Lehman Brothers bankruptcy to be largest in history

The liquidation of Lehman Brothers will be the largest bankruptcy in history, with the defunct investment bank holding consolidated assets of $639 billion and liabilities of $613 billion as of May 31, 2008, according to court documents.

In an affidavit submitted to the US Bankruptcy Court for the Southern District of New York, the investment bank revealed it owes $110.5 billion in senior unsecured notes, $12.6 billion in subordinated unsecured notes and $5 billion in junior subordinated notes. An additional $188 billion in tri-party repurchase agreements remains outstanding.

In a petition attached to the affidavit, Lehman Brothers lists its 30 largest unsecured claims. Citibank and Bank of New York Mellon’s (BoNY) London branch are by far the biggest creditors, with both named as indenture trustees on bond debt worth $138 billion.

Collectively, Lehman’s 30 largest creditors are owed approximately $159 billion, much of which is split among Japanese firms such as Aozora Bank, Sumitomo Mitsubishi and UFJ Bank.

Lehman Brothers’ liquidation will dwarf that of WorldCom, the US telecommunications firm that currently tops the global insolvency leaderboard after collapsing in a bankruptcy worth $107 billion in 2002, in the wake of a massive corporate fraud.

Following Sunday’s emergency trading session, which allowed Lehman Brothers’ counterparties to attempt to offset derivatives positions they had with the defunct dealer, the International Swaps and Derivatives Association has announced plans for an auction to settle credit default swaps (CDSs) referencing the securities firm.

Less clarity exists, however, around derivatives contracts in which Lehman Brothers is a direct counterparty. Isda has advised firms to look to the Isda master agreement for clarification and take advice from legal counsel to determine whether an event of default has taken place and ascertain the net amount owed.

Although Isda chairman Eraj Shirvani claimed yesterday the CDS market “continues to function well in these times”, the unwinding of contracts referencing Lehman Brothers will almost certainly pose the largest test of the settlement process for credit derivatives. The Lehman bankruptcy comes less than a week after the association announced it is compiling a list of deliverable obligations to help the settlement process following the effective nationalisation of Fannie Mae and Freddie Mac.

The fallout from the bankruptcy dominated trading on both exchanges and over-the-counter derivatives markets yesterday as European and North American markets came to terms with the magnitude of the event. The Counterparty Risk Index, which measures the average CDS spread among the 15 largest credit derivatives dealers, widened 98 basis points to 314bp – a 45% rise in a day to reach an all-time high, according to market data provider Credit Derivatives Research.

For the two remaining independent US investment banks, the bankruptcy of Lehman Brothers and acquisition of Merrill Lynch by Bank of America sent CDS spreads into overdrive ahead of the release of third quarter earnings later this week.

Goldman Sachs’ five-year CDS skyrocketed 150bp to finish the day at an unprecedented 347.5bp, while Morgan Stanley climbed 203bp to close at a record spread of 479bp, according to Bloomberg.

Both firms are being carefully watched in the wake of the weekend’s events. Several market commentators, including the chief executives of both Merrill Lynch and Bank of America, have expressed the belief that the days of the standalone broker-dealer may be numbered, with firms forced into mergers with institutions that have consumer banking capabilities to secure long-term funding.

See also: Lehman unwind could take years, says PWC

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