Critical Evaluation Of Lehman Brothers' Financial Crisis Essay.

Prepare a critical evaluation of a public company (of your choosing) that has suffered from a severe financial crisis or become insolvent at some time over the past 10-15 years. Your essay should include (but not be limited by) a discussion about the following issues:

- a (brief) history of the company and how it formed

- its key initial success drivers, financial milestones or achievements

- any major changes in its structure over its life – ie mergers/demergers/major capital management programs etc

- the generally accepted reasons that caused its failure

- the social impact of its failure – both internally (ie staff) and externally, across the wider business community and society in general

- a summary of the lessons learned (This might include regulatory changes)

You are required to undertake a financial analysis of a well-known publically listed company. Your analysis period should include material based upon the most  recent published annual accounts, covering data from the most recent two years. (Note: Where provided, please use ‘consolidated’ data in conducting your analysis.) The analysis should consider each of the main ratio categories of profitability, asset efficiency, liquidity, capital structure, and market performance. Chosen ratiosshould be relevant to the business type – for instance, inventory turnover is not particularly relevant in a servicecompany. Two to three ratios in each category will be sufficient.

The written report should focus what is revealed by the ratios and other calculations in thecontext of the company’s operations. In particular, any important changes over the most recent period should be identified, discussed and, where possible, explained. You should also provide an overall assessment of whether the company’s performance for the most recent period anddiscussion regarding which aspect of the company’s financials has demonstrated the most improvement. Peer-entity comparison will also support submission.

A detailed calculation of relevant ratios and other useful calculations should be included as one or more appendices prepared using Excel or a similar spreadsheet. Students are advised to show the formulae used in determining particular ratios and other figures

Whilst the annual reports will be the primary source of information, you are encouraged to access other publically available information, analysis and data. All sources of information must be fully referenced. Note: Your ratio calculations MUST be included in the appendix to your report.

Background of the company including the formation of the company

The financial crisis is identified as a combination of diverse circumstances and situations that result in the reduction in the nominal value of the financial assets of an organization. The various causes that can be held responsible for the occurrence of a financial crisis can be global recessions, crashing of the stock market, and reduction in the monetary value of currency along with sovereign defaults. The current essay is a critical evaluation of a public listed organization that has recently faced severe financial crises or has become insolvent in the last ten to fifteen years. For the purpose of this assignment, Lehman Brothers Company has been chosen which is a publicly listed under the New Stork Stock Exchange.

The Lehman Brothers were identified as a global organization that was basically engaged in financial services. The company became defunct in the year 2008 and before filling for the bankruptcy, the company was considered to be the fourth largest investment organization in the US after the competitors like Merrill Lynch, Goldman Sachs, and Morgan Stanley. The main business of the company was investment banking, investment management, trading of private equity and the sale of fixed income securities along with private banking (Azadinamin, 2012). The organization was formed by Henry Lehman in the year 1850 and was soon joined by his brothers Emanuel and Mayer and thereby received its name the Lehman Brothers.

The firm was considered as a symbol of power and prominence at both global and domestic level. The American Express after owing the firm for ten years spun off Lehman Brothers in 1994 through the creation of an initial public offering of around $ 3.3 billion capitalizations. The offerings were further extended in the year 1999 with the repeal of Glass-Steagall Act which resulted in the combination of investment banking and commercial activities (Fernando, et. al., 2012). The expansion of the Lehman Brothers helped in developing newer capabilities for dealing in the segment of proprietary banking, asset and securities management. The uncontrolled expansion and the global financial crisis of the year 2008 laid the foundation for the collapse of the Lehman Brothers.

