-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SGVwUnfxTf8RrnWpeL9wgXDm91hb0T3XsMEKp65toVqCBL2dHrx27Kl/gypjZiQv MXhw4JIZMjOtq6TDMQFCLg== 0000912057-02-015117.txt : 20020416 0000912057-02-015117.hdr.sgml : 20020416 ACCESSION NUMBER: 0000912057-02-015117 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20020228 FILED AS OF DATE: 20020415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LEHMAN BROTHERS HOLDINGS INC CENTRAL INDEX KEY: 0000806085 STANDARD INDUSTRIAL CLASSIFICATION: SECURITY BROKERS, DEALERS & FLOTATION COMPANIES [6211] IRS NUMBER: 133216325 STATE OF INCORPORATION: DE FISCAL YEAR END: 1130 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-09466 FILM NUMBER: 02611261 BUSINESS ADDRESS: STREET 1: LEHMAN BROTHERS STREET 2: 3 WORLD FINANCIAL CENTER CITY: NEW YORK STATE: NY ZIP: 10285 BUSINESS PHONE: 2125267000 MAIL ADDRESS: STREET 1: LEHMAN BROTHERS STREET 2: 3 WORLD FINANCIAL CENTER CITY: NEW YORK STATE: NY ZIP: 10285 FORMER COMPANY: FORMER CONFORMED NAME: SHEARSON LEHMAN HUTTON HOLDINGS INC DATE OF NAME CHANGE: 19901017 10-Q 1 a2076954z10-q.txt 10-Q ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED FEBRUARY 28, 2002 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) 745 SEVENTH AVENUE NEW YORK, NEW YORK 10019 (Address of princip (Zip Code) executive offices)
(212) 526-7000 (Registrant's telephone number, including area code) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. Yes |X| No |_| AS OF MARCH 31, 2002, 244,042,186 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE $0.10 PER SHARE, WERE OUTSTANDING. ================================================================================ LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED FEBRUARY 28, 2002 INDEX
PART I. FINANCIAL INFORMATION PAGE --------------------- NUMBER ------ Item 1. Financial Statements - (unaudited) Consolidated Statement of Income - Three Months Ended February 28, 2002 and February 28, 2001.................................... 2 Consolidated Statement of Financial Condition - February 28, 2002 and November 30, 2001.................................... 3 Consolidated Statement of Cash Flows - Three Months Ended February 28, 2002 and February 28, 2001.................................... 5 Notes to Consolidated Financial Statements................................. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 16 Item 3. Quantitative and Qualitative Disclosures About Market Risk...................... 30 PART II. OTHER INFORMATION ----------------- Item 1. Legal Proceedings............................................................... 31 Item 6. Exhibits and Reports on Form 8-K................................................ 33 SIGNATURE............................................................................................... 35 EXHIBIT INDEX........................................................................................... 36 EXHIBITS
LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES PART I - FINANCIAL INFORMATION ITEM 1 FINANCIAL STATEMENTS -------------------- LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) (IN MILLIONS, EXCEPT PER SHARE DATA)
Three months ended ------------------------------ February 28 February 28 2002 2001 ------------- -------------- Revenues Principal transactions $ 569 $ 998 Investment banking 470 483 Commissions 289 278 Interest and dividends 2,886 4,981 Other 12 12 ------------- -------------- Total revenues 4,226 6,752 Interest expense 2,620 4,869 ------------- -------------- Net revenues 1,606 1,883 ------------- -------------- Non-interest expenses Compensation and benefits 819 960 Technology and communications 122 112 Brokerage and clearance 75 77 Occupancy 69 41 Business development 34 50 Professional fees 20 47 Other 27 23 ------------- -------------- Total non-interest expenses 1,166 1,310 ------------- -------------- Income from operations before taxes and dividends on trust preferred securities 440 573 Provision for income taxes 128 172 Dividends on trust preferred securities 14 14 ------------- -------------- Net income $ 298 $ 387 ============= ============== Net income applicable to common stock $ 262 $ 375 ============= ============== Earnings per common share Basic $ 1.07 $ 1.52 ============= ============== Diluted $ 0.99 $ 1.39 ============= ==============
See notes to consolidated financial statements. 2 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL CONDITION (UNAUDITED) (IN MILLIONS)
February 28 November 30 2002 2001 --------------- --------------- ASSETS Cash and cash equivalents $ 2,523 $ 2,561 Cash and securities segregated and on deposit for regulatory and other purposes 3,322 3,289 Securities and other financial instruments owned: Mortgages and mortgage-backed 29,136 33,210 Governments and agencies 22,874 24,101 Derivatives and other contractual agreements 11,078 11,555 Corporate debt and other 9,394 10,918 Corporate equities 7,518 8,302 Certificates of deposit and other money market instruments 2,862 2,759 ---------------------------------- Subtotal 82,862 90,845 Securities owned pledged as collateral 41,028 28,517 ---------------------------------- 123,890 119,362 ---------------------------------- Collateralized short-term agreements: Securities purchased under agreements to resell 91,211 83,278 Securities borrowed 19,561 17,994 Receivables: Brokers, dealers and clearing organizations 3,071 3,455 Customers 10,595 12,123 Others 1,482 1,479 Property, equipment and leasehold improvements (net of accumulated depreciation and amortization of $467 in 2002 and $424 in 2001) 1,636 1,495 Other assets 2,588 2,613 Excess of cost over fair value of net assets acquired (net of accumulated amortization of $152 in 2002 and $151 in 2001) 182 167 --------------- ---------------- Total assets $260,061 $247,816 =============== ================
See notes to consolidated financial statements. 3 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF FINANCIAL CONDITION - (CONTINUED) (UNAUDITED) (IN MILLIONS, EXCEPT SHARE DATA)
February 28 November 30 2002 2001 ---------------- ----------------- LIABILITIES AND STOCKHOLDERS' EQUITY Commercial paper and short-term debt $ 3,201 $ 4,865 Securities and other financial instruments sold but not yet purchased: Governments and agencies 35,658 25,547 Derivatives and other contractual agreements 10,129 10,324 Corporate debt and other 9,336 6,482 Corporate equities 7,367 8,977 ---------------- ----------------- 62,490 51,330 ---------------- ----------------- Collateralized short-term financing: Securities sold under agreements to repurchase 110,714 105,079 Securities loaned 12,324 12,541 Payables: Brokers, dealers and clearing organizations 1,342 2,805 Customers 12,099 13,831 Accrued liabilities and other payables 10,548 9,895 Long-term debt: Senior notes 35,274 35,373 Subordinated indebtedness 2,711 2,928 ---------------- ----------------- Total liabilities 250,703 238,647 ---------------- ----------------- Commitments and contingencies Preferred securities subject to mandatory redemption 710 710 STOCKHOLDERS' EQUITY Preferred stock 700 700 Common stock, $0.10 par value; Shares authorized: 600,000,000 in 2002 and 2001; Shares issued: 256,314,463 in 2002 and 256,178,907 in 2001; Shares outstanding: 244,169,647 in 2002 and 237,534,091 in 2001 25 25 Additional paid-in capital 3,205 3,562 Accumulated other comprehensive income (net of tax) (11) (10) Retained earnings 5,039 4,798 Other stockholders' equity, net 573 746 Common stock in treasury, at cost: 12,144,816 shares in 2002 and 18,644,816 shares in 2001 (883) (1,362) ---------------- ----------------- Total stockholders' equity 8,648 8,459 ---------------- ----------------- Total liabilities and stockholders' equity $ 260,061 $ 247,816 ================ =================
See notes to consolidated financial statements. 4 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) (IN MILLIONS)
Three Months Ended ------------------------------------ February 28 February 28 2002 2001 ---------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 298 $ 387 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 52 38 Tax benefit from issuance of stock-based awards 35 65 Amortization of deferred stock compensation 137 127 Other adjustments 23 17 Net change in: Cash and securities segregated and on deposit (33) (854) Securities and other financial instruments owned (5,027) (8,377) Securities borrowed (1,567) (1,183) Receivables from brokers, dealers and clearing organizations 384 (1,307) Receivables from customers 1,528 (2,051) Securities and other financial instruments sold but not yet purchased 11,160 9,471 Securities loaned (217) 2,897 Payables to brokers, dealers and clearing organizations (1,463) 204 Payables to customers (1,732) 2,600 Accrued liabilities and other payables 638 (249) Other operating assets and liabilities, net 55 (193) ---------------- ---------------- Net cash provided by operating activities 4,271 1,592 ---------------- ---------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of senior notes 1,925 2,485 Principal payments of senior notes (1,545) (2,059) Principal payments of subordinated indebtedness (221) (194) Net payments for commercial paper and short-term debt (1,664) (929) Resale agreements net of repurchase agreements (2,298) (2,609) Payments for treasury stock purchases (254) (679) Dividends paid or accrued (58) (30) Issuances of common stock 1 26 Payments for repurchases of preferred stock -- (100) ---------------- ---------------- Net cash used in financing activities (4,114) (4,089) ---------------- ---------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property, equipment and leasehold improvements, net (179) (128) Acquisition, net of cash acquired (16) -- ---------------- ---------------- Net cash used in investment activities (195) (128) ---------------- ---------------- Net change in cash and cash equivalents (38) (2,625) ---------------- ---------------- Cash and cash equivalents, beginning of period 2,561 5,160 ---------------- ---------------- Cash and cash equivalents, end of period $ 2,523 $ 2,535 ================ ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (IN MILLIONS) Interest paid totaled $2,682 and $5,006 for the three months ended February 28, 2002 and February 28, 2001, respectively. Income taxes paid totaled $21 and $137 for the three months ended February 28, 2002 and February 28, 2001, respectively. See notes to consolidated financial statements. 