ======= ======= =======
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 allocated 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
13
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
been reclassified as international revenues using an allocation consistent with
the Company's internal reporting.
8. COMMON STOCK:
In April 2001, the Company's shareholders' approved the adoption of an amendment
to the Company's Restated Certificate of Incorporation to increase the aggregate
number of authorized shares of common stock from 300 million to 600 million.
9. INCENTIVE PLANS:
During the third quarter, the Company delivered 8.2 million shares of its common
stock to current and former employees in satisfaction of RSUs awarded in 1996.
Substantially all of the shares delivered were funded from the Company's
irrevocable grantor trust for restricted stock units (the "RSU Trust"). The
Company increased additional paid-in capital by approximately $236 million for
the tax effect of the appreciation in the Company's stock price from the grant
date to the delivery date. The Company received 2.6 million shares from current
and former employees in satisfaction of applicable tax withholding requirements.
Shares received were recorded as treasury stock at an aggregate value of $205
million. At August 31, 2001 and November 30, 2000, 46.3 million and 42.4 million
shares were held in the RSU Trust, respectively.
10. EARNINGS PER COMMON SHARE:
Earnings per share was calculated as follows (in millions, except for per share
data):
Three Months Ended Nine Months Ended
------------------------------- -------------------------------
Aug. 31 Aug. 31 Aug. 31 Aug. 31
2001 2000 2001 2000
-------------- ------------- -------------- -------------
NUMERATOR:
Net income $ 309 $ 457 $1,125 $1,376
Preferred stock dividends (11) (13) (84) (83)
------- ------- ------ ------
Numerator for basic earnings per share-
income available to common stockholders 298 444 1,041 1,293
Convertible preferred stock dividends -- 2 -- 6
------- ------- ------ ------
Numerator for diluted earnings per share-
income available to common stockholders
(adjusted for assumed conversion of
preferred stock) $ 298 $ 446 $1,041 $1,299
======= ======= ====== ======
DENOMINATOR:
Denominator for basic earnings per share-
weighted-average shares 240.4 242.3 243.5 245.3
Effect of dilutive securities:
Employee stock options 15.8 14.9 16.5 12.2
Employee restricted stock units 5.6 5.4 6.3 4.7
Preferred shares assumed converted into
common -- 2.4 -- 2.4
------- ------- ------ ------
Dilutive potential common shares 21.4 22.7 22.8 19.3
------- ------- ------ ------
Denominator for diluted earnings per share -
adjusted weighted-average shares 261.8 265.0 266.3 264.6
======= ======= ====== ======
BASIC EARNINGS PER SHARE $ 1.24 $ 1.83 $ 4.28 $ 5.27
======= ======= ====== ======
DILUTED EARNINGS PER SHARE $ 1.14 $ 1.68 $ 3.91 $ 4.91
======= ======= ====== ======
14
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For August 31, 2000, Convertible Voting Preferred outstanding shares were
convertible into common shares at a conversion price of approximately $61.50 per
share. For purposes of calculating diluted earnings per share, these preferred
shares were assumed to be converted into common shares since basic earnings per
share exceeded preferred dividends per share obtainable upon conversion ($0.77
on a quarterly basis). During December 2000, the Company redeemed all
outstanding Convertible Voting Preferred shares.
11. SUBSEQUENT EVENTS:
As a result of damage sustained from the September 11, 2001, terrorist attacks
on the World Trade Center in New York, the Company's workforce located in the
World Financial Center complex and the World Trade Center was displaced.
Key business activities and necessary support functions were quickly relocated
to the Company's back-up facilities in Jersey City, New Jersey, and to various
other temporary sites. The Company has been informed that its offices in the
World Financial Center complex can be repaired, although no timetable has yet
been established for completion. In October 2001, the Company signed a letter of
intent to acquire a new one million square foot building at 745 Seventh Avenue
in New York City. The Company intends to relocate its principal executive
offices to this site.
