Lehman Brothers Investor Event Presentation Deck
August 2007, 65 slides
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chief risk officer brothers brothers risk management risk management august | Lehman Brothers
agenda | Lehman Brothers
agenda | Lehman Brothers
key themes | Lehman Brothers
key themes risk management is one of the core competencies of the firm and is an intrinsic component of our control system as a result of our focus on continuously enhancing our risk capabilities in the current challenging environment we feel confident that our risk position is solid | Lehman Brothers
risk governance | Lehman Brothers
our control environment risk management is one of our core competencies it is tiered and involves many areas of the firm one key feature which differentiates us from our peers is market risk credit risk and quantitative risk are integrated allows us to leverage people analytics systems information flows risk management is more than measuring and reporting risk our approach applies analytical rigor overlaid with sound practical judgment risk management is a partnership with the business we work with the business before a large trade is done to collectively determine the least risky deal structure risk management develops risk policies and procedures develops risk measurement methodologies sets limits tracks actual risk usage against limits evaluates valuation models | Lehman Brothers
risk philosophy our focus is balancing risk versus return we want to help ensure brothers risk appetite is deployed in the most efficient way at the end of the day nothing is fool proof while there is no guarantee against loss we can minimize the probability of loss we minimize market and credit risk through our client driven franchise where we facilitate customers we manage risk both before and after trades are done by mitigating risk via management of the terms outright sales or syndication or hedging the remaining risk we actively manage collateral assessment and collection where applicable risk is minimized through geographic industry asset class and customer diversification | Lehman Brothers
committee structures has established numerous committees to oversee risk taking activities and to ensure that controls are appropriately administered and reviewed the key operating committees at the firm include structured finance business level transaction approval | Lehman Brothers
risk management overview | Lehman Brothers
risk management function risk management is independent from trading | Lehman Brothers
risk management function continued | Lehman Brothers
risk management organization risk management is a global integrated function under the leadership of the chief risk officer the global risk management department consists of professionals with risk managers and technologists | Lehman Brothers
risk management organization continued | Lehman Brothers
risk management organization excluding technologists and administrative staff we have professionals in our professionals are highly qualified many having substantial relevant experience many are either former traders former desk or have relevant business experience | Lehman Brothers
external constituents relationship with regulators | Lehman Brothers
risk analysis and quantification | Lehman Brothers
risk management integrated framework the three core functions of risk management are understanding and identifying all have metrics to measure the risk risks ensuring that appropriate limits are in place for all transactions and products protecting the firm against catastrophic loss for all products define a risk appetite have the ability to measure and monitor tail risk | Lehman Brothers
risk management integrated framework tiered integrated risk framework | Lehman Brothers
risk management integrated framework tiered integrated risk framework | Lehman Brothers
risk management integrated framework risk appetite the risk appetite represents the quantity the firm is prepared to lose in a year from market event and credit risk the risk appetite framework begins with the firm financial targets and is designed to balance risk and return our aim is to deploy enough risk in our businesses to maximize returns while limiting risk to ensure we meet our financial targets significant factors driving risk appetite include base revenue assumptions an estimate of the loss of revenues from non risk taking activities a minimum acceptable roe compensation adequacy | Lehman Brothers
risk management integrated framework risk appetite we start with our financial targets we take into account a potential simultaneous slowdown in customer flow and banking activities origination advisory which would negatively impact our financial targets since revenue shortfalls can also come from non risk taking activities then we subject ourselves to two constraints maintaining a minimally acceptable annual roe ensuring compensation adequacy including maintaining sufficient to protect the franchise for the long term | Lehman Brothers
risk management integrated framework risk appetite the center of our approach to risk the risk appetite represents the quantity the firm is prepared to lose in a year from market event and credit risk it is defined and measured at a percent level of confidence confidence interval and time horizons daily risk appetite equity requirement confidence one day horizon confidence one year horizon confidence year or longer horizon depending on the nature of the trade | Lehman Brothers
risk management integrated framework tiered integrated risk framework | Lehman Brothers
risk management integrated framework risk equity the equity capital the firm requires is the economic capital required to protect the firm against market event credit and operational risks augmented by capital requirements due to external constraints to the extent leverage or regulatory equity is an overriding constraint for the firm businesses are charged incremental equity on top of their economic risk equity equity capital economic capital and regulatory capital market risk event risk credit risk operational risk economic capital augmented by regulatory capital equity capital | Lehman Brothers
risk management integrated framework market risk measures the potential mark to market loss on all positions from adverse market moves we use historical simulations which are walk backs through time to determine what would have been the impact on today portfolio if we relived each day over the past four years we weight the data giving more weight to recent market moves while at the same time giving less weight to market moves further back in time this approach allows us to avoid making assumptions about distributions about diversification about relative risk factor weightings in order to determine the reasonableness of the market risk measures we do back testing comparing the market risk generated for the portfolio using the historical simulation approach to its actual trading | Lehman Brothers