5 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 Holdings' Annual Report on Form 10-K for the twelve months ended November 30, 2001 (the "Form 10-K"). The Consolidated Statement of Financial Condition at November 30, 2001 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. EVENTS OF SEPTEMBER 11, 2001: As a result of the September 11, 2001 terrorist attack, the Company's leased facilities in the World Trade Center were destroyed and its leased and owned facilities in the World Financial Center complex (including the 3 World Financial Center building owned jointly with American Express) were significantly damaged. During the fourth quarter of 2001, the Company recognized a pretax special charge of $127 million ($71 million after-tax) associated with the net losses stemming from the events of September 11, 2001. These losses and costs included the write-off of property damaged, destroyed or abandoned at the Company's downtown facilities (approximately $340 million), compensation paid to employees in lieu of utilizing external consultants for business recovery efforts and to employees for the time they were idled (approximately $100 million), costs incurred to maintain the facilities while they are unusable (approximately $16 million), and other costs associated with redeployment of the Company's workforce to the temporary facilities (approximately $31 million). The losses and costs were offset by estimated insurance recoveries of $360 million. All expenses associated with the Company's use of temporary facilities during this period were reflected as part of occupancy or technology and communications expenses in the consolidated statement of income for the fiscal year ended November 30, 2001, incorporated by reference in the Form 10-K. In the first quarter of 2002, the Company incurred special costs resulting from the terrorist attack of approximately $12 million related to technology restoration and other costs associated with unusable facilities, which were fully offset by estimated insurance recoveries. In addition, during the first quarter of 2002, the Company incurred costs of approximately $9 million to repair damage incurred to the core and shell of the Company's 3 World Financial Center facility, which were fully offset by estimated insurance recoveries. The repair of the 3 World Financial Center facility is ongoing and is expected to be fully recoverable under the Company's building core and shell insurance policy. 6 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For further information regarding the special charge recognized during the fourth quarter of 2001 and the effects of the terrorist attack, refer to Note 2 to the Consolidated Financial Statements incorporated by reference in the Form 10-K. 3. LONG-TERM DEBT: During the three months ended February 28, 2002, the Company issued $1,925 million of long-term debt (all of which were senior notes). Of the total issuances during the period, $1,038 million were U.S. dollar fixed rate, $525 million were U.S. dollar floating rate, $151 million were foreign currency denominated fixed rate, and $211 million were foreign currency denominated floating rate. These issuances were primarily utilized to refinance current maturities of long-term debt in 2002 and to increase total capital (stockholders' equity, long-term debt and preferred securities subject to mandatory redemption). The Company's floating rate new issuances contain contractual interest rates based primarily on London Interbank Offered Rates ("LIBOR"). All of the Company's fixed rate new issuances were effectively converted to floating rate obligations through the use of interest rate swaps. Of the foreign denominated new issuances totaling $362 million, $137 million were effectively swapped to U.S. Dollars, with the remainder match funding foreign currency denominated capital needs. The Company had $1,545 million of long-term debt mature during the three months ended February 28, 2002. Long-term debt at February 28, 2002, scheduled to mature within one year totaled $7,649 million. 4. CAPITAL REQUIREMENTS: The Company operates globally through a network of subsidiaries, with several subject to regulatory requirements. In the United States, LBI, as a registered broker-dealer, is subject to SEC Rule 15c3-1, the Net Capital Rule, which requires LBI to maintain net capital of not less than the greater of 2% of aggregate debit items arising from customer transactions, as defined, or 4% of funds required to be segregated for customers' regulated commodity accounts, as defined. At February 28, 2002, LBI's regulatory net capital, as defined, of $1,662 million exceeded the minimum requirement by $1,549 million. Lehman Brothers International (Europe) ("LBIE"), a United Kingdom registered broker-dealer and subsidiary of Holdings, is subject to the capital requirements of the Financial Services Authority ("FSA") of the United Kingdom. Financial resources, as defined, must exceed the total financial resources requirement of the FSA. At February 28, 2002, LBIE's financial resources of approximately $2,340 million exceeded the minimum requirement by approximately $650 million. Lehman Brothers Japan Inc.'s Tokyo branch, a regulated broker-dealer, is subject to the capital requirements of the Financial Services Agency and at February 28, 2002, had net capital of approximately $259 million which was approximately $90 million in excess of the specified levels required. Lehman Brothers Bank, FSB (the "Bank"), the Company's thrift subsidiary, is regulated by the Office of Thrift Supervision ("OTS"). The Bank exceeds all regulatory capital requirements and is considered well capitalized by the OTS. Certain other non-U.S. subsidiaries are subject to various securities, commodities and banking regulations and capital adequacy requirements promulgated by the regulatory and exchange authorities of the countries in which they operate. At February 28, 2002, these other subsidiaries were in compliance with their applicable local capital adequacy requirements. In addition, the Company's "AAA" rated derivatives subsidiaries, Lehman Brothers Financial Products Inc. ("LBFP") and Lehman Brothers Derivative Products Inc. ("LBDP"), have established certain capital and operating restrictions which are reviewed by various rating agencies. At February 28, 2002, LBFP and LBDP each had capital which exceeded the requirement of the most stringent rating agency by approximately $76 million and $28 million, respectively. 7 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. 5. DERIVATIVE FINANCIAL INSTRUMENTS: Effective December 1, 2000, the Company adopted Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," which requires that all derivative instruments be reported on the consolidated statement of financial condition at fair value and establishes criteria for designation and effectiveness of hedging relationships. The adoption of SFAS No. 133 did not have a material effect on the Company's Consolidated Statement of Financial Condition or its results of operations. Most of the Company's derivative transactions are entered into for trading-related activities for which the adoption of SFAS No. 133 had no accounting impact. The Company's trading-related derivative activities are marked-to-market through earnings as a component of Principal Transactions revenues. The Company also utilizes derivatives for non-trading purposes as an end user to modify the market risk exposures of certain assets and liabilities. In this regard, the Company primarily enters into fair value hedges utilizing interest rate swaps to convert a substantial portion of the Company's fixed rate long-term debt and certain term fixed rate secured financing activities to a floating interest rate. The ineffective portion of the fair value hedges were included in "Interest Expense" on the Consolidated Statement of Income and were immaterial for the three months ended February 28, 2002 and 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 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. 8 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FAIR VALUE* FAIR VALUE* FEBRUARY 28, 2002 NOVEMBER 30, 2001 ------------------------------------------------------------------- (IN MILLIONS) ASSETS LIABILITIES ASSETS LIABILITIES - ------------------------------------------------------------------------------------------------------------------------- Interest rate, currency and credit default swaps, and options (including caps, collars and floors) $5,714 $5,156 $ 6,482 $ 6,485 Foreign exchange forward contracts and options 860 1,132 740 1,111 Other fixed income securities contracts (including futures contracts, options and TBAs) 768 1,163 747 226 Equity contracts (including equity swaps, warrants and options) 3,736 2,678 3,586 2,502 ------------------------------------------------------------------- TOTAL $11,078 $10,129 $11,555 $10,324 -------------------------------------------------------------------