The displacement and relocation of the Company's workforce, the closure of
certain markets for certain periods following the terrorist attacks and other
issues directly related to the September 11th tragedy have impacted the
Company's business and may affect the business for the fourth quarter. The
Company has substantial insurance in place covering the loss of its offices at
the World Trade Center and damages to facilities at the World Financial Center
complex, as well as for losses resulting from business interruption and for
extra expenses associated with the Company's temporary relocation efforts.
15
ITEM 2. 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 September 11, 2001, terrorist attacks on the World Trade Center and the
Pentagon caused securities market and other business closures and disruptions
and forced the Company to temporarily relocate its New York headquarters and
operations. The terrorist attacks, the allied military response and subsequent
developments may impact the global economy. All of these factors may affect the
Company's future results of operations. In October of 2001, Lehman Brothers
signed a letter of intent to acquire a new building at 745 Seventh Avenue in New
York City, which contains approximately one million square feet of space and is
not expected to be ready for occupancy until sometime in fiscal 2002. The
Company intends to relocate its principal executive offices to this site.
Marketplace uncertainties experienced in the second half of 2000 and the first
half of 2001 continued into the third quarter of 2001 as lower corporate profits
and a slower pace of economic growth resulted in generally weak market
conditions. In response to these conditions, the Federal Reserve lowered
interest rates twice during the fiscal third quarter bringing the Federal Funds
rate to 3.5%. Total reductions in the federal funds rates for the first nine
months of 2001 have totaled 300 basis points. In September, the Federal Reserve
lowered interest rates an additional half of a percentage point shortly
following the terrorist attacks on the World Trade Center and the Pentagon in
order to make funds more accessible to consumers, and boost consumer confidence
and the economy. In October, the Federal Reserve again cut the Federal Funds
rate another 50 basis points bringing the overnight bank lending rates to their
lowest levels in nearly 40 years.
During the quarter, all of the major U.S. equity indices declined as a result of
the poor economic conditions. The Dow Jones Industrial Average ("DJIA") finished
the quarter at 9,950, down 9% from the end of the fiscal second quarter. The
NASDAQ decreased 14% during the fiscal third quarter and the S&P 500 ended down
10% from the end of the fiscal second quarter. In first week of resumed trading
following the terrorist attacks, the DJIA and the NASDAQ declined 14% and 16%,
respectively. By mid-October, however, both indices had recovered from those
levels.
Globally, other world markets experienced the same slowing of economic growth
and recessionary fears which resulted in declines in equity market indexes. The
FTSE 100 decreased 8% during the quarter while the DAX decreased 15%. In Asia,
the Nikkei was down almost 20%, resulting in a 17-year low. To attempt to
alleviate the economic slowdown, the Bank of England and the European Central
Bank both cut interest rates 25 basis points during the fiscal quarter. For the
European Central Bank, this was the second consecutive quarter the bank cut
rates 25 basis points. For the Bank of England, this was the third consecutive
quarter with a 25 basis points cut. Consistent with the action of the U.S.
Federal Reserve, major central banks throughout the world also made additional
cuts to their respective discount rates subsequent to quarter-end to help spur
the global economy, stabilize the markets and boost consumer confidence.
In the equity origination markets, global new issuance volume for the fiscal
third quarter of 2001 was down slightly from the fiscal second quarter of 2001
and down approximately 20% from the year-ago period as equity markets continued
to feel the affects of the uncertain economic outlook. Market volume for initial
public offerings ("IPOs") was down 45% when compared to the third quarter of
2000. For the
16
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
first nine fiscal months of 2001 equity origination market volume was down 26%
and IPO market volumes were down approximately 60% compared to the first nine
fiscal months of 2000, according to Thompson Financial Securities Data Corp
("TFSD").
Fixed income markets, however, continued to benefit from declining interest
rates. Global debt new issuances, which were strong during the first half of
2001, continued this pace into the third quarter of 2001. Activity was bolstered
globally by interest rate cuts by many central banks as absolute rates continued
to be very attractive for borrowing companies. Reflecting this improving market,
debt new issuances and high yield new issuances for the quarter were both up 15%
over last year's fiscal third quarter and both up over 30% over the fiscal first
nine months of 2000, according to TFSD.