Considering the achievements and financial milestones that were achieved by the Lehman Brothers, the core success factor was the mortgage orientation of the company. Lehman was identified as the one of the primary Wall street organization that was focusing over the mortgaging business. In the year 1997, the Lehman Brother acquired the Colorado-based lender, the Aurora loan service which was one of the top lenders of its time. Continuing the expansion in the year 2000, the purchase of BNC Mortgage LLC, which was basically a west coast subprime mortgage lender, was made by Lehman Brothers. With these two acquisitions, the Lehman Brothers soon became a renowned name in the subprime mortgaging sector. In the year 2003, a potential amount of $ 18.2 billion was earned by the Lehman Brothers through loans and mortgaging and it was ranked as the third top organization in the lending and mortgaging sector (Chakrabarty & Zhang, 2012). The number increased by $ 40 billion in the year 2004 and then by the year 2006 both BNC and Aurora were lending an amount of $ 50 billion on monthly basis. The Lehman Brother had a total of $ 680 billion assets that were backed up by just $ 22.5 billion of firm capital. It was quite risky at that from an equity viewpoint because the holdings of the commercial real estate were greater than the capital almost three times. This means a reduction of 3% to 5% in a highly levered structure in the real estate values would result in wiping of the entire capital.

Major primary success drivers, achievements and financial milestones achieved by the Lehman Brothers

The merger of the Lehman Brother with the Barclays was done in order to improve the existing financial condition of the Lehman Brothers. The Lehman Brothers sold its capital market and investment banking operations to the Barclays for an amount of $ 250 million. The Lehman Brother’s acquisition was considered as beneficial for the Barclays in the process of merger and acquisition; the Barclays become one of the most powerful franchises and the seventh-largest investment bank in the United States. The deal was preferably better for the Barclays as it made a careful assessment for the future liabilities and made possible attempts for limiting it (Mio & Fasan, 2012). The Barclay’s regulator restricted Barclays to go for acquisition before the declaration of the insolvency which was proved to be positive for the organization as at the time of the merger, the Barclays avoided from undertaking toxic assets of the Lehman Brother which was around $ 600 billion in debt. Thus, as a result of this, Barclays managed to avoid liabilities for most of such assets of the company.

There were several factors that resulted in the financial crisis and ultimate collapse of the company but from a deeper analysis, the major reasons that were suggested by the financial experts were the low level of trust within the company, the poor strategy regarding long-term investment of the company, inadequate funding and the over-leveraging. One of the core causes of the firm’s collapse was recognized as overzealous lending between years 2003 to 2004 during the housing bubble (Aragon & Strahan, 2012). The Lehman Brother was assumed to be investing in a risky affair with the acquisition of the top five lending firms whose major business was subprime lending. In the year 2007, although the company was earning a significant market capitalization of around $ 60 billion, the company faced problems due to mounting defaults in the subprime loans. The value of the mortgage portfolio of the Lehman Brother was no longer compelling as the company was over-leveraged at that time. Many of the regulatory organizations were of the view that the Lehman Brothers did not have the required collateral for covering the bailout period (Lioudis, 2017). As no potential aid was provided to the Lehman Brothers by the Federal Reserve Bank, the only option left with the company was to quit its operations and functions.

In addition to this, the housing market began to crash in the year 2006 due to lenders that were defaulting on the unsustainable subprime mortgages and the risky loans but the Lehman Brother continued its operations which resulted in the rise in the real estate share of the company up to $ 111 billion in the securities and assets in the year 2007. In September, there was an unpredicted loss of $ 3.9 billion in the third quarter but in order to improve its situation, the Lehman Brothers reduced mortgage loan by 20%, leveraging factor by seven points and enhanced the liquidity by $ 45 billion (Sraders, 2018). The stock of the company was decreasing drastically at the rate of about 77%. Although efforts were made by the Bank of America and the Barclays through company takeover but all in vain and on 15 September 2008, the Lehman Brother was finally declared bankrupt.  

Changes in the structure of the Lehman Brothers over its useful life: Merger of Barclays and Lehman Brothers

The financial crisis of the Lehman Brother was not less than a disaster in the history of the world economy. The widespread recession that was generated due to the elements of the economic turmoil created by this collapse. It was estimated that around 6 million jobs were practically lost that result in the rise in the unemployment rate by 10%. The Dow Jones Industrial Average reduced by 5000 points and adverse social impacts were experienced in the economies of countries like the European Union, Latvia, Lithuania and Hungary (Davies, 2017). The effects were also felt by countries like Pakistan that managed to seek a bailout from the IMF along with the crisis at Iceland wherein it was announced by the officials that the Government of the country had no significant amount of funds to enhance the existing condition of the major banks in the country. The bankruptcy of the Lehman Brothers was considered to be synonymous with wealth destruction and financial crisis in the global banking history.

