David K.

Settlement Auction for Lehman CDS: Surprises Ahead?

Michael, I may be missing something here, but it seems to me that the CDS market is vastly understating what the eventual recovery on Lehman's senior debt will be. Shortly before Lehman filed for bankruptcy, it had common shareholders equity of $19 billion. It had $7 billion of preferred stock outstanding. It had about $18 billion of subordinated notes and $138 billion of senior notes. Thus, as I see it, Lehman's assets need to be overvalued by $44 billion before the senior noteholders even begin to suffer loss of value. Granted, some of Lehman's assets are soft assets like goodwill. Also, it is safe to assume that the real estate on Lehman's books was overvalued by 20% to 30%. Still, it is tough to make $44 billion vanish, no matter how badly you invest money. If Lehman's senior debtholders recover 50 cents on the dollar, that implies that about $113 billion of asset value is going to simply vanish. If Lehman's assets are sold over a 2 to 3-year period, I have a hard time seeing that much value disappearing.