The value of merger and acquisition advisory activity slowed significantly
during the third quarter when compared to the same period a year-ago. Worldwide
completed mergers and acquisitions for the fiscal third quarter of 2001
decreased almost 60% when compared to the fiscal third quarter of 2000,
according to TFSD. In addition, "deal announcements" industry-wide decreased
over 50% when compared to the fiscal third quarter of 2000.
--------------------------------------------------------------------------------
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.
17
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED AUGUST 31, 2001 AND AUGUST 31, 2000
The Company reported net income of $309 million for the quarter ended August 31,
2001, a decrease of 32% from the third quarter of 2000. Net revenues for the
third quarter of 2001 were $1,628 million and earnings per common share
(diluted) were $1.14. Pre-tax operating margin for the third quarter was 26.7%
and return on equity was 16.2%. These relatively strong results during an
extremely difficult market environment demonstrate the growing breadth and depth
of the franchise.
The Company continues to maintain its discipline toward managing expenses, risk
and liquidity as well as capital deployment and utilization. For the quarter,
non-personnel expenses remained relatively flat from the second quarter of 2001
and increased 16% from the third quarter of 2000, as compared to a 26% increase
in headcount since the third quarter of 2000.
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 AUGUST 31, 2001 AND AUGUST 31, 2000
--------------------------------------------------------------------
Net Revenues
(in millions) for the
Three Months Ended
------------------------------
August 31 August 31
2001 2000
-------------- ---------------
Investment Banking $ 460 $ 571
Capital Markets 965 1,282
Client Services 203 199
-------------- ---------------
Total $ 1,628 $ 2,052
============== ===============
--------------------------------------------------------------------
18
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion provides an analysis of the Company's net revenues.
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 19% during the third quarter to $460
million from $571 million in the third quarter of 2000, as strong fixed income
underwriting activity was more than offset by decreases in equity origination
and merger and acquisition activity.
------------------------------------------------------
INVESTMENT BANKING NET REVENUES
------------------------------------------------------
Three Months Ended
Aug. 31 Aug. 31
(in millions) 2001 2000
------------------------------------------------------
Debt Underwriting $ 228 $ 150
Equity Underwriting 101 194
Merger and Acquisition Advisory 131 227
------------------------------------------------------
$ 460 $ 571
------------------------------------------------------
Debt underwriting revenues totaled $228 million for the third quarter of 2001, a
52% increase over last year's third quarter. Fixed income origination benefited
this quarter as issuers continued to move to raise lower-coupon long-term debt
to replace short-term financing. Also contributing to these results was an
increase in the Company's global market share for debt origination, which grew
to 6.7% for the fiscal third quarter from 5.9% for calendar year 2000, according
to TFSD.
Equity origination revenues were down 48% compared to the year-ago period, as
industry-wide equity underwriting declined. However, during the quarter the
Company continued to grow its equity underwriting market share. Global equity
origination volume share increased more than 60% to 5.4% through August 31, 2001
year-to-date versus calendar year 2000, according to TFSD.
Merger and acquisition advisory fees, essentially flat compared to the second
quarter of 2001 fees of $128, decreased 42% compared to last year's third
quarter as industry-wide volumes for completed deals decreased almost 60%.
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 $965 million for the third quarter of 2001,
down 25% from the third quarter of 2000 as strong fixed income results were more
than offset by lower equities revenues. Overall, the Company continued to have
strong institutional customer flow activity across a wide range of products.
This customer flow business provides the Company with a relatively stable form
of revenues as customers continually rebalance their portfolios across market
cycles with the full array of capital market products that are provided by the
Company.
