credit outlook - stanford university
TRANSCRIPT
ILEHMi\N BROTHERS!
Credit Outlook
April2008
Eric Felder
This material has been prepared by Credit Trading and is not a product of Lehman's Research Department. It is for information purposes only. All levels and prices are indications only and do not represent firm market levels. Changes in market conditions since the issuance of this document may affect some or all of the levels and prices listed. For firm levels and prices please call the desk. Lehman Brothers Inc. and/or its affiliates may trade and/or have a principal position in the securities, financial instruments and/or related derivatives mentioned herein.
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
LBH I_ SEC07940 _ 393578
After a Period of Low Volatility, 2007 was a Turning Point in the Credit Cycle. In 2008, Credit has had its Worst Start to a Year on Record.
(bp)
900
600
300
0
(300) .
(600)
·····lillliilllil·····
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1110 2008
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
1
LBH I_ SEC07940 _ 393579
As a Loss of Faith in Rating Agency Models Impaired the Securitization Process ...
Liabilities
$
IRatingAgency] // ./ $
Liabilities ... /··/
····· .... $
Liabilities
$
Liabilities IRatingAgencyJ • $ Liabilities ·
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
2
$ ,···
LBH I_ SEC07940 _ 393580
And pushed "Risk-Free" Asset Spreads to All-Time Wides, Which, in Turn, Made Credit Appear Very Rich on a Relative Basis
900 .····
800 .
700 .
600 .
500 .......................................................... .
400 .·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.0·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.~
300 .......................................................... .
200 .
100 .·.·.·.·.·.·.·.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· .. ·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·. #
O""""·"""""""'"""""""'"""""""'"""""""'"""""""'"""""""'""""""""""""""'"""""""'""""""""""""""'~ Jan-06 Jul-06 Jan-07 Jul-07 Jan-08
350 .····
3oo ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·. m
250 .
200 .
150 .......................................................... .
100 .......................................................... .
50 .
0 .
Jan-06 Jul-06
Source: Lehman Brothers.
Jan-07 Jul-07 Jan-08
Sp; eud w LIBOfl shu rm, Em opeun F6'rfBS Sp; eud inaVcazes Dutch :A:47I Sp; eua':s 5 y; Fixed w Srvap.
LEHMAN BRC)THERS 3
200 .····
175 .
150 .
125 .
100 .
75 .····
50 .
25 .
0 .
Jan-06
200 .····
180 .
160
140 .
120 .
100 .····
80 .
60 .
Jul-06 Jan-07 Jul-07
40 ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· .. ·.·.··.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·F
20 -.----------------------~ Jan-06 Jul-06 Jan-07 Jul-07
Jan-08
Jan-08
0
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
LBHI_SEC07940_393581
And Locked the Market into a Vicious Cycle Where Delevering in One Asset Class Caused De levering in Another
0
800 ......................................................................... . ABX 06-2 AAA Implied Spread
700 ·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.··.·.·.·.·.·.~·.··.·.·.·.·.·.· .. ·.·.·.·.·~.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·./·.1%········
600 ....................................................... .
500 .·····
400
300
200
100 . 0 llllllllllllllllllllll~ .... ;t!t ........ :::?.% .... ~
300
250 ....................................................... .
200 ....................................................... .
150
100 ....................................................... .
50 ....................................................... .
0 .. ,.,.,.,,,,,.,·,:,.,.,.,.,.,.,.,.,,:·,·,·,·,·,·,·,·,·,·:·:·,·,·,·,·,·,·,·:·:·:·:·:·:·:·:.:.;.;.;.;.;.;.,.,.,.,.,.,.;.;.;.;.;.;.;.:::·:
80 .
60
40
0
-20
01107
Source: Lehman Brothers.
04/07 08/07
LEHMAN BRC)THERS
12/07
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
03/08
4
iiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiili~llliliiiBIBBiiiiBBIII,~iiii~BB1iiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiii 120
110 ········································································································································~············
100 .
30
01107 04/07 08/07 12/07 03/08
LBH I_ SEC07940 _ 393582
Culminating in a Series of Regulatory Actions by the Fed.
250
0 .·····
07/04
Source: Lehman Brothers.
08/23
LEHMAN BRC)THERS
10/12
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
12/01 01120
5
0
03/10
LBH I_ SEC07940 _ 393583
Which Have Materially Reduced the Likelihood of a Liquidity Event in the Financial Markets
+ Discount window will now be extended to include primary dealers (20 large, non-bank broker I dealers)
+ There is no limit on the amount of money that can be borrowed
+ The Fed will accept a wide range of investment grade collateral- including, but not limited to ABS, CP, convertible bonds, munis, and private label CMOs
+ For difficult to finance products, the haircuts are quite generous compared to current market margin levels
+ The rate charged will be 25 bp over Fed Funds
+ The new program is for overnight funding- but it is assumed to be renewable daily using the same collateral
+ Should help prevent forced liquidations
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
6
LBH I_ SEC07940 _ 393584
With a Meaningful Reduction in the Likelihood of a Tail Event, Markets have Stabilized and Sentiment has Improved Significantly
35 .
30
25
20 .
15 .
10 .·····
Jan-08 Jan-08 Feb-08 Mar-08
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
Apr-08
7
1.00 .