* Amounts represent carrying value (exclusive of collateral) and do not include receivables or payables related to exchange-traded futures contracts. In addition, includes end-user derivative activity on a mark-to-market basis in accordance with SFAS No. 133. Assets included in the table above represent the Company's net receivable/payable for derivative financial instruments before consideration of collateral. Included within the $11,078 million fair value of assets at February 28, 2002 was $10,112 million related to swaps and other over-the-counter ("OTC") contracts and $966 million related to exchange-traded option and warrant contracts. Included within the $11,555 million fair value of assets at November 30, 2001 was $10,555 million related to swaps and other OTC contracts and $1,000 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 $6,144 million at February 28, 2002, representing the fair value of the Company's OTC contracts in an unrealized gain position, after consideration of collateral. Presented below is an analysis of the Company's net credit exposure at February 28, 2002 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 14% 2 AA-/Aa3 or higher 26% 3 A-/A3 or higher 34% 4 BBB-/Baa3 or higher 22% 5 BB-/Ba3 or higher 3% 6 B+/B1 or lower 1%
9 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company's OTC contracts credit exposure by weighted-average maturity is set forth below:
Less Greater Counterparty Than 2-5 5-10 than Risk Rating 1 Year Years Years 10 Years Total --------------------------------------------------------------------------------- 1 2% 5% 4% 3% 14% 2 5% 11% 5% 5% 26% 3 9% 15% 4% 6% 34% 4 6% 6% 3% 7% 22% 5 1% 1% - 1% 3% 6 1% - - - 1% --------------------------------------------------------------------------------- Total 24% 38% 16% 22% 100% =================================================================================
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 the 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 the Notes to the Consolidated Financial Statements, incorporated by reference in the Form 10-K. 6. SECURITIZATIONS: The Company is a market leader in mortgage- and asset-backed securitizations and other structured financing arrangements. In connection with these activities, the Company utilizes special purpose entities principally for (but not limited to) the securitization of commercial and residential mortgages, home equity loans, government and corporate bonds, and lease and trade receivables. The Company derecognizes financial assets transferred in securitizations provided that the Company has relinquished control over such assets. The Company may retain an interest in the financial assets it securitizes ("Retained Interests") which may include assets in the form of residual interests in the special purpose entities established to facilitate the securitization. Any Retained Interests are included in Securities and Other Financial Instruments Owned within the Company's Statement of Financial Condition. 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. When 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. During the first quarter of fiscal 2002, the Company securitized approximately $26 billion of financial assets. As of February 28, 2002, the Company had approximately $1.1 billion of non-investment grade retained interests from its securitization activities. The Company records its Retained Interests at fair value and actively monitors the market risk exposures associated with Retained Interests. 10 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 7. SECURITIES PLEDGED AS COLLATERAL: The Company enters into secured borrowing and lending transactions to finance trading inventory positions, obtain securities for settlement, and meet customers' needs. The Company primarily receives collateral in connection with resale agreements, securities borrowed transactions, customer margin loans and other loans. The Company is generally permitted to sell or repledge these securities held as collateral and use the securities to secure repurchase agreements, enter into securities lending transactions or deliver to counterparties to cover short positions. The Company carries secured financing agreements for financial reporting purposes on a net basis when permitted under the provision of Financial Accounting Standards Board Interpretations No. 41 ("FIN 41"). At February 28, 2002 and November 30, 2001, the fair value of securities received as collateral and securities owned that have not been sold, repledged or otherwise encumbered totaled approximately $43 billion and $38 billion, respectively. At February 28, 2002 and November 30, 2001, the gross fair value of securities received as collateral where the Company was permitted to sell or repledge the securities was approximately $263 billion and $245 billion, respectively. Of this collateral, approximately $251 billion and $234 billion at February 28, 2002 and November 30, 2001, respectively, has been sold or repledged, generally as collateral under repurchase agreements or to cover securities and other financial instruments sold but not yet purchased. Securities owned pledged as collateral at February 28, 2002 and November 30, 2001 for which the counterparty has the right to sell or repledge are comprised of the following amounts:
FEBRUARY 28, NOVEMBER 30, (IN MILLIONS) 2002 2001 - -------------------------------------------------------------------------------------------------------------------- Securities and other financial instruments owned: Corporate equities $15,246 $15,178 Governments and agencies 10,281 2,596 Corporate debt and other 9,235 10,051 Mortgages and mortgage-backed 5,531 - Certificates of deposit and other money market instruments 735 692 - -------------------------------------------------------------------------------------------------------------------- Total $41,028 $28,517 ====================================================================================================================
The carrying value of securities and other financial instruments owned that have been pledged to counterparties where those counterparties do not have the right to sell or repledge are as follows:
FEBRUARY 28, NOVEMBER 30, (IN MILLIONS) 2002 2001 - -------------------------------------------------------------------------------------------------------------------- Securities and other financial instruments owned: Governments and agencies $17,703 $17,672 Mortgages and mortgage-backed 15,096 20,776 Corporate debt and other 4,196 7,199 Certificates of deposit and other money market instruments 2,015 2,173 Corporate equities 1,807 4,098 - -------------------------------------------------------------------------------------------------------------------- Total $40,817 $51,918 ====================================================================================================================
11 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. OTHER COMMITMENTS AND CONTINGENCIES: As of February 28, 2002 and November 30, 2001, the Company was contingently liable for $1.0 billion and $1.1 billion, respectively, of letters of credit, primarily used to provide collateral for securities and commodities borrowed and to satisfy margin deposits at option and commodity exchanges, and other guarantees. In connection with its financing activities, the Company had outstanding commitments under certain lending arrangements of approximately $2.0 billion and $2.1 billion at February 28, 2002 and November 30, 2001, 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, at February 28, 2002 the Company had commitments to enter into forward starting secured resale and repurchase agreements of $60.0 billon and $23.7 billion, respectively, as compared to $52.3 billion and $26.5 billion, respectively, at November 30, 2001. 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. The Company utilizes various hedging and funding strategies to actively manage its market, credit and liquidity conditions exposures on these commitments. In addition, total commitments are not indicative of actual risk or funding requirements, as the commitments may not be drawn or fully utilized. These commitments and any related draw downs of these facilities typically have fixed maturity dates and are contingent upon certain representations, warranties and contractual conditions applicable to the borrower. At February 28, 2002 and November 30, 2001, the Company had net lending commitments to investment grade borrowers of $3.3 billion (gross commitments of $5.3 billion less $2.0 billion of associated hedges) and $4.1 (gross commitments of $5.9 billion less $1.8 billion of associated hedges), respectively. Lending commitments to non-investment grade borrowers totaled $1.4 billion at both February 28, 2002 and November 30, 2001, respectively. In addition, the Company has pre-arranged funding facilities with third party lenders of $4.9 billion at both February 28, 2002 and November 30, 2001, available against these commitments. These funding facilities contain limits for certain concentrations of counterparty, industry or credit ratings of the underlying loans. At February 28, 2002 and November 30, 2001, the Company had commitments to invest up to $787 million and $555 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. After considering all relevant facts, available insurance coverage and the advice of counsel, in the opinion of the Company such litigation will not, in the aggregate, have a material adverse effect on the Company's consolidated financial position, but may be material to the Company's operating results for any particular period, depending on the level of income for such period. 