This summary is based on the third quarter fiscal 2007 earnings call conducted by Lehman Brothers Holdings Inc. (LEH) on September 18, 2007.
Chief Financial Officer, Executive Vice President: Chris O''Meara
Investor Relations: Shaun Butler
Key Investors Issues
- EPS were $1.54 per share compared to $1.57 a share last year.
- Net income fell to $887 million from $916 million a year earlier.
- Net revenue climbed 3% to $4.3 billion.
Third Quarter Highlights
Market conditions were challenging, as what began as a broad-based reassessment of credit risk morphed into heightened liquidity and market risk over the course of the summer.
Valid concerns regarding the underlying credit quality of sub-prime mortgages and related CDOs became more systemic as risk premiums became elevated and liquidity became scarce across asset classes, extending across rating categories into double A and triple A rated assets.
Spreads widened out accordingly, with high grade and high yield spreads essentially doubling over the period, representing approximately a five standard deviation move in percentage terms.
The repricing of credit risk had second order effects that extended into foreign exchange, as carry trades were unwound and into the global equity markets as financials repriced and investors sought liquidity. Volatility spiked in equities, interest rates, and foreign exchange, as investors rushed to buy protection, and correlations between asset classes moved towards one, as they generally do in a distressed environment.
Secondary markets in certain asset classes became illiquid, particularly in highly structured products.
These market moves were exacerbated by concerns over the significant pipeline of high yield debt supply expected to enter the market, coupled with the de-levering of investment vehicles.
As risk aversion increased, investors horded liquidity. Consequently, asset repricing was amplified by the need to sell assets and raise cash. Certain hedge fund strategies were under pressure, given the market environment, which caused the combination of margin calls and redemption notices that required significant and immediate delivering. Liquidity risk was most acute in the asset-backed commercial paper market, where issuers were forced to raise alternative sources of liquidity.
This disorder in the front-end of the market, among other factors, prompted central banks to infuse substantial amounts of liquidity into the financial system. As a knock-on effect to market price deterioration and higher volatility, investment banking activity declined.
On a sequential basis, the volume of announced M&A transactions declined 20%, equity underwriting volumes fell 5%, and debt underwriting volumes fell 29%.
- Net revenues were $4.3 billion, up 3% year over year but down 22% from the record set last quarter.
- Net income was $887 million and EPS was $1.54 per share, including after-tax charges of $37 million, or 6 cents per share associated with restructuring mortgage origination platform, including the closure of BNC Mortgage, U.S. sub-prime originator.
- Net income was down 3% and 30% respectively compared to the prior year in second quarter levels, respectively.
- Excluding the restructuring charges, net income was $924 million and EPS was $1.60, both ahead of last year’s third quarter. Return on equity was 17.1%.
This performance is attributed to several factors: strong risk management culture, with regard to the setting of risk limits and the management of market and counter-party credit risk, and strong liquidity framework. From a business standpoint, growing footprints in investment banking, equities and investment management, as well as in Europe and Asia, which have reduced reliance on any one business or region, and continued emphasis on customer flow activities versus proprietary as a primary source of revenues, which has helped to mitigate the impact of the difficult market environment.
Segment Performance
Investment Banking Segment
- Revenues were $1.1 billion, up almost 50% year over year and down 7% from last quarter’s record level.
- Pretax income was $288 million.
- M&A Advisory revenues were $425 million, up substantially from both benchmark periods.
- Volume of completed M&A transactions totaled approximately $111 billion. There was a significant amount of advisory activity not included in these volumes, from private deals where transaction sizes were not disclosed and therefore not included in the lead table data.
Volume of announced M&A transactions totaled $156 billion as the company continued to grow pipeline, and announced M&A market share rose to 20.2% year-to-date versus 15.7% for full year 2006.
- In equity origination, revenues were $296 million, up substantially year over year and down slightly from last quarter’s record level. This represents second-highest level of revenues for this business.
- Volume of equity origination transactions totaled approximately $8.6 billion, down from last quarter’s level and in line with the decline in the overall market. Although results for the period declined sequentially, mainly due to somewhat lower convertible and derivative related activity, IPO volume and market share increased.
- Fixed income origination revenues were $350 million, essentially flat year over year and down substantially from last quarter’s record level. The decrease reflected the decline in both high yield and investment grade issuance activity caused by the dramatic credit spread widening witnessed over the period.
- Volumes in both high grade and high yield origination dropped substantially for the period, along with the overall market.
- Despite recent market conditions, the company continues to have momentum in the investment banking business and both volume and fee pipelines remain strong.
- From a volume perspective, pipeline across all products was $813 billion. M&A volume pipeline was $616 billion, equity origination pipeline was $18 billion, and debt origination pipeline was $179 billion.
- Aggregate fee backlog was approximately $1 billion, down from the record fee pipeline at the end of the second quarter.
Capital Market Segment