0.90 .·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·. ·.·.·.·.·.~·~.~.~:~.9.Y.~.~·g·.·.·.·.·.·····
0.80 .····· .·.·.·.·.·.·.·.~··
0.70 J II ·.·.·.·.·.·.·.·.·.·.·.·.·.· .. ·.·.· .. ·.·.·.·.·.· ... · .. ·.·.·.·.·.·.·~· .·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· .. ·.·.·.·.·., .. ·.·.·.·.·.·.·.·.·.·.·.·.··n···~ .·.·.·.·.·.·.· .. ·.·,
0.60 ~ .lll! l ~ +··.·.·.·.·.·.·.·.~~%~~! Iii Iii···· ····· ~~···~··.·.·.·.·. 1··.·.·.·.·.·.·.·.~ ~nl. ········· n.·.·.·.·.·.·.·l······
0.50
0.40 ~~················· ................. ~A·· 0.30 =r=~===r~r·········· , ........................... ,.:
Risk-Averse
Jan-07 Apr-07 Aug-07 Dec-07 Apr-08
LBH I_ SEC07940 _ 393585
However, Questions Regarding the Fundamental Outlook and Potential Ongoing Stress From the High Leverage Levels Left in the System Remain
Along these lines, we see several key drivers for credit going forward
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
-
9
LBH I_ SEC07940 _ 393587
Recently, There Have Been Signs of Liquidity Normalization as Firms Have Been Able to Raise Capital in Segments of the Market That Appeared Shut Just One Month Ago ...
12,000
10,600
10,000 .
8,000 .
2,000
0 = .c ""' ""'
>. Q) >. ell c. - > '-' ~ Q) ~ c. ~ = = = Q) '-' 0 Q)
>-:> ... ~ < ~ = < rFl 0 z ~ >-:> >-:>
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
= .c ""' ""' ~ Q) ~ c. >-:> ... ~ <
~ E-< ~
10
Deal Size, $bn
8
6
4
0
FNMA,
Dec-07 ~ C,Jan-08 BACR, WB, HSBC,
Nov-07 Apr-08 Dec-07 Apr-08
LBH I_ SEC07940 _ 393588
And There Has Been Renewed Demand for Leveraged Loans (Particularly from Private Equity)
250
200 BIIIIBIIII!jiiiilll!jiii!iillljiiiBIIIIBIIII~UIIIjiii!illll
150 .
100
50 .
0 .
6/27/07
Source: Lehman Brothers.
9/26/07
LEHMAN BRC)THERS
119/08
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
4/9/08
11
LIBOR 2.70% Loan Coupon 2.75%
Loan Price 88 Leverage 3 Funding Cost 1.25%
Cash On Cash Yield 12.92%
IRR Assuming Principal Repayment at End of Period End of 3 Years 29.01% End of 4 Year End of 5 Years End of 6 Year End of 7 Years
24.23% 21.50% 19.74% 18.52%
LBH I_ SEC07940 _ 393589
There Have Also Been Signs of Stability in the Muni Market, Where Record Yields (When Compared to Other Assets) Have Helped Expand The Buyer Base
80 .
79 .
72·
71 ·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·
70 .
11101
Source: Lehman Brothers.
12/03
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
01104 02/06 03/09 04/11
12
LBH I_ SEC07940 _ 393590
Certain Segments of the Mortgage Space Have Shown Signs of Stabilization
0 ----........_ ___ _
5
10 .
15
20 .
25 Dec-06 Apr-07
Source: Lehman Brothers.
Aug-07
LEHMAN BRC)THERS
Dec-07
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
Apr-08
13
Spread(bp)
80
70
60
50
40
30
10
0
Jan-01 Jan-26 Feb-20 Mar-16 Apr-11
LBHI_SEC07940_393591
While There Have Been Many Positive Developments on the Liquidity Front in Recent Weeks, Renewed Signs of Stress in the Funding Markets Indicate That Normalization Is Unlikely to Be an Overnight Process
Change From (bp)
10-April 15-Mar 15-Dec Jun-07
Rates
2y Tsy
lOy Tsy
2y2y BE
SySy BE
Spreads!Vol
2y Sprd
lOy Sprd
MtgLOAS
CDXHG
CDXHY
3m2y Vol
Money Market
3mLIBOR-FF
6m6m LIBOR-FF
FF GC (lm)
1.86
3.53
2.03
2.45
81
65
40
117
617
135
76
42
15
Source: Lehman Brothers Interest Rates Strategy.
LEHMAN BRC)THERS
28 -119
-1 -51
-40 -16
-23 5
-17 -16
-14 -5
-26 33
-61 41
-135 131
-27 5
3 -26
0 7
-27 -32
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
-311
-157
-39
0
35
4
46
80
328
69
64
30
1
14
120 .................................................................................................................................................. 50
100
80
20
0
6/112007 8/18/2007
-Bank CD- OIS (1m)
6m6m LIBOR-FF (RHS)
1114/2007 112112008
10
4/9/2008
····················Financial CP- OIS (1m)
LBH I_ SEC07940 _ 393592
And the Economic Backdrop has Deteriorated. The Consumer is Facing Massive Headwinds as the Housing Crisis, Tightening Lending Standards, and High Commodity Prices Take Their Toll
Factor
Unemployment Rate
Payroll Growth (6-Month MA)
Gas Prices
Lending Standards
Housing Wealth Effect
Trailing 12-Month S&P 500 Return
Savings Account Yield
30-Year Jumbo Mortgage Rate
Factor
Consumer Confidence
Automobile Sales (SAAR)
Holiday Retail Sales (Yo Y)
Credit Card Delinquency Rate
Auto Loan Delinquency Rate
Prime Mortgage Delinquency Rate
Subprime Mortgage Delinquency Rate
Source: Bloomberg.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
January 2007
4.6
189K
$2.30
Loosening
1.1%
15%
4.08%
6.07%
December 2006
110.0
16.6
5.9
3.92
1.27
2.57
13.33
15
Current Impact
5.1 Negative
2K Negative
$3.39 Negative
Tightening Negative
(0.3%) Negative
-7.56% Negative
2.57% Negative
7.02% Negative
Current Impact
64.5 Negative
15.3 Negative
4.2 Negative
4.55 Negative
2.67 Negative
3.24 Negative
17.31 Negative
LBH I_ SEC07940 _ 393593
And we can Expect More Pressure to Come as Home Prices Continue to Deteriorate ...