The regulatory changes relate to the regulatory responses toward the subprime crisis and involve actions taken over by the government all over the globe for effectively dealing with the subprime mortgage crisis within the world economy. The various regulators and legislation focus over action with respect to lending practices, the credit counseling, bankruptcy protection, financial education and licensing, the affordable housing policies and tax policies. The guidelines that are issued in this respect aims at influencing the nature, transparency and the regulatory requirements regarding the securities and complex legal companies involved in such kind of transactions (Davies, 2017). In order to protect the financial sector that remained after the occurrence of the Lehman Brother financial crisis, the then US President, George Bush made an announcement for $ 700 billion bailout plan. This was followed by the Dodd-Frank Act which was mainly implemented for enhancing financial regulation in the finance sector.

In the year 2009, the President with the top financial advisers developed and provided comprehensive regulatory proposals. These proposals majorly addressed towards the financial cushions and capital requirements of the bank, consumer protection, expansion of the regulation regarding derivates and shadow banking system, executive pay and the increased authority of the Federal Reserve in systematically managing the important institutions (Cassidy, 2013). The Dodd-Frank Wall Street Reform and Consumer Protection Act mainly address the following elements with a varying amount of degree along with the creation of the Consumer Financial Protection Bureau.  These are as follows:

• Expansion of the FDIC (Federal Deposit Insurance Scheme) in the banking resolution mechanism for inclusion of non-banking financial institutions
• To ensure the corporations fail in an organized manner does not need to be rescued
• Need to develop stronger liquidity and capital positions for financial corporations and the associated regulatory authority
• Application of suitable checks and balances to the Federal Reserve and FDIC in the process of resolution

Causes of failure for the company

The other regulatory changes included setting the minimum requirement for the home mortgage by 10% along with the income verification, maintenance of sufficient capital by the financial institutions, the establishment of an early-warning system in order to detect the system generated risk (Lioudis, 2017). Along with this, it also included regulation of credit derivatives for ensuring that are adequately traded on the efficiently capitalized exchanges in order to reduce the counterparty risk.

The above essay helped in critically evaluating the financial crisis and the subsequent insolvency and bankruptcy in the US-based public listed company Lehman Brothers and what important lessons were learned by the world economies after the occurrence of this financial crisis. The essay provides a thorough discussion regarding the background information of the company, the major achievements, and factors responsible for the success of the Lehman Brothers, the merger of the company with Barclays, the well-known reasons for the failure of the company along with the adverse social impact both internally and externally. In addition to this, the in-depth summary has been provided to explain the regulatory changes made after the crisis.

BCE is the largest communication company in Canada. The company provides the broadband communication services to the public on the large scale. The company is expanding its business worldwide by making the additional capital investment in the year 2017 (Chiaramonte & Casu, 2017). Here in the present report, the discussion about the financial performance of the company is made after calculating the certain ratios of the company based on the financial statements of the company at the year-end of 2017.

Calculations of the financial ratios of the company which helps the manager of the company in planning the activities of the company and also allows the manager in the decision making of the company:

Description of various ratios for the financial performance of the company is calculated as under:

 Profitability ratios make the comparison between the income statements of the company and various categories of it to reflect the company’s ability to operate profitability from various options of the company (Delen, et. al., 2013).

The main reason for the calculation of profitability ratio in an organization is to calculate the companies return from the investment made by it the assets and the inventory of the company. This ratio mainly reflects the profits gained by the company from various operations of the company.

Various type of profitability ratios of the company are:

Social impact of Lehman Brothers' failure

Return on assets ratio = Net income / Total assets

Particulars	2017	2016
REVENUE	2,970	3,087
TOTAL ASSETS	54,263	50,108
return on asset	0.054733428	0.061606929

It can be clearly concluded that the return on asset has been decreasing in comparison to last year. It may be possible that the company has reduced the investment in the capital assets of the company due to the recession period (Maina & Ishmail, 2014).

Return on Equity = Net operating income / shareholders Equity

Particulars	2017	2016
REVENUE	2,970	3,087
Total Equity	19,483	17,854
Return in equity	0.152440589	0.172902431

Return on equity is decreasing in comparison to last year reason of decline can be concluded as the company has decreased using the investor's fund and has now focused more on working with the owned fund.