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, credit or counterparty, liquidity, legal and operational risks. Management has developed a control infrastructure throughout the Company to monitor 12 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS and manage these risks on a global basis. For further discussion of these matters, refer to the Risk Management section of Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated by reference in the Form 10-K and the Risk Management section of Management's Discussion and Analysis of Financial Condition and Results of Operations contained in this Report. 9. SEGMENTS: The Company operates in three segments: Investment Banking, Capital Markets and Client Services. The Investment Banking Division provides advice to corporate, institutional and government clients throughout the world on mergers, acquisitions and other financial matters. The Division also raises capital for clients by underwriting public and private offerings of debt and equity securities. The Capital Markets Division includes the Company's institutional sales, trading, research and financing activities in equity and fixed income cash and derivatives products. Through the Division, the Company is a global market-maker in numerous equity and fixed income products, including U.S., European and Asian equities, government and agency securities, money market products, corporate high grade, high yield and emerging market securities, mortgage- and asset-backed securities, municipal securities, bank loans, foreign exchange and derivatives products. The Division also includes the Company's risk arbitrage and secured financing businesses, as well as realized and unrealized gains and losses related to the Company's direct private equity investments. The financing business manages the Company's equity and fixed income matched book activities, supplies secured financing to institutional clients and customers, and provides secured funding for the Company's inventory of equity and fixed income products. Client Services revenues reflect earnings from the Company's private client and private equity businesses. Private Client revenues reflect the Company's high-net-worth retail customer flow activities as well as asset management fees earned from these clients. Private Equity revenues include the management and incentive fees earned in the Company's role as general partner for thirty-three private equity partnerships. In addition, these revenues also include the appreciation of its general partnership interests. The Company's segment information for the first quarter of 2002 and 2001 is presented below and was developed consistent with the accounting policies used to prepare the Company's consolidated financial statements.
INVESTMENT CAPITAL CLIENT (IN MILLIONS) BANKING MARKETS SERVICES TOTAL ---------------- ------------- ------------- ------------ FEBRUARY 28, 2002 Net Revenue $ 459 $ 945 $ 202 $ 1,606 ================ ============= ============= ============ Earnings before taxes (1) $ 118 $ 276 $ 46 $ 440 ================ ============= ============= ============ Segment assets (billions) $1.6 $ 252.8 $ 5.7 $ 260.1 ================ ============= ============= ============ FEBRUARY 28, 2001 Net Revenue $ 471 $ 1,208 $ 204 $ 1,883 ================ ============= ============= ============ Earnings before taxes (1) $ 75 $ 451 $ 47 $ 573 ================ ============= ============= ============ Segment assets (billions) $1.4 $ 229.2 $ 5.7 $ 236.3 ================ ============= ============= ============
(1) And before dividends on preferred securities. 13 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following are net revenues by geographic region:
February 28 February 28 (IN MILLIONS) 2002 2001 ------------------- ------------------- U.S. $ 1,057 $ 1,232 Europe 417 519 Asia Pacific and other 132 132 ------------------- ------------------- Total $ 1,606 $ 1,883 =================== ===================
10. INCENTIVE PLANS: In February of 2002, the Company transferred 9.3 million shares of its common stock held in treasury into the Company's irrevocable grantor trust for restricted stock units (the "RSU Trust") awarded to current and former employees. The RSU Trust is included in the Consolidated Statement of Financial Condition as a component of other stockholders' equity. The transfer had no impact on the total stockholders' equity of the Company, as the decrease in treasury stock was offset by a corresponding decrease in additional paid-in capital and other stockholders' equity. At February 28, 2002 and November 30, 2001, 49.7 million and 45.7 million outstanding shares, respectively, were held in the RSU Trust. 11. EARNINGS PER COMMON SHARE: Earnings per share was calculated as follows (in millions, except for per share data):
THREE MONTHS ENDED ------------------------------------- FEBRUARY 28 FEBRUARY 28 2002 2001 ---------------- ---------------- NUMERATOR: Net income $298 $387 Preferred stock dividends (36) (12) ---------------- ---------------- Numerator for basic and diluted earnings per share-income available to common stockholders $262 $375 ================ ================ DENOMINATOR: Denominator for basic earnings per share - weighted-average shares 245.3 246.2 Effect of dilutive securities: Employee stock options 15.1 17.3 Employee restricted stock units 4.8 7.2 ---------------- ---------------- Dilutive potential common shares 19.9 24.5 ---------------- ---------------- Denominator for diluted earnings per share - adjusted weighted- average shares 265.2 270.7 ================ ================ BASIC EARNINGS PER SHARE $1.07 $1.52 ================ ================ DILUTED EARNINGS PER SHARE $0.99 $1.39 ================ ================
14 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 12. SUBSEQUENT EVENT: Subsequent to quarter-end, Holdings issued $575 million in 20-year convertible floating-rate senior notes. The proceeds from the issuance of the notes will be used to refinance current maturities of long-term debt and increase total capital. The notes carry an initial coupon of 0.9% below three-month LIBOR, subject to adjustment in certain events. The notes are redeemable by Holdings at par after April 1, 2004. The holders of notes may cause Holdings to repurchase the notes at par on April 1, 2004, 2007, 2012 or 2017, or upon a change of control of Holdings. The notes are convertible in certain circumstances (including upon the trading price of the common stock or of the notes reaching certain levels, a downgrade of the ratings of the notes and certain other events) into common stock of Holdings at $96.10 per share, subject to adjustment for certain events. The description of the notes herein is only a summary; a complete description of the notes is contained in Exhibit 4.01 to Holdings' Current Report on Form 8-K dated March 26, 2002, which is incorporated herein by reference. 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 sales and trading, 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. Marketplace uncertainties experienced throughout 2001 continued into the first quarter of 2002. In response to these conditions and to stimulate growth, the Federal Reserve lowered interest rates 25 basis points in mid-December, the eleventh reduction in the Federal Funds rate since January of 2001. As of February 28, 2002, the Federal Funds rate was 1.75%, its lowest level in nearly 40 years. These economic conditions, combined with a number of high-profile defaults and concerns over accounting and corporate governance issues, produced lower returns in all major equity markets during the fiscal first quarter of 2002, when compared to the same period a year ago. The Standard & Poor's 500 Index declined by 11% from the end of the fiscal first quarter of 2001 and 3% from the end of fiscal year 2001. The NASDAQ experienced even greater deterioration, closing the fiscal first quarter of 2002 with decreases of 20% from a year ago and 10% from November 30, 2001. Globally, other world markets experienced the same slowing of growth and declines in equity market valuations. The FTSE 100 decreased 14% from the end of the fiscal first quarter of 2001, while the DAX decreased 19%. In Asia, the Nikkei was down 18% from the end of the fiscal first quarter of 2001, resulting in its lowest level in the past two decades. Equity origination markets improved during the quarter as economic data released towards the end of the fiscal quarter pointed to the early stages of a possible cyclical recovery. As a result, global equity origination market volume was up 17% when compared to the fiscal first quarter of 2001, according to Thomson Financial Securities Data Corp. ("TFSD"). Fixed income markets, which benefited from declining interest rates during 2001, continued to be strong during the fiscal first quarter of 2002, as lower interest rates resulted in very attractive borrowing rates. The volume of global debt origination was up approximately 7% when compared to the fiscal first quarter of 2001, according to TFSD. - -------------------------------------------------------------------------------- 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 AND LIQUIDITY RISKS INCLUDE CHANGES IN INTEREST AND FOREIGN EXCHANGE RATES AND SECURITIES AND COMMODITIES VALUATIONS, THE AVAILABILITY AND COST OF CAPITAL AND CREDIT, CHANGES IN INVESTOR SENTIMENT, GLOBAL ECONOMIC AND POLITICAL TRENDS AND INDUSTRY COMPETITION. LEGAL RISKS INCLUDE LEGISLATIVE AND REGULATORY DEVELOPMENTS IN THE U.S. AND THROUGHOUT THE WORLD. 