20
Forecast
15 .............................................................. .... \:
10
5
0
-5
-10
-15
-20 Mar-88 Aug-93 Jan-99 Jun-04
Source: Federal Reserve Flow of Funds, Commerce Dept, Lehman Brothers;
Dec-09
2
1
0
-1
-2
Mar-90 Aug-94
-Housing
Jan-99 Jun-03 Dec-07
Note: Housing wealth effect assumes consumers spend 6¢ for every additional dollar of housing wealth over a two year adjustment period. Stock market wealth effect assumes consumer spend 6¢ for every additional dollar of equity wealth over a three year adjustment period (assuming a 10% increase in equities from now through year-end and 10% average increase next year.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
16
LBH I_ SEC07940 _ 393594
Lending Standards Continue to Tighten for Consumers and Corporates
Fed Senior Loan Officer Survey: Net% of banks reporting tightening of standards
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40 II, (::) •••••••.• Ilt __ ,.IIJH'l'll'l.'llilf'l •• IIIII ••••• ~ •••• lll!lii .•• liiiiiiiiii. (40) .·.·····
Q290 Q292 Q294 Q296 Q298 Q200 Q202 Q204 Q206
56 ·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· I
42 ·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· L
(28) .
Q390 Q392 Q394 Q396 Q398 Q300 Q302 Q304 Q306
Source: Federal Reserve.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
17
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80 ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.· .. ·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·. J
60
:: • Ut •••.....• 1 ••..•• il •..• ,... ~~~tlllllllrllfi ·~~ ,]tl 9~ . ·······················································~··················· (40) .·.·····
Q390 Q392 Q394 Q396 Q398 Q300 Q302 Q304 Q306
36
27
18
9
0
(18) ..
Q196 Q198 Q100 Q102 Q104 Q106 Q1m
LBH I_ SEC07940 _ 393595
And Corporates are Pulling Back on Investments ...
15
10
5
0
-5
Mar-05 Dec-05 Sep-06
Source: Federal Reserve Flow of Funds, Commerce Dept, Lehman Brothers,'
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
Jun-07
111111111111111% q-o-qar
18
Forecast
\
Mar-08 Dec-08 Sep-09
LBH I_ SEC07940 _ 393596
On the Back of All of These Issues, Growth is Expected to Slow. Importantly, we Believe this Will be a Global Slowdown ...
. . . And the macro backdrop will remain increasingly challenging for credit
+ We expect an extended period of slower growth as housing hits the US consumer and credit dislocation crimps activity. Aggressive fiscal and monetary easing- with a 1% terminal funds rate- should prevent a deep recessiOn
+ Despite strong fundamentals in EM, the world will not be able to "decouple": we expect a slowdown across the board
3.5%
2.8%
2.1%
1.4%
0.7%
0.0%
Global
Source: Lehman Brothers Economics. Note: 2007 Includes 4Q07 Estimate.
LEHMAN BRC)THERS
us 1111112007
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
EuroArea UK Japan
:::::2008 :;:::2009
19
LBH I_ SEC07940 _ 393597
Challenging Macro Backdrop Will Weigh on Fundamentals
Negative Global growth likely to slow in 2008
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
-
20
LBH I_ SEC07940 _ 393598
With Global Growth Slowing, we Would Expect Corporate Fundamentals to Deteriorate
(%)
12%
10%
7%
5%
2%
0%
1969-1970 1973-1974 1979-1980 1981-1982 1990
1111112 Quarters before Beginning ofRecession
::::::Lowest in Recession
Source: BEA, Commerce Department, Lehman Brothers Economics, Q4 Estimates,
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
2001
21
(%)
38%
19%
0%
(19%) ··················~··········································································u,n········································~
(38%) .·····
(57%) .................................................................................................................................................... .
