The Financial Crisis of 2008 and its Implication for Lehman Brothers

The world has faced a huge financial crisis in year 2008 and the impacts of the same were witnessed by Lehman Brothers. During the month of September, 2008 the newspapers highlighted one story that makes the world to witness one of the most terrible market crashes in history. It was Lehman Brothers Holdings Inc., going bankrupt during the year. It was a US based company and was regarded as the fourth largest financial services group across the country. With such bankruptcy, it was expected that the assets and other parts of the group would be soon bid on by other firms who are engaged in financial services. Out of many, Nomura investment banking group find it the best opportunity to expand and grow its business on a global level.  The bank closely followed all the events at Lehman and prepared a deal to purchase Lehman’s operations in various regions such as Europe, India and Asia. However, before making such acquisition decision, a proper analysis is been done based on the data provided in case study.

Nomura Holdings Inc., is a Japanese company engaged in providing financial services to its customers. The company closely followed the process of Lehman Brothers’ bankruptcy, which was the largest investment bank of United States. However, the international presence of Nomura remained limited to Japan and its client based business only. Furthermore, the economy of the country faces a down turn in 1990s, which affected the success of Nomura to a considerable extent. The bankruptcy of Lehman provides a great opportunity for Nomura to acquire some of the assets and employees of the group mainly in Asia –pacific region and Europe. This will help the bank to increase its international pace and establish its business in America and other countries (The Telegraph. 2018). On 15 September 2008, Lehman filed for bankruptcy protection after working for 158 years. It also lost its 955 of the stock post its peak in 2007. Its bet on trading with toxic assets choked it and the collapse of the same in the global crisis indicated that there would be no return from this trading. However, the group survived the market crash of 1929 but it could not deal or cope up with the credit crisis, which was created by the foundations of Wall Street (CNBC 2009).

According to the directions given by Richard Fuld, CEO of Lehman, the group got indulged in the transactions that were highly leveraged. Before the collapse, Richard was appointed as the CEO in 1993, who make the company the most powerful financial service group in terms of profits worth US$4.2 billion in 2007. The market collapsed in 2008 which came out to be an unexpected threat to Lehman’s profitability. The group faced losses due to the important positions held in sub-prime and lower-rated mortgages that were in default at a fast rate. With an intention to save the group, the general counsel of Lehman requested loans from the institutions and offices, situated outside America. However, foreign business protected themselves and did not respond to the request. After witness the failure from the end of two potential buyers, Lehman filed for chapter 11 of the United States Bankruptcy Code on 15 September 2008. At that time, the group has assets amounted to US$639 billion and debt worth US$ 619 billion. The number of employees working worldwide was 25000 and the potential buyers were the Bank of America and British financial group Barclays. This was considered as the largest bankruptcy filing in the history, even bigger than the worldwide collapse of Enron and WorldCom.

Nomura Holdings’ Background and Interest in Lehman Brothers’ Assets

Chief Operating Officer and Deputy President of Nomura; Takuma Shibata took a follow up of all the events happening at Lehman. It was found out that Barclays would acquire the investment bank of Lehman and other segments of United States. However, there was no clarity regarding the operations of the group outside America.  Within few days, the COO on behalf of Nomura flew to the Asia – Pacific offices of Lehman situated at Hong Kong, with a motive to present a deal. The offer includes the acquisition of staff and other operating assets worth US$225 million and in addition the cost related to the employment contracts which were to be negotiated with the interested staff. Nomura appointed a Chief Executive Officer named Kenichi Watanabe in 2008, who came with an intention to expand the business in Europe, Asia and US. Both the CEO and COO grab the opportunity of increasing their international scope by acquiring the operations of Lehman Brothers (Foley & Meyer, 2009). However, Lehman’s US operations were facing a crisis but its other segments were enjoying a steady growth. So, the Asia-Pacific became the first target for Nomura, followed by Europe. Moreover, it was also known that regions like India and Middle East will become the potential opportunity for the purpose of expansion in coming future.  

There was no doubt that the locking of deal would provide many benefits to Nomura Holdings but it would come with some costs, risks and challenges. The main benefits include increase in international presence, growth in the business and expansion of operations. From this deal, Nomura would get the potential and smartest staff in its group and it would take over the administrative and technological infrastructure of Lehman that consists of trade engine with high velocity in IT platforms. Moreover, the group would get a chance to establish its operations in those areas and regions where they had no presence before. Nomura could offer great and new products to its growing global pace and get access to the highly valued deals of mergers and acquisitions. Apart from the above benefits, the main advantage would be the availability of many sources for raising funds for company’s capital.

