Lehman Brothers Holdings Capital Trust III (LEHKQ)

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Lehman creditors in fight to recover collateral
By Henny Sender in New York

http://www.ft.com/cms/s/0/909ba63c-5e99-11de-91ad-00144feabdc0.html
Published: June 21 2009 22:31 | Last updated: June 21 2009 22:31

Leading hedge funds have been buying up Lehman Brothers’ debt in the hope that the bankrupt investment bank’s estate will be able to win court battles to recover billions of dollars in collateral held by competitors with whom it did business.

The bulk of the potential claims stems from JPMorgan Chase’s role as a clearing bank for Lehman in the repurchase – or repo – markets. Lehman borrowed heavily in the repo markets – in which banks receive overnight loans in return for pledges of collateral – a practice that left it susceptible to a loss of confidence.

Lawyers for the Lehman estate and for unsecured creditors are trying to determine whether Lehman surrendered too much collateral, at the expense of other creditors, to JPMorgan and other lenders. The Lehman estate has already filed a complaint against Bank of America for allegedly improperly seizing $500m collateral. Lehman and the other banks declined to comment, citing confidentiality concerns.

Lawyers say it is not unusual for unsecured creditors, such as hedge funds, to pursue secured creditors, such as the banks, in the courts. Unsecured creditors hold Lehman debt that once had a face value of $80bn but now trades at about 15 cents on the dollar.

EDITOR’S CHOICE
Fed plans repo markets revamp - Jun-21Push to reduce risks in short-term funding - Jun-21Big names eye Lehman’s debt - Jun-21The Lehman saga shines a light on the complicated relationship that existed between Lehman and JPMorgan. JPMorgan served as the clearing bank for Lehman in the repo market and as one of the two clearing banks – the other was Bank of New York Mellon – for the New York Federal Reserve Bank’s credit facility for securities firms.

In addition to serving as its clearing agent, JPMorgan was also Lehman’s biggest counterparty on billions of dollars of derivatives trades. In such transactions, each side tots up its net exposure every night, demanding additional collateral when the amounts owed exceed a certain threshold. If Lehman defaulted, according to the agreements, the value at which these trades were automatically closed out was determined by JPMorgan.

Background
The clearing banks in the repo market stand between borrowers and lenders, providing services such as valuing the collateral posted by the borrowers and advancing cash during the hours when trades are being made and unwound.

In that capacity, the clearing banks stand to lose money if the value of collateral falls and can put pressure on a repo borrower to pledge additional collateral if market conditions turn sour.
These multiple activities exposed JPMorgan to potentially massive losses if Lehman failed. Unsurprisingly, in the days leading up to Lehman’s bankruptcy filing on September 15 there were a series of crisis meetings between the banks.

On August 26, JPMorgan reworked its existing credit agreements with Lehman so that the parent guaranteed the obligations of the broker-dealer and also provided collateral to secure that guarantee. Because the collateral the parent supplied JPMorgan involved very customised structured securities, which did not trade, JPMorgan relied on Lehman’s own values “initially”, a person familiar with the thinking at JPMorgan says. Lawyers familiar with the matter say about 30 per cent of the collateral Lehman pledged was illiquid, hard to trade and therefore hard to value.

Then, on September 4, JPMorgan was briefed on Lehman’s upcoming earnings results and was told it expected to report a $4bn loss, according to people familiar with the matter.

Five days later, JPMorgan signed another agreement with Lehman in which the Lehman parent’s guarantee covered not just its failing broker-dealer but all Lehman entities and covering all transactions, including the large book of derivatives trades.

Hedge funds draw lessons from Enron experience
Hedge funds that have bought billions of dollars of Lehman claims are taking a page from the Enron playbook.

When Enron filed for Chapter 11 bankruptcy protection in 2001, the value of much of its debt fell to pennies on the dollar. But hedge funds figured out that recoveries could be made by targeting the banks that worked for Enron. These banks were found to have arranged equity and debt underwritings that did not accurately convey the extent of Enron’s debts and in some cases facilitated transactions that ultimately involved fraud.

To settle claims, banks gave billions of dollars to the Enron estate, which led to recoveries of between 85 cents and 100 cents on the dollar for some holders of Enron debt. However, people involved in the matter say the Lehman bankruptcy, which has not involved any allegations of fraud, is likely to be more complicated.

“In Enron, you at least knew what the liabilities were,” said one hedge fund manager. “Here it is all a black box.”
After Lehman filed for bankruptcy at the holding company level, it lost its ability to trade with most counterparties in the repo market. The Fed stepped in to provide it with emergency funding in exchange for collateral, the value of which was estimated by JPMorgan. JPMorgan advanced an initial $87bn to Lehman to help it unwind repo arrangements on the day it filed.

People familiar with JPMorgan say the bank gave the Fed access to its internal values for most of the securities pledged by Lehman, although some of those estimates reflected third-party input. In cases involving collateral unique to Lehman – for example customised and non-traded securities – Lehman provided price estimates to the Fed. Several people familiar with the matter say the overall values for the Lehman collateral reflected JPMorgan’s calculations.

The creditors’ committee now alleges that JPMorgan had collected about $17bn in collateral from Lehman in the first two weeks of September 2008. A filing on behalf of unsecured creditors states that as of the Friday before the bankruptcy petition, the Lehman holding company had “at least $17bn in excess assets in the form of cash and securities” that were held by JPMorgan and subsequently frozen by JPMorgan.

“JPMC’s refusal to make those assets available to [Lehman] and its subsidiaries in the days leading up to the bankruptcy filing may have contributed to Lehman’s liquidity constraints,” the filing claims.

People familiar with JPMorgan say the bank is unsure how the $17bn figure was arrived at. JPMorgan’s own calculations suggest the bank received only $13bn in additional collateral payments, according to people familiar with the matter.

A bank spokesman declined to comment.

Separately, creditors are looking into whether banks and other counterparties including JPMorgan closed out derivatives transactions with Lehman at values that were unfavourable to the bankrupt investment bank.
Copyright The Financial Times Limited 2009