Mar-89 Mar-92 Mar-95 Mar-98 Mar-01 Mar-04 Mar-07
LBH I_ SEC07940 _ 393599
However, Unlike the Previous Cycle, Leverage for Non-Financials is Starting Off at Lower Levels
2.5
1995 1997
Source: Lehman Brothers, Factset, Note,' 2007 Includes 4Q07 Estimate,
1999 2001
LEHMAN BRC)THERS
2003
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
2005 2007
10
8
6
4
2
0
1995 1997 1999 2001 2003 2005 2007
22
LBH I_ SEC07940 _ 393600
And the Liquidity Profile for Non-Financials Is Much Improved
Non-Financial CP outstanding has declined significantly as corporales have termed out I iabi I ities
($bn)
1,200 ................................................................................................................................................................................................................................................................................................................................... 325
1,100 ................................................................................................................................................................................................................................................................................................................................ 275
1,000
900 .. 175
800
700 ................................................................................................................................................................................................................................................................................................................................... 75
Jan-01 Nov-01 Sep-02 Jul-03 May-04 Mar-05
·····················Lehman Brothers Credit Index -Industrials+ utilities Amt. Outstanding
Source: Lehman Brothers, Federal Reserve.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
23
Jan-06 Nov-06 Sep-07
-Non-Financial CP Outstanding
LBHI_SEC07940_393601
With Respect to Financials, Many Issuers have Taken Substantial Losses and Seen Significant Erosions in their Book Values
$U.S. in billions
AMBAC Freddie
Fannie Mae MBIA
Cmmtrywide Radian
Capital One MGIC
CIT Group Rescap
lndymac
Menill Lynch Morgan Stanley Credit Agricole
Bear Stearns Goldman Sachs
Lehman Barclays
Credit Suisse Nomura
AIG
Swiss Re
Allianz Metlife
Assured lNG
MuuichRe
Scottish Re
0 2 3 4
!Ill! Specialty Finance
11.9
6.5 :
5.0 . . ffimmm3.S ~3.7
0m®3.3 ~2.8. %1.0
0 5 10 15
m Broker-Dealers
0 3 6 9
:;:;:; Insurers I Reinsurers
Source: As of Apri/14, 2008. Lehman Brothers Research
LEHMAN BRC)THERS
6.3 6.0 .
5 6 7
24.5
20 25
14.8
12 15
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
UBS C itigro up
HSBC IKB Deutsche
Bank of America Wachovia
Deutsche Bank Bayerische Landesbank
WaMu CIBC
Societe Generale M izuho
Royal Bank of Scotland J.P. Morgan
West LB Taiwan Banks I Insurers
Sachen Landesbank D resdner Bank
ABN Amro Fortis
N atixis H SH No rdbank
Wells Fargo Sumitomo M FG
DZ Bank National City
Bank of China BNP Paribas
Caisse d'Epargne Sun Trust
Commerzbank National Bank of Canada
M itsubishi UFJ Bank of Montreal A me rica Express
Bank Hapoalim Alliance & Leicester
Royal Bank of Canada No rinchukin
Australia New Zealand Standard Chartered
Sumitomo Trust ICICI
Shinsei Bank of New York
DBS Group Deutsche Postbank AG
Desjardins Group
24
0 1 2 3 4 5
iiiiiiBanks
5.80
6 7 8 9 10
.................. oi3.37.1 -32;0 ... 12.4
37
LBH I_ SEC07940 _ 393602
A Critical Issue for Market Liquidity Will be How Quickly Issuers are Able to Repair Their Balance Sheets. Many Issuers have Raised Large Amounts ofNew Capital to Offset Their Losses
Equity Convertible Preferred
Domestic Capital Markets SLM- $1.5bn SLM- $1.0bn FNM- $7.0bn UBS- CHF 6.4bn C- $2.0 bn FRE- $6.0bn
GLE- $ 8.7bn BAC- $6.9bn WM- $8.5bn
WM- $ 1.5bn LEH- $ 4.0bn BAC- $6.0bn
WB- $3.5bn
Sovereign Wealth Funds MER- $5.0bn MS- $5.0bn BSC- $1.0bn C- $14.4bn UBS- CHF 13.0bn
Long-Term MER- $1.2bn C- $5.6 bn Domestic Investors MBI- $1.0bn MER- $6.6 bn
Source: Lehman Brothers equity research. Note: Mandatory convertible preferred treated as a convertible. MER- $600mn option to buy stock is considered as exercised. UBS- Treasury stock reissuance and stock dividend is treated as equity issue.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
25
LBH I_ SEC07940 _ 393603
In Particular, the Cumulative Actions of the Fed and Other Institutions will Ease Funding Constraints on Highly Rated Assets Owned by Banks and Brokers, which Removes a Key Risk for Those Issuers
5,000
4,000
3,000
2,000
Additional Funding I Investment ~$700bn
---------~----------( "'\
New Investment in
Financing for Banks & Brokers Securities
1,ooo ................................ * ...................... < ....... ,,..... _ _.A .... _ ..... \ ( \
0····~···
TAF
.. TSLF
1'_!'/_!'/_!'/_!'/_!'/ --
PDCF
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
GSE FHLB Capital Investment
Reduction Authority Increase
Source: Lehman Brothers Economics, Lehman Brothers Securitized Products Strategy.