------------------------------------------------------
CAPITAL MARKETS NET REVENUES
------------------------------------------------------
Three Months Ended
Aug. 31 Aug. 31
(in millions) 2001 2000
------------------------------------------------------
Fixed Income $ 663 $ 557
Equities 302 725
------------------------------------------------------
$ 965 $ 1,282
------------------------------------------------------
Net revenues from the fixed income component of Capital Markets increased 19%
from the third quarter of 2000 to $663 million, principally driven by a strong
level of institutional customer flow activity. Central bank easings prompted
lower rates, which led to higher volumes across almost all fixed income
19
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
products. Areas that benefited the most from the strength in institutional
customer flow included mortgages, governments, high-grade debt and municipals.
Net revenues from the equity component of Capital Markets were $302 million in
the third quarter of 2001, down significantly from the third quarter of 2000.
This decrease was driven by difficult market conditions, a slowdown in the
growth of the U.S. economy, a decrease in market volatility and declines in
revenues from both private equity and risk arbitrage investments from year-ago
levels.
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-five private equity partnerships.
Client Services' net revenues were $203 million in the third quarter of 2001 up
slightly from the third quarter of 2000. Although retail market activity
declined significantly during the quarter, the high-net-worth sector in which
the Company operates was less affected. For the third quarter, high-net-worth
sales declined only 8% compared to the third quarter of 2000, driven primarily
by weak equity markets. Partially offsetting this decline was record fixed
income activity, as investors adjusted their portfolios to compensate for the
volatile equity market environment. Private equity revenues more than doubled
from the year-ago period due principally to a $20 million incentive fee
recognized from the Company's general partner interest in a single Merchant
Banking investment.
------------------------------------------------------
CLIENT SERVICES NET REVENUES
------------------------------------------------------
Three Months Ended
Aug. 31 Aug. 31
(in millions) 2001 2000
------------------------------------------------------
Private Client $171 $186
Private Equity 32 13
------------------------------------------------------
$203 $199
------------------------------------------------------
Non-Interest Expenses Non-interest expenses were $1,193 million for the third
quarter of 2001 compared to $1,379 million for the third quarter of 2000.
Compensation and benefits expense, as a percentage of net revenues was 51% for
the quarter, consistent with the Company's fiscal 2000 level. Non-personnel
expenses were $363 million for the third quarter of 2001 compared to $312
million for the third quarter of 2000 and flat compared to the second quarter of
2001. The increase in non-personnel expenses is less than the 26% increase in
headcount from the third quarter of 2000 and reflects the Company's continued
investment in technology and increased occupancy costs offset by firmwide
savings initiatives.
Income Taxes The Company's income tax provision was $112 million for the third
quarter of 2001 versus $202 million for the third quarter of 2000. The effective
tax rate was 25.8% for the third quarter of 2001 compared to the third quarter
of 2000 tax rate of 30.0%. The decrease in the tax rate reflects a greater
impact of tax preference revenues on a lower pre-tax income base.
20
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FOR THE NINE MONTHS ENDED AUGUST 31, 2001 AND AUGUST 31, 2000
The Company reported net income of $1,125 million for the nine months ended
August 31, 2001, a decrease of 18% from the nine months ended August 31, 2000.
Earnings per common share (diluted) were $3.91 for the nine months of 2001
compared to $4.91 for the comparable period in 2000. Earnings per share
computations for both periods include the impact of the annual $50 million
dividend on the Company's Redeemable Voting Preferred Stock paid in the second
quarter. (The last such dividend will be payable in 2002, prorated for the
partial year from December 2001 through May 2002.)
These results reflect the Company's continued ability to execute its strategy of
growing its high margin investment banking and equities businesses; increasing
its presence in certain strategic businesses in Europe; and, at the same time,
maintaining a strict discipline with regard to its expenses, all during a very
difficult market environment. Net revenues were $5,533 million for the first
nine months of 2001 compared to $6,009 million for the first nine months of
2000. Pre-tax operating margin was approximately 30% through the end of the
third quarter of 2001 and return on equity (excluding the impact of the $50
million in dividends on the Company's Redeemable Voting Preferred Stock) was 20%
for the same period. Non-interest expenses decreased 2% in the first nine months
of 2001 compared to the first nine months of 2000, and the Company's
compensation and benefits ratio decreased to 51% of net revenues from 52% for
the comparable period a year ago.