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 AND, ACCORDINGLY, READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH STATEMENTS. THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. 16 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Merger and acquisition advisory activity, which slowed considerably in 2001, continued to be weak during the fiscal first quarter of 2002. Quarterly merger and acquisition advisory volume reached its lowest level since 1997, as the combination of accounting concerns and weak global equity markets led to a significant reduction in activity. Worldwide completed mergers and acquisitions for the fiscal first quarter of 2002 decreased almost 75% from the fiscal first quarter of 2001, according to TFSD. In addition, announced transaction volumes industry-wide decreased approximately 45% when compared to the fiscal first quarter of 2001. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED FEBRUARY 28, 2002 AND FEBRUARY 28, 2001 The Company reported net income of $298 million for the quarter ended February 28, 2002, a decrease of 23% from the first quarter of 2001. Net revenues for the first quarter of 2002 were $1,606 million and earnings per common share (diluted) were $0.99. During the quarter, the Company accrued a $25 million special preferred dividend on its Redeemable Voting Preferred Stock, the final payment required. The Company's pre-tax operating margin for the first quarter was 27.4%, and its return on equity was 14.6% (excluding the impact of the special preferred dividend). These relatively strong results in a very difficult market environment demonstrate the growing breadth and depth of the Company's franchise. The Company continued to maintain strict discipline with regard to expense management, risk management and capital deployment. For the quarter, non-personnel expenses decreased slightly from the first quarter of 2001 and remained relatively flat when compared to the fourth quarter of 2001. The Company is segregated into 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 all revenue categories contained in the Company's Consolidated Statement of Income. (Net revenues by segment also contain certain internal allocations, including funding costs, which are centrally managed.) THREE MONTHS ENDED FEBRUARY 28, 2002 AND FEBRUARY 28, 2001
(IN MILLIONS) Net Revenues ---------------------------------- for the Three Months Ended ----------------------------------- Feb 28 Feb 28 2002 2001 ---------------- --------------- Investment Banking $ 459 $ 471 Capital Markets 945 1,208 Client Services 202 204 ---------------- --------------- Total $ 1,606 $ 1,883 ================ ===============
The following discussion provides an analysis of the Company's net revenues. 17 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 3% during the first quarter of 2002 to $459 million from $471 million in the first quarter of 2001, as strong fixed income and improved equity underwriting activity was more than offset by a decrease in merger and acquisition ("M&A") advisory activity.
- -------------------------------------------------------- INVESTMENT BANKING NET REVENUES - -------------------------------------------------------- (IN MILLIONS) Three Months Ended February 28 February 28 2002 2001 - -------------------------------------------------------- Debt Underwriting $ 205 $ 183 Equity Underwriting 163 105 M&A Advisory 91 183 - -------------------------------------------------------- $ 459 $ 471 - --------------------------------------------------------
Debt underwriting revenues totaled $205 million for the first quarter of 2002, a 12% increase over last year's first quarter. Fixed income origination benefited this quarter as issuers continued to take advantage of lower interest rates to raise long-term debt and replace short-term financing. Contributing to these results was a 40% increase from the year-ago period in the Company's global debt origination market volume, compared to a 7% increase industry-wide, according to TFSD. Equity origination revenues for the first quarter of 2002 were $163 million, up 55% compared to the year-ago period, as an improved outlook for the U.S. economy led to increased activity. Driving the increase in revenues was a significant increase in secondary offering volume, as the value of transactions completed by the Company increased almost 30% compared to the year-ago period, according to TFSD. M&A advisory fees for the first quarter of 2002 were $91 million, down 50% versus the first quarter of 2001 as industry-wide volumes for completed transactions decreased almost 75% during the same time period, according to TFSD. 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 $945 million for the first quarter of 2002, down 22% from the first quarter of 2001 as record fixed income results were more than offset by lower revenues from equity products. Overall, the Company continued to experience strong institutional customer flow activity across a wide range of products.
- -------------------------------------------------------- CAPITAL MARKETS NET REVENUES - -------------------------------------------------------- (IN MILLIONS) Three Months Ended February 28 February 28 2002 2001 - -------------------------------------------------------- Fixed Income $ 681 $ 523 Equities 264 685 - -------------------------------------------------------- $ 945 $ 1,208 - --------------------------------------------------------
This customer flow business provides the Company with a recurring 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. Net revenues from the fixed income component of Capital Markets increased 30% to $681 million from the first quarter of 2001, principally driven by strong institutional customer flow in credit products, such as high grade bonds and municipals. Favorable interest rates led to higher volumes across almost all fixed income 18 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS products, particularly residential mortgages, which was driven by the continued high levels of refinancings and new home sales. In addition, a combination of periods of high volatility and increased corporate debt issuance during the quarter drove increased investor demand for interest rate derivatives. Net revenues from the equity component of Capital Markets were $264 million in the first quarter of 2002, down 61% from the first quarter of 2001. This year-over-year decrease was driven by a decline in market volatility, which reduced customer activity in derivative-related products, and declines in revenues from both private equity investments and risk arbitrage activity 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 thirty-three private equity banking partnerships. Client Services net revenues were $202 million in the first quarter of 2002, down slightly from the first quarter of 2001. Despite weak equity markets, high-net-worth sales remained relatively unchanged as the decline in equities was partially offset by record fixed income activity, as investors continued to adjust their portfolios to compensate for the volatile equity market environment.
- -------------------------------------------------------- CLIENT SERVICES NET REVENUES - -------------------------------------------------------- (IN MILLIONS) Three Months Ended February 28 February 28 2002 2001 - -------------------------------------------------------- Private Client $ 191 $ 192 Private Equity 11 12 - -------------------------------------------------------- $ 202 $ 204 - --------------------------------------------------------
Private equity net revenues were virtually unchanged from the first quarter of 2001 as an increase in management fees was offset by lower incentive fee revenue. NON-INTEREST EXPENSES Non-interest expenses were $1,166 million for the first quarter of 2002 compared to $1,310 million for the first quarter of 2001. Compensation and benefits expense of $819 million decreased 15% from the first quarter of 2001 due to the decrease in revenues. Compensation and benefit expense, as a percentage of net revenues however, remained at 51% for the quarter, consistent with the Company's fiscal 2001 level. Nonpersonnel expenses were $347 million for the first quarter of 2002, down slightly compared to the first quarter of 2001, as increases in occupancy and technology were offset by decreased business development activity and savings initiatives in other areas. INCOME TAXES The Company's income tax provision was $128 million for the first quarter of 2002 versus $172 million for the first quarter of 2001. The effective tax rate was 29% for the first quarter of 2002 versus 30% for the first quarter of 2001. 19 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 A firm's legal entity structure may constrain liquidity. Regulatory requirements can restrict the flow of funds between regulated and unregulated group entities, and this must be accounted for in liquidity planning. The Company's Funding Framework incorporates these principles and mitigates liquidity risk whenever possible. This Framework is comprised of 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 2% of adjusted total assets and less than 8% of total debt. 20 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS TOTAL CAPITAL The Company's Total Capital (defined as long-term debt, preferred securities subject to mandatory redemption and stockholders' equity) was $47.3 billion at February 28, 2002 compared to $47.5 billion at November 30, 2001. The slight decrease in Total Capital resulted from a net decrease in long-term debt, principally due to redemptions, offset by an increase in total equity, principally due to net income.