risk management integrated framework event risk measures stress and gap risks which go beyond potential market risk losses we measure these risks using statistically measurable stress analyses which capture losses associated with downgrades for high grade and defaults for high yield loans bonds and convertibles defaults for sub prime mortgage loans property value losses on real estate dividend risk for equity derivatives deal break risk for merger positions gap risk for fund derivatives | Lehman Brothers
risk management integrated framework credit risk measures the potential loss the firm can suffer due to forward settlements financing and derivative transactions with its customers the measurement is a three step process measure the potential exposure of all transactions over the appropriate time horizon assign each a probability of default based on its internal credit rating and a recovery rate based its internal facility rating run these inputs through the model to create a cumulative joint probability distribution from which we cut a tail | Lehman Brothers
risk management integrated framework operational risk a | Lehman Brothers
risk management integrated framework tiered integrated risk framework | Lehman Brothers
risk management integrated framework risk limits the overall philosophy of our firm is that we have a zero tolerance level for ignoring limits and internal processes disciplinary actions for limit breaches include compensation adjustment or terminations the chief risk officer has the authority to approve exceptions the global heads of market risk and credit risk will make recommendations risk appetite limits the overall risk appetite limit is recommended by the chief risk officer and approved by the executive committee and the board on an annual basis and is reviewed quarterly for requisite changes limits are cascaded down to divisions businesses and regions trading desk heads further allocate limits to individual desks limits are monitored daily credit limits all with credit exposure are given internal ratings every hedge fund requires a limit the by industry region and product are reviewed on a quarterly basis all rated below a are formally reviewed on an annual basis brothers | Lehman Brothers
risk exposure | Lehman Brothers
risk appetite usage | Lehman Brothers
risk appetite usage firm | Lehman Brothers
trading revenues ell | Lehman Brothers
credit risk | Lehman Brothers
non investment grade derivatives exposure a | Lehman Brothers
stress testing | Lehman Brothers
stress tests | Lehman Brothers
areas of increased focus | Lehman Brothers
| Lehman Brothers
exposure | Lehman Brothers
high yield and leveraged loans | Lehman Brothers
high yield and leveraged loans | Lehman Brothers
hedge funds | Lehman Brothers
hedge funds the firm is engaged in a number of activities involving hedge funds | Lehman Brothers
comprehensive credit risk framework | Lehman Brothers
hedge funds exposure despite recent volatility and widely reported problems incurred by a number of funds we have not experienced any recent credit losses from hedge funds this is not to say that we don take risk but rather our controls are designed to ensure that the risk is substantially reduced through our tight controls especially those relating to the taking and monitoring of collateral | Lehman Brothers
conclusion | Lehman Brothers
conclusion we have a strong culture of risk management throughout the firm our franchise is to facilitate clients we have developed a very robust and comprehensive framework for thinking about and managing all forms of risk our powerful risk and equity allocation tools help guide the firm in its overall management and decision making we are prudent toward our approach to credit risk which has resulted in a very high quality and well diversified credit portfolio we have very low tolerance for delays on receiving collateral where applicable we give close scrutiny to the value of customer collateral posted against margin loans our approach is to mitigate risk through various hedging strategies and follow a model of credit facilitation where we act as a conduit between our clients and the capital markets rather than as the ultimate holder of the risk our overall risk management philosophy of conservatism and prudence has been an important factor in our improving credit spreads ratings and credit worthiness | Lehman Brothers
appendix | Lehman Brothers
stress scenarios | Lehman Brothers
bull steepening modeled after post flight to quality | Lehman Brothers
bull flattening modeled after the period before the major rates backup in the summer of generally strong market tone across all asset classes due to signs of economic recovery and low inflation expectations but reduced demand for energy may may | Lehman Brothers
bear flattening treasury down trade caused by asset reallocation and yield searching spreads generally moderately tightened and equity and high yield asset classes outperformed modeled after the period | Lehman Brothers
bear steepening modeled after post | Lehman Brothers
crisis market driven by default with spiked idiosyncratic risk higher defaults higher correlations falling energy demand modeled after the period | Lehman Brothers
rating default and hedge fund risk significant rating risk one name default in or coupled with hedge fund blow out on structured credit products causing panic selling significant market widening with basis gapping out modeled after the period | Lehman Brothers
default risk global default rate increase coupled with lower recovery investor demand dries up after hot market leading to a longer syndication time line or no syndication in large or a loan deals modeled after the period | Lehman Brothers
equity crash weakening us dollar deteriorating us current account deficit escalating us government debt high low dividend yields modeled after the period | Lehman Brothers
black modeled after | Lehman Brothers
parallel move down modeled after post flight to quality | Lehman Brothers
parallel move up similar to period | Lehman Brothers
oil supply crisis major oil supply disruption at the source likely due to political events in oil producing countries and or terrorism with great uncertainty around supplies returning to normal levels in the near future | Lehman Brothers
liquidity crunch hawkish federal reserve and major central banks continuing on a path of raising rates draining the extra liquidity enjoyed previously resulting in a decline in the risky assets and spread products | Lehman Brothers
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