Estimate of Mortgage Assets Held by Banks & Brokers
$3,000bn
$270bn
US Banks/Thrifts Broker/Dealers
!IIIII Agency 11111 AAA Priv. Label
·•·• Comm MBS + Loans
AgencyMBS$4200bn
Commercial MBS$700bn
Amount Outstanding- EOY2007
Note: PDCF Size is unlimited Figures represent estimates of financing that is likely to be used Mid-point of range used for Broker/Dealer Mortgage Holdings Estimate
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
27
LBH I_ SEC07940 _ 393605
However, it is Important to Note that Less Diversified Financials have Outsized Exposures to Real-Estate Lending. Thus, the Fundamental Outlook Across Subsectors is Not Uniform
70%
60%
50%
40%
30%
20%
10%
0% I ...... •• BAC C JPM CMA FHN MI MfB SNV TCB ZION
Integrated Providers MidCap Banks
iii!CRE
Source: Lehman Brothers, SNL Financials,
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
::::: Cons tr & Land Dev
28
BBT FlfB KEY NCC PNC RF STI USB WB WFC
Super Regional Banks
llli Multi-Family
LBH I_ SEC07940 _ 393606
Overall, as the Market Struggles with Liquidity and Asset Quality Issues and Fundamentals Deteriorate Across Industrials Due to Weaker Growth, We Expect Default Rates to Pick Up From Multi-Year Lows
(%)
0.0%
1.2%
2.4%
3.6%
Dec-92 Dec-94 Dec-96 Dec-98 Dec-00
-Real GDP% YoY(LHS) (Inverted)
Source: Lehman Brothers, Federal Reserve, Moody's.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
29
(%)
10%
...................... 6%
4% Estimate
for Defaults
Dec-02 Dec-04 Dec-06 Dec-08
.................... HY Default Rate (RHS)
LBH I_ SEC07940 _ 393607
So the Fundamental Backdrop Is Unlikely to Be Supportive Going Forward ... What about the Technical Backdrop?
Negative Global growth likely to slow in 2008
LEHMAN BRC)THERS
Negative As growth slows, fundamentals to deteriorate
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
30
LBH I_ SEC07940 _ 393608
In Recent Years, a Large Amount of Debt has been Raised in Segments of the Market where Liquidity has Declined
($bn)
1,200
960
720
480
240
2001
1. Source: Lehman Brothers.
2002
LEHMAN BRC)THERS
2003
!Ill Fixed
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
2004 2005 2006 2007
''''Hybrids ,,,, Floating '' Extendible
31
LBH I_ SEC07940 _ 393609
As a Result, We Estimate Risk-Adjusted Supply to Be up Significantly
(%)
100%
80%
60%
40%
20%
0%
1111 Extendible
Source: Bloomberg.
2006
1. Uszng szmzlar Mzx to 4Q07.
:::: Floating
2. Approxzmatzon uszng spread duratzon.
LEHMAN BRC)THERS
2007
Fixed
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
2008E
l8i Pref.
33
($bn)
1,600
1,280
960
640
320
0
2006 2007 2008E
LBHI_SEC07940_393611
In Line with Expectations, Fixed Issuance in the First Quarter has Outpaced 2007 and Will Likely Remain Strong as Other Sources of Funding Remain Tight
200 .
180
160
140 ....................................................................................................................... .
120
100
80
60
40
2
: II
1Q.2007- $110 bn 1Q.2008- $169 bn
1Q 1997 1Q 1998 1Q 1999 1Q 2000 1Q 2001 1Q 2002 1Q 2003 1Q 2004 1Q 2005 1Q 2006 1Q 2007 1Q 2008
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
34
LBHI_SEC07940_393612
On the Demand Side, Inflows from Abroad have Slowed and Will Likely Remain Biased Towards Equities
(bn) 40 ........................................................ .
32
24
16
8
0
Treasury
11111!2006
Agency/ MBS
Fixed Income 90%
Corporate
Equity 10%
::::::2007
Equities
($bn)
400
320
240
160
80
0
Equity
1111112007
Corporate
::::::2008
While official institutions have diversified away from fixed income assets, given the current size of equity exposure there is scope for further diversification. Assuming an fixed income/equity shift to 85%/15% and a $130bn slowdown in official flows(l), foreign purchases of US corporate bonds would decline by $50bn in 2008
Source: Lehman Brothers; TIC.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
35
LBHI_SEC07940_393613
The Drop in Synthetic CDO Issuance Will Result in a Further Decrease in Demand for Credit Risk
+ We expect Synthetic COO Issuance to decline by approximately 60% in 2008 due a combination of limited investor confidence in structured products and rating agency models
+ A 60% drop in issuance and decreased leverage on new deals would result in approximately a $290bn drop in 5year equivalent notional demand for risk
Global Synthetic CDO Issuance
($bn)
45
36
27
18
9
0
2000 2001 2002 2003 2004 2005 2006 2007 2008E Source: Lehman Brothers, Intex, IFR, Moody's, S&P
($bn)
375
300
225
150
75
0
Synthetic CDO Issuance -Delta-Adjusted 5-Year Equivalent
Down $290bn
2007 2008E
Note,' Synthetic issuance only includes only public transactions that were in funded format 2008 Estimate is based on a projected decline of 57% in cash and 50% in synthetic transactions,
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
36
LBHI_SEC07940_393614
In addition, Stressed Financial Issuer Balance Sheets will Likely Continue to Weigh on Demand for Risky Assets
100 ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.· 300%
90 .
50
40
10
0
1987 1990 1993 1996
illllllllllllll Reser~($ bn)
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
250%
200%
150%
100%
50%
1999 2002 2005
37
LBHI_SEC07940_393615
Putting it All Together, the Supply I Demand Imbalance Will Likely Continue To Weigh On Credit
(bn)
2,000
1,600
1,200
800
400
0
2006 Source: Lehman Brothers. Note: Approximation using spread duration.
LEHMAN BRC)THERS
2007
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
iiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiillllll,iiiliii~lliliii-~~iiiilillliiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiiii
+International Demand: Down $50bn
+ Synthetic Demand: Down $290bn
+Front End Demand: Down $280bn
+Redemptions: Down $75bn
+Total: Down $600bn
2008E
38
LBHI_SEC07940_393616
No Discussion of the Technical Backdrop Would be Complete Without Looking at Spreads
Negative Global growth likely to slow in 2008
LEHMAN BRC)THERS
Negative As growth slows, fundamentals to deteriorate
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
39
-Negative Large supply I demand imbalance to persist
LBHI_SEC07940_393617
Across Sectors, Spreads Remain Close to Their Widest Levels in Cash
... since 2002 and investors must put much more focus on relative value going forward
(bp)
560 ·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.· .. ·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.