FEBRUARY 28 NOVEMBER 30 (IN MILLIONS) 2002 2001 - ------------------------------------------------------------------------------------------------------------------- LONG-TERM DEBT Senior Notes $ 35,274 $ 35,373 Subordinated Indebtedness 2,711 2,928 -------- -------- 37,985 38,301 PREFERRED SECURITIES 710 710 STOCKHOLDERS' EQUITY Preferred Equity 700 700 Common Equity 7,948 7,759 -------- -------- 8,648 8,459 - ------------------------------------------------------------------------------------------------------------------- TOTAL CAPITAL $ 47,343 $ 47,470 - -------------------------------------------------------------------------------------------------------------------
During the first quarter of 2002, the Company issued $1.9 billion in long-term debt securities, which was $380 million in excess of maturing debt securities. Long-term debt decreased to $38.0 billion at February 28, 2002 from $38.3 billion at November 30, 2001, with a weighted-average maturity of 3.7 years at February 28, 2002 and 3.8 years at November 30, 2001. 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 (at quarter end) for up to 364 days. In April 2002, the Company renegotiated the Credit Agreement; under the new terms, the banks have committed to provide up to $1 billion for three years with a final maturity in April 2005. The Credit Agreement contains covenants that require, among other things, that the Company maintain a specified level of tangible net worth. In October 2001, the Company renegotiated its $1 billion Committed Securities Repurchase Facility (the "Facility") for LBIE, the Company's major operating entity in Europe. The Facility provides secured multi-currency financing for a broad range of collateral types. Under the terms of the Facility, the bank group has agreed 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. This commitment expires in October 2002, but the Company anticipates obtaining a new $1 billion commitment on substantially similar terms. There were no borrowings outstanding under either the Credit Agreement or the Facility at February 28, 2002. Although the Company has not previously actively used the Credit Agreement, it now intends to do so and to use the proceeds for general corporate purposes. The Company has maintained compliance with the applicable covenants for both the Credit Agreement and the Facility at all times. 21 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BALANCE SHEET The Company's total assets increased to $260.1 billion at February 28, 2002 from $247.8 billion at November 30, 2001. 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 $168.9 billion at February 28, 2002 compared to $164.5 billion at November 30, 2001. 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 associated with increased customer flow activities within the Company's 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 net leverage ratios based on adjusted total assets were 18.0x and 17.9x as of February 28, 2002 and November 30, 2001, respectively. Consistent with maintaining a single A credit rating, the Company targets an adjusted leverage ratio of under 20x. The Company continues to operate below this level. Due to the nature of the Company's sales and trading activities, the overall size of the Company's balance sheet fluctuates from time to time and, at specific points in time, may be higher than the fiscal quarter ends. 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 cost and availability of unsecured financing generally are dependent on the Company's short-term and long-term credit ratings. Factors that may be significant to the determination of the Company's credit ratings or otherwise affect the ability of the Company to raise short-term and long-term financing include its profit margin, its earnings trend and volatility, its cash liquidity and liquidity management, its capital structure, its risk level and risk management, its geographic and business diversification, and its relative positions in the markets in which it operates. A deterioration in any of the previously mentioned factors or combination of these factors may lead rating agencies to downgrade the credit ratings of the Company, thereby increasing the cost to the Company of, or possibly limiting the access of the Company to, certain types of unsecured financings. In addition, the Company's debt ratings can impact certain capital markets revenues, particularly in those businesses where longer-term counterparty performance is critical, such as over-the-counter derivative transactions, including credit derivatives and interest rate swaps. As of February 28, 2002 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. AA-1 A A-1 A+*/A
* Provisional ratings on shelf registration ** Senior/subordinated 22 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS HIGH YIELD 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 relatively higher levels of indebtedness, resulting in an increased sensitivity to adverse economic conditions. The Company recognizes these risks and aims to reduce market and credit risk through the diversification of its products and counterparties. High yield debt instruments are carried at fair value, and unrealized gains or losses for these securities are recognized in the Company's Consolidated Statement of Income. Such instruments at February 28, 2002 and November 30, 2001 included long positions with an aggregate market value of approximately $3.8 billion and $3.5 billion, respectively, and short positions with an aggregate market value of approximately $1.4 billion and $1.0 billion, respectively. The Company mitigates its aggregate and single-issuer net exposure through the use of derivatives, non-recourse securitization financing and other financial instruments. PRIVATE EQUITY The Company has investments in thirty-three private equity partnerships, for which the Company acts as general partner, as well as related direct investments. At February 28, 2002, the Company's private equity related investments were $927 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 8 to the Consolidated Financial Statements (Other Commitments and Contingencies). SUMMARY OF CONTRACTUAL OBLIGATIONS As of February 28, 2002 and November 30, 2001, the Company was contingently liable for $1.0 billion and $1.1 billion, respectively, of letters of credit, primarily used to provide collateral for securities and commodities borrowed and to satisfy margin deposits at option and commodity exchanges, and other guarantees. In connection with its financing activities, the Company had outstanding commitments under certain lending arrangements of approximately $2.0 billion and $2.1 billion at February 28, 2002 and November 30, 2001, 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, at February 28, 2002 the Company had commitments to enter into forward starting secured resale and repurchase agreements of $60.0 billon and $23.7 billion, respectively, as compared to $52.3 billion and $26.5 billion, respectively, at November 30, 2001. 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. The Company utilizes various hedging and funding strategies to actively manage its market, credit and liquidity conditions exposures on these commitments. In addition, total commitments are not indicative of actual risk or funding requirements, as the commitments may not be drawn or fully utilized. These commitments and any related draw downs of 23 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS these facilities typically have fixed maturity dates and are contingent upon certain representations, warranties and contractual conditions applicable to the borrower. At February 28, 2002 and November 30, 2001, the Company had net lending commitments to investment grade borrowers of $3.3 billion (gross commitments of $5.3 billion less $2.0 billion of associated hedges) and $4.1 (gross commitments of $5.9 billion less $1.8 billion of associated hedges), respectively. Lending commitments to non-investment grade borrowers totaled $1.4 billion at both February 28, 2002 and November 30, 2001, respectively. In addition, the Company has pre-arranged funding facilities with third party lenders of $4.9 billion at both February 28, 2002 and November 30, 2001, available against these commitments. These funding facilities contain limits for certain concentrations of counterparty, industry or credit ratings of the underlying loans. As of February 28, 2002 and November 30, 2001, the Company had commitments to invest up to $787 million and $555 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 MILLIONS Amount of Commitment Expiration Per Period --------------------------------------------------------- Total Contractual Remaining FEBRUARY 28, 2002 Amount 2002 2002-2005 2005-2007 2008-Thereafter - ------------------------------------------------------------------------------------------------- ---------------------- Lending commitments High grade $3,285 $2,310 $ 481 $ 424 $ 70 High yield 1,386 93 676 438 179 Secured lending transactions 85,726 29,955 22,058 9,070 24,643 Standby letters of credit 990 990 Private equity investments 787 787