In the following tables, the Company's results have been segregated into three
business segments: 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 clients as well as high-net-worth retail clients and are
recognized within the different revenue categories in the Company's Consolidated
Statement of Income. (Net revenues by segment contain certain internal
allocations, including funding costs, which are centrally managed.)
-------------------------------------------------------------------
Net Revenues
for the
(in millions) Nine Months Ended
------------------------------------
August 31 August 31
2001 2000
----------------- ---------------
Investment Banking $ 1,482 $ 1,635
Capital Markets 3,447 3,703
Client Services 604 671
----------------- ---------------
Total $ 5,533 $ 6,009
================= ===============
-------------------------------------------------------------------
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 of $1,482 million decreased 9% in
the first nine months of 2001 when compared to $1,635 million for the first nine
months of 2000. The decrease was primarily due to a decrease in equity
underwriting and merger and acquisition advisory revenues partially offset by
strong results in debt underwriting.
21
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Debt underwriting revenues increased 61% to $676 million in the first nine
months of 2001 from $419 million for the first nine months of 2000. The increase
was primarily due to an increase in fixed income issuances combined with a
increase in the Company's market share to 6.7% for the first nine months of
fiscal 2001 compared to 5.9% for calendar year 2000, according to TFSD.
------------------------------------------------------
INVESTMENT BANKING NET REVENUES
------------------------------------------------------
Nine Months Ended
Aug. 31 Aug. 31
(in millions) 2001 2000
------------------------------------------------------
Debt Underwriting $ 676 $ 419
Equity Underwriting 364 682
Merger and Acquisition Advisory 442 534
------------------------------------------------------
$1,482 $1,635
------------------------------------------------------
Equity underwriting revenues were $364 million for the first nine months of 2001
compared to $682 million for the first nine months of 2000. Although the
Company's market share for the first nine months of 2001 was up over 12% from
the year-ago period, according to TFSD, results decreased as industry-wide
equity underwriting activities were down over 25%.
Merger and acquisition advisory revenues for the first nine months of 2001
decreased 17% when compared to the first nine months of 2000 driven by a 32%
industry-wide decrease in completed market volume.
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 $3,447 million for the first nine months of
2001, down 7% from the first nine months of 2000, as an extremely weak market
environment was partially offset by strong institutional customer flow activity.
------------------------------------------------------
CAPITAL MARKETS NET REVENUES
------------------------------------------------------
Nine Months Ended
Aug. 31 Aug. 31
(in millions) 2001 2000
------------------------------------------------------
Fixed Income $1,849 $1,403
Equities 1,598 2,300
------------------------------------------------------
$3,447 $3,703
------------------------------------------------------
Net revenues from the fixed income component of Capital Markets increased to
$1,849 million for the first nine months of 2001 compared to $1,403 million for
the first nine months of 2000. These record results were driven by strong
institutional customer flow activity as clients moved into interest-rate based
products.
Net revenues from the equity component of Capital Markets decreased 31% to
$1,598 million for the first nine months of 2001 compared to $2,300 million for
the first nine months of 2000. This decrease was driven by reduced volatility
levels versus the same period last year, spread compression beginning in the
second quarter of 2001 from NASDAQ decimalization and declines in revenues from
both private equity and risk arbitrage investments from year-ago levels,
partially offset by stronger results in institutional customer flow activity and
convertible securities.
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 in
its private equity partnerships.
22
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Client Services' net revenues were $604 million for the first nine months of
2001 compared to $671 million for the first nine months of 2000. Excluding a
special performance-based asset management fee of $73 million in the year-ago
period, Client Services' results improved slightly as the Company's
high-net-worth retail sales force continued to produce strong results despite
the weak equity market environment. In addition, private equity revenues
increased from the year-ago period primarily due to a $20 million incentive fee
recognized from the Company's general partner interest in a single Merchant
Banking investment.