480 .......................................................... .
400 l 1
240 .
. J.
160 .····
80 .
0 .····
"' -; ... "CC "' -; .... ~ 0 = " "' .... 0 ;§ ~ § :s " 0 = .. "' ... ..... -; "'
... = "' "§ u 0 = i ui .... .. e " u ~ e
0 u = 0 u
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
... ~ 0 0 ..e "' " E-<
·::;:::·
. . . . . . . . . . . . . . . . . . . . ................ :;;;~~;:: .. .
= "' "' ~ " " "' ;§ -; ·;::: ..
~ ~ "' ~ ~
-; ..... 0 .. " ·o .. ·;::: "' .... ·= .. ~ ..... 1;] ~ -; = ~ .. .... = .... = .... .. ~ ~ ~ .,§ 0 "CC .a ~ 0 e ~ .s .e .s ·~ = "' .. 0 ~;::: = z u .... 1;] .. .... .... " " .f.S E-< .; "' = 0 0 .. .e ....
40
LBHI_SEC07940_393618
However, While Spreads Are Much More Supportive Than Last Year, All-In Yields are Essentially the Same
(bp)
700
0-2 Years 2-4 Years 4-6 Years 6-8 Years 8-12 Years O~r 12 Years
18! Treasury ::::Swap :::: Credit Risk
Source: Lehman Brothers.
LEHMAN BRC)THERS 41
(bp)
300
200
100
0
(100) .
(200)
(300) .
(400) .
0-2 Years 2-4 Years 4-6 Years 6-8 Years 8-12 Years
Change (137bp) (54bp) (27bp) 24bp 28bp in Yields
vs. 12/06 !Ill Treasury ,,,,,Swap '''' Credit Risk
Over 12 Years
22bp
0
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
LBHI_SEC07940_393619
And in Derivatives, Spreads Have Retraced a Substantial Portion of the Recent Widening
18 .
16 ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·. Over half the names have retraced over 60% of ·.····
14 .·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· the widening from early-January to mid-March .····
12 .
10 ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.
8 .
6
4
2 ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.
0············································································
0% - 5% - 10% - 15% - 20% - 25% - 30% - 35% - 40% - 45% - 50% - 55% - 60% - 65% - 70% - 75% - 80% - 85% - 90% - 95% -10% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100%
70%
60%
50%
40%
30%
20%
10%
0°/o
Source: Lehman Brothers.
IG
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
HVOL CMBXAAA ABX07-1 AAA
42
LBH I_ SEC07940 _ 393620
In Addition, Corporate Credit has not Cheapened as Much as Some Other Spread Sectors. As the De leveraging Continues we Believe Spreads Will Need to Remain at Levels That Deliver Attractive Returns Even at No or Low Leverage
(bp)
900 800 700 600 500 400 300 200
... .... 100
····.·.· .. .. ;:.:·:
0
Jun-99
Asset Class
AB S Home Equity
ABSAuto
Ius Credit
CMBS
AB S Credit Card
Source: Lehman Brothers. Note: As of 4114/2008
Jul-00 Aug-01 Sep-02
-US Credit- OAS
·········· ABS Credit Card- OAS
· · · · · · · · · · ABS Home Equity- OAS
Average Rating
AAA
AAA
Al/A2
AAA/AA1
AAA
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
Oct-03 Oct-04 Nov-05
................... US Mlrtgage Backed Securities - OAS
-ABS Auto- OAS
~ CMBS: Erisa Eligible- OAS
Wides Since 2001 OAS (bp)
855 851
403 382
268 245
486 330
263 251
43
Dec-06 Jan-08
Chg Since 12/31/07 (bp)
+373
+168
+63
+161
+90
LBH I_ SEC07940 _ 393621
Bringing it all Together, what is the Outlook for Different Parts of Credit ?
Negative Global growth likely to slow in 2008
LEHMAN BRC)THERS
Negative As growth slows, fundamentals to deteriorate
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
44
-Negative Large supply I demand imbalance to persist
Positive Cash Spreads near multiyear wides. However, liquidity situation needs to improve further to get full benefit
LBH I_ SEC07940 _ 393622
We Remain Generally Bearish on Investment Grade Credit Despite Current Valuations. However, this has Become a More Bifurcated View.
High quality financials, especially money center banks and brokers, have seen significant widening and provide attractive value at these levels. We remain cautious on independents and regional banks due to ongoing asset quality concerns
(bp) 350 ·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·. ;;
300
250
200
150
100
50
Apr-03
70% 60%
50% 40% 30% 20%
Sep-03
10% .. . .. . 0% ... :-:·:·:·:·:·:·:·:·: ... ---------- .... -~~~~~~~~~~ ....