For additional information on contractual obligations see Summary of Contractual Obligations section of Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated by reference in the Form 10-K. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES For a discussion of the Company's use of derivative instruments and the risks related thereto, see Note 5 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 in the Company's day-to-day operations. Consequently, the Company devotes 24 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS significant resources (including investment in personnel and technology) across all of its worldwide trading operations to the measurement, management and analysis of risk. 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. Nonetheless, the effectiveness of the Company's policies and procedures for managing risk exposure can never be completely or accurately predicted or fully assured. For example, unexpectedly large or rapid movements or disruptions in one or more markets or other unforeseen developments can have an adverse effect on the Company's results of operations and financial condition. The consequences of these developments can include losses due to adverse changes in inventory values, decreases in the liquidity of trading positions, higher volatility in the Company's earnings, increases in the Company's credit exposure to customers and counterparties and increase in general systemic risk. 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 weekly 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, but remains 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 combination facilitates the analysis of counterparty credit and market risk exposures, while leveraging 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 25 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS of the Company's overall risk management framework. The Market Risk Management Department ("MRM Department") has global responsibility for implementing the Company's overall market risk management framework. It is responsible for the preparation and dissemination of risk reports, developing and implementing the firmwide Risk Management Guidelines, and evaluating adherence to these guidelines. These guidelines provide a clear framework for risk management decision-making. To that end, the MRM Department identifies and quantifies risk exposures, develops limits, and reports and monitors these risks with respect to the approved limits. The identification of material market risks inherent in positions includes, but is not limited to, interest rate, equity and foreign exchange risk exposures. In addition to these risks, the MRM Department also evaluates liquidity risks, credit and sovereign concentrations. 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, 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. 26 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company enters into foreign exchange transactions in order to facilitate the purchase and sale of non-dollar instruments, including equity and interest rate securities. The Company is exposed to foreign exchange risk on its holdings of non-dollar assets and liabilities. The Company is active in many foreign exchange markets and has exposure to the euro, Japanese yen, British pound, Swiss franc, and Canadian dollar, as well as a variety of developed and emerging market currencies. The Company hedges its risk exposures primarily through the use of currency forwards, swaps, futures and options. If any of the strategies utilized to hedge or otherwise mitigate exposures to the various types of risks described above are not effective, the Company could incur losses. 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 following table sets forth the daily value-at-risk for each component of market risk as well as total value-at-risk:
Three Months Ended As of February 2002 -------------------------- ------------------------------------------ Feb. 28 Nov. 30 (IN MILLIONS) 2002 2001 Average High Low ---------- ------------ ----------- ------------ ----------- Interest rate risk $15.4 $14.6 $11.1 $15.4 $14.5 Equity price risk 12.5 15.1 13.7 15.1 12.4 Foreign exchange risk 1.8 1.9 1.8 1.9 1.8 Diversification benefit (9.8) (8.3) (4.2) (9.0) (8.8) ---------- ------------ ----------- ------------ ----------- Total Company $19.9 $23.3 $22.4 $23.4 $19.9 ========== ============ =========== ============ ===========
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. 27 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 the Company's 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 February 28, 2002: [Graphic omitted--bar graph showing: ] Weekly trading net revenues: Less than $0 0 weeks $ 0-50 million 0 weeks $ 50-100 million 8 weeks $100-150 million 4 weeks $150-200 million 0 weeks $200+ million 1 week 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. SIGNIFICANT ACCOUNTING POLICIES The Company's financial statements are prepared in conformity with generally accepted accounting principles, many of which require the use of management estimates and assumptions. Management believes that the estimates utilized in preparing its financial statements are reasonable and prudent. Actual results could differ from these estimates. FAIR VALUE The Company records its inventory positions, including Securities and Other Financial Instruments Owned and Securities Sold but not yet Purchased, at fair value, with unrealized gains and losses reflected in Principal transactions in the Consolidated Statement of Income. Market value is generally based on listed prices. If listed market prices are not available, or if liquidating the Company's position is reasonably expected to affect market prices, fair value is determined based on either internal valuation pricing models, which take into account time value and volatility factors underlying the financial instruments, or management's estimate of the amounts that could be realized under current market conditions, assuming an orderly liquidation over a reasonable period of time. The determination of fair value is fundamental to the Company's financial condition and results of operations and, in certain circumstances, it requires the use of complex judgments. The use of different pricing models or assumptions could produce different estimates of fair value. TRANSFERS OF FINANCIAL ASSETS The Company accounts for the transfer of financial assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities--a replacement of FASB No. 125" ("SFAS No. 28 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 140"). This statement requires that the transfer of financial assets be accounted for as a sale when control over the asset has been relinquished. Control is deemed to be relinquished when the following conditions are met: (i) the assets have been isolated from the transferor (even in bankruptcy or other receivership), (ii) the transferee has the right to pledge or exchange the assets received and (iii) the transferor has not maintained effective control over the transferred assets. The Company is a market leader in mortgage- and asset-backed securitizations and other structured financing arrangements. In connection with these activities, the Company utilizes special purposes entities principally for (but not limited to) the securitization of commercial and residential mortgages, home equity loans, government and corporate bonds, and lease and trade receivables. The Company derecognizes financial assets transferred in securitizations provided that the Company has relinquished control over such assets. The Company may retain an interest in the financial assets it securitizes ("Retained Interests"), which may include assets in the form of residual interests in the special purpose entities established to facilitate the securitization. Any Retained Interests are included in Securities and Other Financial Instruments Owned within the Company's Statement of Financial Condition. The Company records its Securities and Other Financial Instruments Owned, including Retained Interests, at fair value, with changes in fair value reported in earnings. For additional information on the Company's significant accounting policies see Note 1 to the Consolidated Financial Statements (Summary of Significant Accounting Policies) incorporated by reference in the Form 10-K. NEW ACCOUNTING DEVELOPMENTS In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under SFAS 142, intangible assets with indefinite lives and goodwill will no longer be amortized. Instead, these assets will be evaluated annually for impairment. The Company adopted the provisions of SFAS 142 at the beginning of fiscal year 2002. The adoption of SFAS 142 had an immaterial effect on the Company's financial position and results of operations. 29 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. 