Despite having such gains, there were some costs associated with this deal. The investment banking group had to pay US$225 millions to Lehman for acquiring its assets and some undecided amount that would be treated as new employment compensation costs.  After critically examining the annual report of Lehman for 2007, Nomura estimated that the cost per employee would amount to US$500.000 along with the possibility of taking in 2600 employees. The total value would be equal to US$1.3 billion, though depends upon the acceptance of staff members. Such costs were only associated with the offices of Asia- Pacific and the acquisition of more would result in high and great costs.

Benefits, Costs, and Challenges Associated with the Acquisition

Apart from the costs and benefits discussed above, there were some challenges also in conducting this negotiation. Out of many, the employment contract was one of the challenges faced by Nomura. With an intention to attract and retain the staff of Lehman, Nomura had to consider different styles of the contracts during negotiation. When compared, Nomura had a very conservative style and it offers fewer incentives to the employees. It also pays some parity income in exchange of job security. On the other hand, Lehman paid high incentives to its staff based on their specialization and performance. Therefore, in order to acquire the employees, Nomura had to change its styles and would have to offer both options. This could be a very challenging task for the culture of Nomura.  Other difficulties include exposure to the risk arises from fluctuations in the currency exchange rates, foreign tax policies and regimes and various political risks associated with different countries.

Nomura Holdings Inc. was founded in 1925 in Osaka, Japan. The company initially focused on the bond market and later on became the largest brokerage and investment bank in the country. It is listed on different stock exchanges and as far as Japan is considered, Nomura is listed in Osaka, Tokyo and Nagoya. In New York stock exchange, it is listed as American Depository Receipts (ADRs). Before 2008 crisis, the company was only operating in Japan and had only one office in New York, which was opened in 1927. It offers wide range of services, divided in five main categories named as Retail, Investment Banking, Global Markets, Asset Management and Merchant Banking. The clients of the company include financial institutions, corporations, individuals and government agencies (Reuters. 2018). Nomura has 85% of the employees residing in Japan and rest work in regional offices situated in Europe, Asia and America. The working culture offered at bank is very local with the high security of job and modest compensation. If the company wants to acquire the employees who had worked in western cultures it had to change its approach and start paying high incentives.

On the other hand, Lehman was found as dry-goods store in 1850 in Alabama. At that time, the payments were made in form of cotton as well as cash. For that purpose the store needs to enter into the commodities markets for the purpose of selling cotton (Bloomberg 2018). Trading and brokerage became the core activities of Lehman and with that it also started providing financial services to the people. It was considered as the fourth largest investment bank across the country. The CEO of the bank had an aggressive style and high tolerance to risk which make the company more powerful. However, the faith of the company changes when the market started to crash and its positions and toxic results in the loss of value. It forced the company to file for bankruptcy on September 15, 2008

Nomura Holdings’ Business Model and Culture

The above analysis of Nomura’s income statement reflected that there was a decrease of 139% in company’s net profit during the years 2007 and 2008. In 2007, the figure was positive and it went negative in 2008 reported at US$67,847 million. While in the same year, the revenue from commissions had shown an increase of 20% while other sources reflected a reverse trend. Overall, there was a decline in company’s net revenue worth 28%. On the other side, the expenses of the group increases by 11%, contributed by a huge upsurge in the commissions and floor brokerage expense worth 78%. However, experiencing such negative performance in 2008 was due to the global financial crisis which was followed by the crashes of European and Asian markets.

When the balance sheet of the company is analyzed it reflected contraction of the assets by 27%. Furthermore, there are some categories in the balance sheet which reported a significant decrease such as collateralized agreements reduces by 42%, Trading assets and private equity investments falls by 19%. Retained earnings also fall by 7%. The reason for this downfall is the global crisis that happened during the year as well as the process adopted by Nomura to get rid of bad assets. Overall, the position of company’s balance sheet deteriorates in 2008.

 The analysis of Lehman Brother’s income statement is done for the year 2006 and 2017. It can be interpreted that there was a slightest increase in company’s net income worth only 5% while the revenue rises by 10% in the same year. However, the expenses of the company also increase by 13%. It can be observed from the statement that in 2007, Lehman made revenue of US$19.2 billion and net profit was amounted to US$4.2 billion in the same year. Therefore, there was no doubt in saying that Lehman was giant company.

The balance sheet analysis of Lehman Brothers shows an upsurge in banks trading assets. For instance, its cash and securities increased by 109%, financial instruments rose by 38% to a value of US$313.1 billion, brokers and dealers increased by 48% and other categories also shown an increasing trend. All this reflected the size of assets Lehman had in 2017. The equity of the entity also rose by 17% along with the increase in its liabilities.