Profit margin ratio:

Profit margin ratio = net operating income / net sales

Particulars	2017	2016
REVENUE	2,970	3,087
Sales	22,719	21,719
profit margin ratio	0.130727585	0.142133616

 This ratio indicates how the company is managing the expenses of the organization in comparison to the sales of the company. Higher the ratio indicates higher profitability of the company (Ouma, 2012). In the present case, the profit margin ratio of the company is decreasing in comparison to last year it indicates that the company has earned less profit in comparison to last year.

Asset Efficiency ratio:

This ratio indicates that how the company is utilizing the assets of the company for generating the maximum profit of it. These are the ratios used by the company to improve the operational profitability of the company.

Following are the efficiency ratios of the company which is calculated to evaluate the performance of the company:

Account receivable turnover ratio: Net credit sales / Average account receivables

Particulars	2017	2016
Sales	22,719	21,719
Ttal receivables	3,135	2,979
Receivables ratio	7.246889952	7.290701578

This ratio is decreasing. It indicates that the company has is facing the difficulty in the collection from the debtors of the company in comparison to last year (Ouma, 2012). This indicates that the company should improve the collection procedure from the customer to increase the revenue of the company.

Working capital ratio:

 Working capital ratio = Current assets / current liabilities

Particulars	2017	2016
Current assets	4,639	4,855
Current liabilities	10,787	10,108
Working capital ratio	0.430054695	0.480312624

Higher the ratio of the company more favorable the company’s position is. In the present case, the ratio of the company is decreasing this indicates the unfavorable situations for the company. The ideal ratio of the company is 1.

Quick ratio = Quick assets / current liabilities

 Quick assets = current assets – inventory

Particulars	2017	2016
Current assets	4,639	4,855
Prepaid expenses	375	420
Inventory	380	403
Quick assets	3,884	4,032
Current liabilities	10,787	10,108
Quick ratio	0.36006304	0.398891967

Higher the quick ratio of the company indicates the high liquidity position of the company. Here in the present case, the company’s quick ratio is decreasing which indicates that the liquidity position of the company has reduced in the current year in comparison to last year (Chiaramonte & Casu, 2017).

Lessons learned

Time interest ratio: EBIT / Interest expense

Particulars	2017	2016
Income after tax and interest	2,970	3,087
Interest expense	955	888
Tax	1,039	1,110
EBIT	4,964	5,085
Time interest ratio	5.19790576	5.726351351

Higher the ratio of the company indicates the better position of the company. In the present case, the ratio is decreasing in comparison to last year.

Debt to Equity ratio = Total debts / total equity

Particulars	2017	2016
Total debt	34,780	32,254
Total equity	19,483	17,854
Debt to equity ratios	1.78514602	1.806541951

In the present case, the debt-equity ratio of the company is decreasing. It indicates the company is operating on its owned fund then the borrowed fund.

Equity to fixed assets ratio = Equity / Total fixed assets

Particulars	2017	2016
Total equity	19,483	17,854
Total fixed assets	24,033	22,346
Equity to fixed asset ratio	0.81067699	0.79897968

In the present situation, the company is operating more income from the capital assets of the company as compared to last year.

Equity ratio = Shareholders Equity/ Total capital employed

Capital employed = Total assets – total current liabilities

Particulars	2017	2016
TOTAL ASSETS	54,263	50,108
Current liabilities	10,787	10,108
Capital employed	43,476	40,000
Total equity	19,483	17,854
Equity ratio	0.4481323	0.44635

There is not much difference in the equity ratios of the company which indicates that company is operating with the same amount of capital in comparison to last year (Reich, et. al., 2012).

Market performance ratios:

Earnings per share = Net income – preference dividend / common outstanding shares

Particulars	2017	2016
Net income	2,970	3,087
Preference dividend	128	137
Income attributable to equity shareholders	2,842	2,950
Outstanding number of shares	894	869
Earning per shares	3.17897092	3.39470656

Earnings per share of the company have been reduced in comparison to last year. The company is distributing fewer profits to the shareholders in the year 2017 in comparison to last year.