30 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 generally 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 it intends to defend vigorously each such case. Based on information currently available and established reserves, the Company believes that the eventual outcome of the actions against it, including the matters described below, will not, in the aggregate, have a material adverse effect on the consolidated financial position of the Company but may be material to the Company's operating results for any particular period, depending on the level of the Company's income for such period. IN RE ENRON CORPORATION SECURITIES LITIGATION In April 2002 a Consolidated Complaint for Violation of the Securities Laws was filed in the United States District Court for the Southern District of Texas in IN RE ENRON CORPORATION SECURITIES LITIGATION, adding as defendants Holdings along with eight other commercial or investment banks. The case is purportedly brought on behalf of purchasers of Enron Corporation's publicly traded equity and debt securities between October 19, 1998 and November 27, 2001, and, in addition to the banks, names 38 current or former Enron officers and directors, Enron's accountants, Arthur Anderson and affiliated entities and partners, and two law firms. The complaint seeks unspecified compensatory and injunctive relief for purported violations of federal and state securities laws based on the theory that defendants engaged or participated in manipulative devices to inflate Enron's reported profits and financial condition, made false or misleading statements and participated in a scheme or course of business to defraud Enron's shareholders. Against Holdings, the complaint alleges violations of Sections 11 and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act") and the Texas Securities Act. IPO ALLOCATION CASES (reported in Holdings' 2001 Annual Report on Form 10-K) A new suit was filed in April 2002 in Delaware Chancery Court by Breakaway Solutions Inc. ("Breakaway"), which names LBI and two other underwriters as defendants. The complaint purports to be brought on behalf of a class of issuers who issued securities in initial public offerings ("IPOs") through at least one of the defendants during the period of January 1998 through October 2000 and whose securities increased in value 15% or more above the original price within 30 days after the IPO. It alleges that defendants underpriced IPO securities and allocated those underpriced securities to certain favored customers in return for alleged arrangements with the customers for increased commissions on other transactions and alleged tie-in arrangements. The complaint asserts claims for breaches of contract, of the implied covenant of good faith and fair dealing and of fiduciary duty, and for indemnification or contribution and unjust enrichment or restitution. Breakaway seeks, among other relief, certification of a 31 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS class, a permanent injunction preventing defendants from engaging in the alleged practices, an accounting of all defendants' commissions, profits and compensation in connection with the IPOs, declarations requiring defendants to indemnify Breakaway in the pending consolidated IPO securities class actions and determining that Breakaway has no indemnification obligation to defendants in those actions, and compensatory damages. ACTIONS REGARDING FRANK GRUTTADAURIA (reported in Holdings' 2001 Annual Report on Form 10-K) The following additional actions have been filed relating to the alleged conduct of Frank Gruttadauria, the former branch manager of the Company's Cleveland office: DOMINIC A. VISCONSI, SR. AND DOMINIC A. VISCONSI, JR. AND JAMES V. STANTON V. LEHMAN BROTHERS, INC. AND S.G. COWEN SECURITIES CORP. In March 2002, LBI was served with a complaint in the United States District Court for the Northern District of Ohio. The complaint alleges breach of fiduciary duty, fraud, aiding and abetting, promissory estoppel, negligent misrepresentation, breach of contract, conversion, negligent hiring, negligent supervision and violations of the Investment Advisers Act of 1940 (the "Advisers Act"). Plaintiffs seek unspecified compensatory and punitive damages, a full accounting of all account activity, attorneys fees and costs and prejudgment and postjudgment interest. GEORGIA SARANTAKIS AND CAROL ANN COYLE V. FRANK DOMINIC GRUTTADAURIA, LEHMAN BROTHERS, INC., LEHMAN BROTHERS HOLDINGS, INC. ET AL. In March 2002, LBI and Holdings were served with a complaint in the United States District Court for the Northern District of Illinois. The complaint alleges violations of Sections 10(b) and 20(a) of the Exchange Act, of Illinois securities laws and of various NASD and New York Stock Exchange rules, breach of fiduciary duty, fraud, negligent hiring and supervision and negligent misrepresentation. Plaintiffs seek unspecified compensatory and punitive damages, prejudgment and postjudgment interest and attorneys fees and costs. SAMUEL GLAZER V. LEHMAN BROTHERS, INC. AND S.G. COWEN SECURITIES CORPORATION. In March 2002, LBI was served with a complaint in the United States District Court for the Northern District of Ohio. The complaint alleges breach of fiduciary duty, fraud and deceit, negligent retention, hiring and supervision, negligent and reckless misrepresentation, breach of implied contract, conversion, violations of Sections 10(b) and 20(a) of the Exchange Act, civil conspiracy, aiding and abetting and promissory estoppel. Plaintiff seeks the amounts in his accounts from various times, alleged to be in excess of $24 million, the value of income tax paid on non-existent transactions and expense to correct tax returns, fair compensation for value converted from his accounts including interest, punitive damages in the amount of $500 million and attorneys fees and costs. ALAN YALE AND JUDITH YALE V. S.G. COWEN SECURITIES CORPORATION AND LEHMAN BROTHERS INC. In April 2002, LBI was served with a complaint in the United States District Court for the Northern District of Illinois. The complaint alleges violations of Sections 10(b) and 20(a) of the Exchange Act, of the Advisers Act and of Illinois laws, conversion, fraud, civil conspiracy, aiding and abetting, breach of fiduciary duty, negligent misrepresentation, negligence, promissory estoppel and breach of contract. Plaintiffs seek "benefit of the bargain damages", compensatory damages in an amount substantially exceeding $12 million, treble compensatory damages under the Illinois Consumer Fraud Act, punitive damages in the amount of five times compensatory damages, a full accounting of all account activity, attorneys fees and costs and prejudgment and postjudgment interest. 32 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: The following exhibits are filed as part of this Quarterly Report or, where indicated, were heretofore filed and are hereby incorporated by reference: 3.01 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) 3.02 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) 3.03 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) 3.04 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) 3.05 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) 3.06 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) 11.01 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 11 TO THE CONSOLIDATED FINANCIAL STATEMENTS (EARNINGS PER COMMON SHARE)) 12.01 Computation of Ratios of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends (FILED HEREWITH) 33 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES PART II - OTHER INFORMATION (b) REPORTS ON FORM 8-K: The following reports on Form 8-K were filed during the quarter for which this Quarterly Report is filed: 1. Form 8-K dated February 5, 2002, Item 7. 2. Form 8-K dated February 1, 2002, Item 7. 3. Form 8-K dated December 26, 2001, Item 7. 4. Form 8-K dated December 20, 2001, Items 5 and 7. Financial Statements: Exhibit 99.2 Selected Statistical Information (Preliminary and Unaudited) Exhibit 99.3 Consolidated Statement of Income (Three Months Ended November 30, 2001) (Preliminary and Unaudited) Exhibit 99.4 Consolidated Statement of Income (Twelve Months Ended November 30, 2001) (Preliminary and Unaudited) Exhibit 99.5 Segment Net Revenue Information (Three and Twelve Months Ended November 30, 2001) (Preliminary and Unaudited) 34 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. LEHMAN BROTHERS HOLDINGS INC. (Registrant) Date: April 15, 2002 By: /s/ DAVID GOLDFARB -------------------------------------- Chief Financial Officer (principal financial and accounting officer) 35 EXHIBIT INDEX EXHIBIT NO. EXHIBIT - ----------- ------- Exhibit 12.01 Computation of Ratios of Earnings to Fixed Charges and to Combined Fixed Charges and Preferred Stock Dividends 36 EX-12.01 3 a2076954zex-12_01.txt EXHIBIT 12.01 EXHIBIT 12.01 LEHMAN BROTHERS HOLDINGS INC. AND SUBSIDIARIES COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS (DOLLARS IN MILLIONS) (UNAUDITED)
For the Three Months For the Twelve Months Ended November 30 Ended ------------------------------------------------------ Feb. 28, 1997 1998 1999 2000 2001 2002 ---------- ---------- ---------- ---------- ---------- ----------- Pre-tax earnings from continuing operations $ 937 $ 1,052 $ 1,631 $ 2,579 $ 1,748 $ 440 Add: Fixed charges (excluding capitalized interest) 13,043 15,813 13,681 18,778 15,724 2,643 ---------- ---------- ---------- ---------- ---------- ----------- Pre-tax earnings before fixed charges 13,980 16,865 15,312 21,357 17,472 3,083 ========== ========== ========== ========== ========== =========== Fixed charges: Interest 13,010 15,781 13,649 18,740 15,656 2,620 Other (a) 41 47 71 57 78 29 ---------- ---------- ---------- ---------- ---------- ----------- Total fixed charges 13,051 15,828 13,720 18,797 15,734 2,649 ---------- ---------- ---------- ---------- ---------- ----------- Preferred stock dividend requirements 109 124 174 195 192 65 ---------- ---------- ---------- ---------- ---------- ----------- Total combined fixed charges and preferred stock dividends $ 13,160 $ 15,952 $ 13,894 $ 18,992 $ 15,926 $ 2.714 ========== ========== ========== ========== ========== =========== RATION OF EARNINGS TO FIXED CHARGES 1.07 1.07 1.12 1.14 1.11 1.16 RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS 1.06 1.06 1.10 1.12 1.10 1.14
(a) Other fixed charges consist of the interest factor in rentals and capitalized interest. -----END PRIVACY-ENHANCED MESSAGE-----