------------------------------------------------------
CLIENT SERVICES NET REVENUES
------------------------------------------------------
Nine Months Ended
Aug. 31 Aug. 31
(in millions) 2001 2000
------------------------------------------------------
Private Client $546 $638
Private Equity 58 33
------------------------------------------------------
$604 $671
------------------------------------------------------
Non-Interest Expenses Non-interest expenses were $3,900 million for the first
nine months of 2001 and $3,984 million for the comparable period of 2000.
Compensation and benefits expense as a percentage of net revenues decreased to
51%, which is consistent with the Company's fiscal 2000 level. Non-personnel
expenses were $1,078 million for the first nine months of 2001 and $859 million
for the first nine months of 2000, an increase of approximately 25% reflecting
the Company's strategic growth plan and the 26% increase in headcount.
Income Taxes The Company's income tax provision was $466 million for the nine
months of 2001 compared to $607 million for the nine months of 2000. The
effective tax rate was 28.5% for the first nine months of 2001 compared to 30.0%
for the first nine months of 2000. The decrease in the effective tax rate
relates to an increase in tax preference revenues on a lower level of pre-tax
income.
23
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 The 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 10% of total debt.
24
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Total Capital Total Capital (defined as long-term debt, preferred securities
subject to mandatory redemption and stockholders' equity) was $48.2 billion at
August 31, 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 employee share awards) and the
redemption of the Cumulative Convertible Voting Preferred Stock for $150
million.
Aug. 31 Nov. 30
(in millions) 2001 2000
------------------------------------------------------------------
LONG-TERM DEBT
Senior Notes $ 36,402 $ 32,106
Subordinated Indebtedness 2,934 3,127
------------ -------------
39,336 35,233
PREFERRED SECURITIES 710 860
STOCKHOLDERS' EQUITY
Preferred Equity 700 700
Common Equity 7,411 7,081
------------ -------------
8,111 7,781
------------------------------------------------------------------
TOTAL CAPITAL $ 48,157 $ 43,874
------------------------------------------------------------------
As a result of the favorable interest rate and credit spread environment, the
Company issued $8.8 billion in long-term debt, which was $3.2 million in excess
of maturing debt, during the first nine months of 2001. Long-term debt increased
to $39.3 billion at August 31, 2001 from $35.2 billion at November 30, 2000,
with a weighted-average maturity of 3.8 years at both August 31, 2001 and
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 $1 billion 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, which require, among other things, that the Company maintain
a specified level of tangible net worth. During the second quarter of 2001, the
Company elected to reduce the committed amount under the Credit Agreement to $1
billion from $2 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 multicurrency 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
25
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 $243.3 billion at August
31, 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
$156.4 billion at August 31, 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 fixed
income securities, particularly mortgages and corporate debt, associated with
increased customer flow activities within the Capital Markets business.
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 17.7x
and 16.6x as of August 31, 2001 and November 30, 2000, respectively. Consistent
with maintaining a single A credit rating, the Company targets an adjusted
leverage ratio of under 20x. The Company continued to operate below this
targeted level. Due to the nature of the Company's Capital Markets 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.
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.
On June 20, 2001, Fitch IBCA, Inc. upgraded Holdings long-term senior debt from
A to A+. Fitch also upgraded LBI's senior debt from A to A+ and its subordinated
debt from A- to A. As of August 31, 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
* Provisional ratings on shelf registration
** Senior/subordinated
26
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 August 31, 2001 and November 30, 2000 included long positions
exposure with an aggregate market value of approximately $3.4 billion and $3.5
billion, respectively, and short positions with an aggregate market value of
approximately $993 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 6 to the
Consolidated Financial Statements (Other Commitments and Contingencies).
The Company has investments in twenty-five private equity partnerships, for
which the Company acts as general partner, as well as related direct
investments. At August 31, 2001, the Company's private equity related
investments were $811 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 6 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.
27
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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
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
28
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
exposures. In addition to these risks, the MRM Department also evaluates
liquidity risks, credit and sovereign concentrations.
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
29
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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.
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.