Mar-04 Sep-04 Mar-05 Sep-05 -Invest. Grade: Industrial- OAS
BAC C JPM
Integrated Providers
CMA FHN Ml MfB SNV TCB ZION
MidCap Banks
IIIICRE
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
:,:,: Cons tr & Land Dev
45
Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 ·········· ln\es t. Grade: Finance - OAS
BBT FlfB KEY NCC PNC RF STI USB WB WFC
Super Regional Banks
1111 Multi-Family
LBH I_ SEC07940 _ 393623
Given Our Expectations for Slower Growth we Believe That the Credit Cycle Turn Will Continue. We Thus Expect More Cyclical Sectors to Remain Under Pressure.
(bp)
300
250
200
150
100
50
Dec-05
400
200
0
(200)
(400)
(600)
4Q2000
Jun-06 Dec-06
-Imest. Grade: Consumer Cyclical- OAS
4Q2001 4Q2002 4Q2003
Jun-07 Dec-07
··················· Irnest. Grade: Consumer Noncyclical- OAS
........................................................ i,·i .. i •. i .. i •. i .. i •. i .. i,·.· . . . . IJIJ Ill
.11~:~:~:~: ... 11~~~~~~~~~. ·········~·············~·············:::::::::: .•. 1:;:;:;:;:····~· • (lj ··········~·r ::::~~~
4Q2004 4Q2005 4Q2006 4Q2007
111111 Consumer Cyclical ::::::: Consumer Non-Cyclical
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
46
LBH I_ SEC07940 _ 393624
We Recommend Negative Basis Trades for Investors with Access to Cheap Funding and for Those Looking to Source Convexity in This High Volatility Environment
10
(30) ·.·····
(70) .
(90)
(110) .
Jul-07
Profit
Loss
Source: Lehman Brothers. Note: Assumes 40%Recovery
Aug-07
Credit Rallies
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
Oct-07 Dec-07 Feb-08 Mar-08
Credit Defaults
Credit Deteriorates
47
LBH I_ SEC07940 _ 393625
In High Yield, the Default Cycle will be Unique as we are Coming Off of a Period of Lenient Lending Standards. A Combination of a Worse Credit Profile and Increased Issuer Flexibility will Likely Lead to Lower Recoveries for Unsecured Bonds.
20%
18% .
16% .
14%
12%
10% .
8% .
6%
4%
:: &llo•••••••••••·•••••lllllltl 01104 08/04 03/05 10/05 05/06 12/06 07/07 02/08
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
48
100
CCC& Lower form
80 more than
20°/o of index
60
40
20
0
1993 1995 1997 1999 2001 2003 2005 2007
LBH I_ SEC07940 _ 393626
At Current Levels, We Prefer Leveraged Loans to High-Yield Bonds Given Their Structural Seniority and Low Dollar Price
100%
80%
60%
40%
20%
Jul-06 Mar-07 Jun-07 Jun-07 Oct-07 Feb-08
1111<90 {90-98 illllll98-100
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
49
7% illllll% ofLoans
6%
5%
4%
3%
2%
1%
oo/o ....... ~ ....... 11118 ················~·181·······&&··~·
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
4%
4%
3%
3%
2%
2%
1%
1%
0%
0%
r:al% ofBonds
.................... Mean-32% St Dev -17% Count = 1603 Issues
10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
LBH I_ SEC07940 _ 393627
Within Structured Credit, AAA Tranches of CLOs present the Best Opportunity for Investors with Stable Funding. While CLO's are Fundamentally Different from ABS CDO's .....
Collateral
Asset Diversity
CDO within CDO
Leverage/Subordination
Cash flow Triggers
Impact of Asset Downgrades
Excess Interest and Deleveraging
Portfolio Management
Modeling
Source: Lehman Brothers.
LEHMAN BRC)THERS
CLO
Primarily high yield corporate
senior secured loans
Highly diversified, typically 150-200 issuers across different sectors
"Structured finance buckets" are capped at 3-5% - Managers rarely use more than
1-2%
Rating agencies require more par subordination for HY collateral ( ~8% equity)
Waterfall structure diverts cashflow to senior holders if coverage tests fail
Caa/CCC assets in excess of 5. 0-7.5% are carried at market value for OC purposes (typical
size is 0-2% now
Higher excess interest means faster deleveraging in the event of an OC breach
Almost all are actively managed
Simpler
50
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
ABSCDO
Primarily HELs
Concentrated in
residential real estate, consumer risks
10 to 3 0+% of portfolio consist of other AB S CDO tranches
Rating agencies require less par subordination for IG collateral (<1% for HG and ~5% for
Mezz eguity) Transactions from 2006 were increasingly
without triggers
OC haircuts kick in when downgrades to BB and B are in excess
Very slow deleveraging, especially with HG
assets
Some are static or partially managed
Complex (re-securitization)
LBH I_ SEC07940 _ 393628
Spreads have Widened Substantially In Line With other Structured Products, Even Though AAAs are well Protected Against Principal Losses
(bps)
400
350
300
250
200
150
100
50
0
Mar-98 May-99 Jun-00 Jul-01 Aug-02 Sep-03 Oct-04 Nov-05 Jan-07 Feb-08
-AAA .,.,.,.,.,.,.,.,.,.,.AA
+ Recent widening seems to have been driven by concerns over investors' ability to finance AAA assets going forward
+ Even under extreme stress scenarios, AAA CLOs are well protected against principal losses. Even at 60% average recovery, annual default rates must be greater than 3 1% per annum to break AAACLOs
Source: Lehman Brothers. 1. 2006- 2007.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
51
40 50
Insurance
Banks
60-70%
60
Loan Recovery (% )
Other
5-10%
70
Asset
Managers
/Levered
80
LBH I_ SEC07940 _ 393629
As Growth Slows and Fundamentals Deteriorate, Junior Parts of the Capital Structure Should Continue to Underperform Both Within Issuers
900
400
12/31 01125
~CDXHY9
Source: Lehman Brothers, Bloomberg.