It is one of the techniques to analyze the financial position and performance of the company for a specified time period. Under this, several categories of ratios are calculated for a particular company and then are properly examined to assess the position of the entity in financial terms. Ratio analysis helps the investors and management of the firm to take correct and accurate decisions related to investment and its growth and success.  

Ratios	Nomura	Lehman
	2007	2008	2006	2007
Return on Assets	0.49%	-0.26%	0.80%	0.61%
Return on Equity	8.04%	-3.41%	20.88%	18.64%
Net Profit Margin	8.58%	-4.26%	8.58%	7.10%
Gross Profit Margin	37.55%	53.45%	37.64%	32.64%
Net Interest Income	2.74%	3.03%	6.01%	6.03%
Interest cost as % of sales	46.75%	50.60%	62.36%	67.36%
Asset turnover	5.71%	6.06%	9.28%	8.54%
Current Ratio	0.78:1	1.07:1	1.62:1	1.87:1
Debt to Equity	15.41	12.23	25.24	29.73
Debt ratio	93.91%	92.44%	96.19%	96.74%
Equity Ratio	6.09%	7.56%	3.81%	3.25%
Interest coverage ratio	2.14	1.98	1.60	1.48

Analysis of Nomura’s Income Statement

The above table shows the ratios calculated for Nomura Holdings and Lehman Brothers as per the financial data provided for the years. Lehman’s ratios are calculated for 2006 and 2007 as the company got bankrupt in 2008 whereas Nomura’s ratios are calculated for the financial years 2007 and 2008. When both companies’ financial ratios are compared, some interesting facts are been observed. Considering the debt ratio, it can be interpreted that there is a minor difference between the ratio of Lehman and Nomura.  Lehman Brothers had high debt ratio of 96.74% in 2017 whereas Nomura reported only 92.44% in the same year. This makes the US bank more risky as compare to Japanese investment group. However, such difference is because of the nature of financial services provided by the business where most of the assets are financed through debt. Along with this, the debt equity ratio of Lehman was also more than Nomura’s ratio. In 2007, its ratio increased to 29.73 and on the other side, the ratio was 15.14 in the same year. This again proves that Lehman is riskier as there was less protection for debt. However, both the companies are highly leveraged.

In addition to this, the interest coverage ratio of Lehman was lower than Nomura Holdings which again indicated that company was not efficient enough to pay off its interest payments regularly. Looking at the profitability ratios, it can be said that Lehman had high competency to generate more profits from its assets as compare to Nomura. The net profit margin of both the companies was same in 2007 but the gross profit margin of Lehman was lower than the Nomura. This means that company did not have enough profit to meet its operating expenses because of high cost of sales. Its interest cost was also higher along with the upsurge in net interest income ratio. Because of such high risk, the profits for Lehman were also higher which can be clearly seen from its profitability ratios.

Conclusion and Recommendation 

After analyzing the performance for both the companies, based on the data provided in their financial statements and the ratios calculated, it is concluded that Nomura Holdings should go ahead with the deal. The information about the background of the companies and the case presented in the report clearly explains the reasons for collapse of Lehman Brothers and the survival of Nomura Holdings. The report provides the understanding about each market in which Lehman had operated, the type of assets possessed by them, their management of the same and the way events got unfolded. It can be interpreted from the report that the factor which contributed to the debacle of Lehman was the lack of management. However, this does not indicate that the staff and non-trading assets were bad.

As per the analysis, Lehman’s infrastructure and presence was great and it had the smartest employees who worked hard to make the company giant and fourth largest in United States. So, overall it will be recommended to Nomura to proceed further with the deal as it would provide many benefits to the bank on a global level, which would eventually surpasses all the identified costs and challenges.

References

Bloomberg (2018). Company Overview of Lehman Brothers Holdings, Inc. Retrieved from https://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=473285 

CNBC (2009). Lehman Brothers: ‘A Colossal Failure’. Retrieved from https://www.cnbc.com/id/32013423 

Foley, C. F., & Meyer, L. N. (2009). Nomura’s Global Growth: Picking Up Pieces of Lehman. Harvard Business School Finance Unit.

Reuters (2018). Nomura Holdings Inc (8604.T). Retrieved from https://in.reuters.com/finance/stocks/company-profile/8604.T 

The Telegraph. (2018). Lehman Brothers collapse. Retrieved from https://www.telegraph.co.uk/finance/recession/3917584/Lehman-Brothers-collapse-How-the-worst-economic-crisis-in-living-memory-began.html