Lehman Brothers Bankruptcy

A number of years ago, when I knew nothing about distressed, my portfolio manager sat me down and said, "Our friends at XYZ hedge fund [name redacted] are telling me these Enron bonds are interesting - start working through it." Over the next 6 months I cut my teeth (hard) on figuring out how much bond holders would receive and what return that translated to. It was one of the best exercises that I've ever been put through as an analyst.

In my opinion, the best situations for distressed debt investors to make out-sized returns are when the bankruptcy filing is unexpected. I remember when Solutia filed in 2003 and Parmalat soon after. In both situations, no one had any idea what to make of the situation. Uncertainty creates opportunity. Chaos as it were. In that vein, of every situation I've encountered in my professional career, Lehman, and its various 'flavors' has been one of the most complex.

On a daily basis I am receiving over 200 trader runs on various Lehman instruments. The most liquid of these instruments are the LBHI bonds, or Lehman Brothers' holding company. In addition, you have runs on "LBSF", "LBCS", "LCPI", "LBIE", "LBT", "LBCC", "LOTC", LBHI Euro, LBHI Yen etc etc. While these instruments are more illiquid, each may hold the possibility of a solid risk adjusted return.

Earlier in July, a diverse group of creditors agreed to a settlement that will (more than likely) enable Lehman to exit Chapter 11. Similar to Enron, this settlement resolves around a partial substantive consolidation (80/20) split. This settlement was agreed upon by a "Who's Who" of hedge funds and prop desks (dubbed the PSA Creditors):

Angelo, Gordon & Co., L.P.
Barclays Bank PLC
Barclays Bank S.A.
BNP Paribas
Canyon Capital Advisors LLC
CarVal Investors UK Limited
Contrarian Capital Management LLC
Credit Suisse International
Credit Suisse Loan Funding LLC
Credit Suisse Securities (Europe) Limited
Cyrus Capital Partners, L.P.
Davidson Kempner Capital Management LLC
DB Energy Trading LLC
Deutsche Bank AG
Elliott Management Corporation (also Elliott Associates, L.P.
Elliott International, L.P. The Liverpool Limited Partnership)
Fir Tree, Inc.
GLG Ore Hill LLC
Goldentree Asset Management, LP
Goldman Sachs Bank USA
Goldman Sachs International
Hayman Capital Master Fund, L.P.
King Street Capital Management GP, L.L.C.
Knighthead Capital Management, L.L.C.
Morgan Stanley & Co. International PLC
Morgan Stanley Capital Group Inc.
Morgan Stanley Capital Services LLC
Mount Kellett Master Fund II, L.P.
Oak Tree Capital Management, L.P.
Och-Ziff Capital Management Group LLC
Paulson & Co. Inc.
Silver Point Capital, L.P.
Societe Generale
Societe Generale Asset Management Banque
Societe Generale Bank and Trust
Taconic Capital Advisors L.P.
The Baupost Group, L.L.C.
The Royal Bank of Scotland plc
Varde Partners, L.P.
York Capital Management Global Advisors, LLC

This group of creditors held over $100 billion (!) of claims against Lehman Brothers.

While the value proposition was definitely there when the LBHI bonds were trading in the teens, another aspect of this case was that A LOT of capital could be put to work with very little correlation to the market with very little downside. And that is still probably the case.

Like in all bankruptcies, the disclosure statement here lays out contemplated recoveries for the various creditor constituencies. And like most bankruptcy cases, these recoveries cannot be relied upon to make actual trading decisions. For instance, LBHI Senior Bonds are contemplated to recover 21.1% whereas in the market as of this afternoon the bonds were trading (depending on the specific bond) between 26 - 26.5%. While in "dollar value" that may not look like a lot, in reality it's a ~25% difference. Why the disparity?
  • As in most cases with financial assets as collateral for creditors, there is a perception that there has been a sense of conservatism and that, over time, these assets throw off cash that increases recoveries to creditors
  • The fact that no one really knows the recovery on foreign inter company receivables. We do know that the recovery of inter company receivables from foreign affiliates, at less than 10% is far below similar (domestic for instance) recoveries contemplated in the disclosure statement - It's also a HUGE number where a 1% bump means $500M more recovered for LBHI
  • Litigation awards that could go any which way
These are just a few factors. In addition, returns to investors depend dramatically on when cash actually gets paid out. The fact that the plan / disclosure statement is on the docket means the likelihood of more timely distributions increases. It will be a sad day when this case finally comes to a close (I believe it accounts for something like 70% of all trade claims).


Anonymous,  7/16/2011  

"another aspect of this case was that A LOT of capital could be put to work with very little correlation to the market with very little downside. And that is still probably the case."

Can you please explain what you mean by this paragraph? Thanks.

An interesting article.

Anonymous,  7/18/2011  

It means if the market crashes, you'll still get a decent return from splitting the Lehman asset pie.

Anonymous,  7/18/2011  

But like you said the recovery as per the plan is approx 21% of the face value for Senior Unsecured and these are trading at 23-26 cents in a Dollar, suggesting there is little upside to the current prices. Unless the recoveries are higher than expected.

Anonymous,  7/18/2011  

Now, I'm sorry if this is completely basic, but is there a way of finding a theoretical price for these bonds? is that just the recovery, or should the interest 'lost' also be factored in?

And what about a distressed bond before bankruptcy? is the theoretical price then similarly yielding bond x expected amount recovered in bankruptcy? Or do you also factor in how long it will take to get your cash back?

Thank you so much in advance!


hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.