02/20
LEHMAN BRC)THERS
03/16
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
550
500
300
250
04/11
52
280 ............................................................................................................................................. 2,500
240
2,000
200
1,500 160
120 1,000
80
500
40
0 ............................................................................................................................................. 0
Jan-07 Apr-07 Aug-07 Dec-07 Apr-08
~AAA
LBH I_ SEC07940 _ 393630
And Across Asset Classes
280 .............................................................................................................................................. 2,500
0 ~~~~::::::'' ........................................................................ 0
Jan-07 Apr-07 Aug-07 Dec-07 Apr-08
-AAA .................. ··BBB- (RHS)
Source: Lehman Brothers.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
53
80 20
·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· .. ·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.··.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.·.· 8 50
Dec-07 Jan-08 Feb-08 Mar-08 Apr-08
-AAA .................. ··BBB-
LBHI_SEC07940_393631
And the Best Shorts Are Likely to Be Those That Could Actually Experience Losses Rather Than Those That Are Simply Trading Too Tight
bp
200
150
100
50
0
Mar-06 Sep-06 Mar-07 Sep-07 Mar-08
( 0-3% > 3-7% 11111117-10% :~:~:~: 10-15% ( 15-30% 111111130-100%
Similar to Last Cycle
Liquid IG Severe 0%-3%
Severe, Credit Cycle
Wiped Out
Extremely Severe
Credit Cycle
Wiped Out
Slight
Tranches Principal Loss (7Y) _____ .....;;..._ _________ _
./ 3%-7%
7%-10%
10%-15% &Above
Liquid 0%-10%
HY 10%-15%
Wiped Out
Principal Loss Heavy Loss
./ ./
./ ./
Wiped Out Wiped Out
Tranches------------~----------~--------~------Wiped Out Wiped Out Wiped Out
(5Y) 15%-25% Heavy Loss Wiped Out Wiped Out
25%-35% ./ Wiped Out Wiped Out
35%-100% ./ Just Touched Significant Loss
Source: Lehman Brothers. Credit cycle data based on Moody "s default data for JG and HY Regular recession scenarios are run on flat periodic default rates. Front I back loaded scenarios assume linearly decreasing I increasing d_'{[f!;.ult rates with a minimum of 0% and a maximum of two times the periodic default rate. ",/"" stands for non- impairment in the tranche.
LEHMAN tlR()THERS 54
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
LBH I_ SEC07940 _ 393632
Concluding Thoughts
Negative Global growth likely
to slow in 2008
Negative As growth slows,
fundamentals to deteriorate
Large supply I demand Negative
imbalance to persist
Cash Spreads near multiyear wides. Positive However, liquidity situation needs to
improve further to get full benefit
LEHMAN BRC)THERS 55
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
• Deteriorating macro backdrop combined with a large demand I supply imbalance should prevent spreads from rallying materially
• Aggressive central bank action should lead to liquidity normalization in the intermediate term, but underlying asset quality issues will remain
• Ability of spreads to rally will be a function of the amount of economic damage done by the credit crunch
LBH I_ SEC07940 _ 393633
This material has been prepared by Credit Trading and is not a product of Lehman Brothers Research Department. It is for informational purposes only. Lehman Brothers makes no representation that the information contained in this document is accurate or complete. Opinions expressed herein are subject to change without notice. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the issuance of this document. Under no circumstances should this document be used or considered as an offer to sell or a solicitation of an offer to buy any financial instrument mentioned in it. The products mentioned in this document may not be eligible for sale in some states or countries, or suitable for all types of investors; their value and the income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors. Clients are advised to make an independent review regarding the economic benefits and risks of purchasing or selling the financial instruments mentioned in this document and reach their own conclusions regarding the legal, tax, accounting and other aspects of any transaction in the financial instrument in relation to their particular circumstances. Lehman Brothers enters into transactions on an arm's length basis and does not act as advisor or fiduciary to its counter parties except where a law, rule or written agreement expressly provides otherwise. Lehman Brothers and/or its affiliated companies may make a market or deal as principal in the financial instruments mentioned in this document or in related securities, options or other derivative instruments based on them. In addition, Lehman Brothers, its affiliated companies, shareholders, directors, officers and/or employees, may from time to time have long or short positions in the financial instruments, including loans, securities or in options, futures or other derivative instruments based on them. One or more directors, officers and/or employees of Lehman Brothers or its affiliated companies may be a director of the borrower or issuer mentioned in this document. Lehman Brothers or its predecessors and/or its affiliated companies may have acted as agent or arranger with respect to the loans of the borrowers mentioned in this report, and may have managed or co-managed a public offering of or acted as initial purchaser or placement agent for a private placement of any of the securities of any issuer mentioned in this document within the last three years, or may, from time to time perform investment banking, lending or other services for, or solicit investment banking or other business from any company mentioned in this document. No part of this document may be reproduced in any manner without the written permission of Lehman Brothers. ©2008 Lehman Brothers Inc. All rights reserved. Member of SIPC.
LEHMAN BRC)THERS
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
56
LBH I_ SEC07940 _ 393634