The following table sets forth the daily value-at-risk for each component of
market risk and in total (in millions):
Three Months Ended
As of August 2001
-------------------- --------------------------------
Aug. 31 Nov. 30
2001 2000 Average High Low
--------- ---------- ---------- ---------- ----------
Interest rate risk $ 12.9 $ 12.6 $ 12.1 $ 13.7 $ 10.5
Equity price risk 15.9 15.1 15.6 17.0 12.0
Foreign exchange risk 1.8 1.5 1.7 1.9 1.5
Diversification benefit (6.8) (5.5) (6.0) (7.5) (3.5)
--------- ---------- ---------- ---------- ----------
Total Company $ 23.8 $ 23.7 $ 23.4 $ 25.1 $ 20.5
========= ========== ========== ========== ==========
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.
30
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Trading Net Revenues Distribution Substantially all of our inventory positions
are marked-to-market on a daily basis and changes are recorded in net revenues.
The following chart sets forth the frequency distribution for substantially all
of the Company's trading net revenues on a weekly basis for the three months
ended August 31, 2001:
N |
O. 10 |
9 |
O 8 |
F 7 |
6 |
W 5 |
E 4 |
E 3 | X X X
K 2 | X X X X X
S 1 | X X X X X X
------------------------------------------------------------
<$0 $0-60 $60-90 $90-120 $120-150 $150+
WEEKLY TRADING NET REVENUES ($ IN MILLIONS)
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 began on March 31, 2001 and the collateral disclosure rules
began during the second quarter. The collateral accounting rules will be
effective for the Company's year-end financial statements. The adoption of
31
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
SFAS 140 is not expected to have a material impact to the Company's financial
position or results of operations.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No.
142, "Goodwill and Other Intangibles Assets". SFAS 141 requires all business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method. Under SFAS No. 142, intangible assets with indefinite lives and
goodwill will no longer be required to be amortized. Instead, these assets will
be evaluated annually for impairment. The Company will adopt the provisions of
SFAS No. 142 at the beginning of fiscal year 2002 and does not expect the
adoption to have a material impact to the Company's financial position or
results of operations.
32
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information under the caption "Item 2, Management's Discussion and Analysis
of Financial Condition and Results of Operations--Risk Management" above in this
Report is incorporated herein by reference.
33
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, 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.
Lehman Brothers Commercial Corporation and Lehman Brothers Special Financing
Inc. v. Minmetals International Non-Ferrous Metals Trading Company (Reported in
Holdings' 2000 Annual Report on Form 10-K and Quarterly Report on Form 10-Q for
the quarter ended May 31, 2001)
The trial date has been postponed to December 10, 2001.
34
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 theretofore 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 (Incorporated
by reference to Exhibit 3.5 to the Registrant's Quarterly Report
on Form 10-Q for the quarter ended February 28, 2001)
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)
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 10 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)
35
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 August 21, 2001, Item 7
2. Form 8-K dated August 14, 2001, Item 7.
3. Form 8-K dated July 26, 2001, Item 7.
4. Form 8-K dated July 3, 2001, Item 7.
5. Form 8-K dated June 29, 2001, Item 7.
6. Form 8-K dated June 19, 2001, Items 5 and 7.
Financial Statements:
Exhibit 99.2 Consolidated Statement of Income
(Three Months Ended May 31, 2001)
(Preliminary and Unaudited)
Exhibit 99.3 Consolidated Statement of Income
(Six Months Ended May 31, 2001)
(Preliminary and Unaudited)
Exhibit 99.4 Segment Net Revenue Information
(Three and Six Months Ended May 31, 2001)
(Preliminary and Unaudited)
Exhibit 99.5 Selected Statistical Information
(Preliminary and Unaudited)
7. Form 8-K dated June 14, 2001, Item 7.
8. Form 8-K dated June 1, 2001, Item 7.
36
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: October 15, 2001 By: /s/ David Goldfarb
--------------------------------------------------
Chief Financial Officer
(principal financial and accounting officer)
37
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT
Exhibit 12.1 Computation of Ratios of Earnings to Fixed Charges and to
Combined Fixed Charges and Preferred Stock Dividends