Price-earnings ratio:

Price Earnings ratio = Market value price per share/ Earnings per share

Particulars	2017	2016
Market price per share	43.3	40.45
Earnings per share	3.18	3.39
price earnings ratio	13.6163522	11.9321534

 Price-earnings ratios of the company have increased as compared to last year. Higher the P/E ratio of the company indicates the better performance of the company over the period of time. The P/E ratio of the company in the year 2017 is greater in comparison to last year.

Dividend payout ratio:

Dividend payout ratio = Total dividend / net operating income

In the present situation, the company has paid a dividend of $2.87 in the year 2018. The company has declared a dividend of $2.73 in the year 2016 (Reich, et. al., 2012). The payment of the dividend in comparison to last year has increased. So it can be concluded that the company is growing in nature and conducting its business successfully.

Conclusion

From the two assessments, it can be concluded that the timely review of the financial statement can help in mitigating the financial risk and crisis to a great extent as these statements are capable of representing the true and fair financial position of the company to its various stakeholders like the public, management and the investors. Thus, decision making and business performance can be improved effectively.

References

Aragon, G. O., & Strahan, P. E. (2012). Hedge funds as liquidity providers: Evidence from the Lehman bankruptcy. Journal of Financial Economics, 103(3), 570-587.

Azadinamin, A. (2012). The bankruptcy of Lehman Brothers: Causes of Failure & recommendations going forward. Swiss Management Center.

Chakrabarty, B., & Zhang, G. (2012). Credit contagion channels: Market microstructure evidence from Lehman Brothers’ bankruptcy. Financial Management, 41(2), 320-343.

Chiaramonte, L., & Casu, B. (2017). Capital and liquidity ratios and financial distress. Evidence from the European banking industry. The British Accounting Review, 49(2), 138-161.

Delen, D., Kuzey, C., & Uyar, A. (2013). Measuring firm performance using financial ratios: A decision tree approach. Expert Systems with Applications, 40(10), 3970-3983.

Fernando, C. S., May, A. D., & Megginson, W. L. (2012). The value of investment banking relationships: evidence from the collapse of Lehman Brothers. The Journal of Finance, 67(1), 235-270.

Maina, L., & Ishmail, M. (2014). Capital structure and financial performance in Kenya: Evidence from firms listed at the Nairobi Securities Exchange. International Journal of Social Sciences and Entrepreneurship, 1(11), 209-223.

Mio, C., & Fasan, M. (2012). Does corporate social performance yield any tangible financial benefit during a crisis? An event study of Lehman Brothers’ Bankruptcy. Corporate reputation review, 15(4), 263-284.

Ouma, O. P. (2012). The relationship between dividend payout and firm performance: a study of listed companies in Kenya. European Scientific Journal, ESJ, 8(9).

Reich, N. H., Mueller, B., Armbruster, A., Van Sark, W. G., Kiefer, K., & Reise, C. (2012). Performance ratio revisited: is PR> 90% realistic?. Progress in Photovoltaics: Research and Applications, 20(6), 717-726.

Cassidy, J. (2013, August 28). What Has Changed Since Lehman Failed? Retrieved November 2, 2018, from The New Yorker: https://www.newyorker.com/news/john-cassidy/what-has-changed-since-lehman-failed

Davies, J. (2017, June 23). Global Financial Crisis - What caused it and how the world responded. Retrieved November 2, 2018, from Canstar: https://www.canstar.com.au/home-loans/global-financial-crisis

Lioudis, N. K. (2017, December 11). The collapse of Lehman Brothers: A case study. Retrieved November 2018, 2018, from Investopedia: https://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp

Nageswaran, V. A. (2018, March 13). What has changed since the 2008 financial crisis? Retrieved November 2, 2018, from Live mint: https://www.livemint.com/Opinion/Qk0YdpJiHzW7YA5MAIhutL/What-has-changed-since-the-2008-financial-crisis.html

Sraders, A. (2018, September 12). The Lehman Brothers Collapse and How It's Changed the Economy Today. Retrieved Novemeber 2, 2018, from The Street: https://www.thestreet.com/markets/bankruptcy/lehman-brothers-collapse-14703153