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Lehman in Jakarta

By Stephen Lubben

On Friday, Lehman filed a fascinating motion to enforce the automatic stay and adversary proceeding that seeks essentially the same relief. The pleadings involve Lehman's attempt to settle a dispute regarding a swap transaction in the bankruptcy court in New York, and the counterparty's attempt to litigate in Indonesia, despite a choice of law clause that says "New York."

These pleadings have provoked a few unrelated thoughts, but in this post, let's talk about the deal itself.  And maybe also ask, "what was Lehman thinking?"

The parties to the swap are a Lehman subsidiary and an Indonesian corporation, PT Mobil-8 Telecom, which is publicly traded in its home country.

I'm told the swap in question is called a "Range Accural Trade." But the swap can be best understood as a series of daily digital interest rate options, with the corporate counterparty paying Lehman a fixed rate and Lehman paying either nothing or 80 basis points more than the fixed rate. Lehman's contingent payment was determined by whether the 30 year Euro swap rate was higher than the 2 year Euro swap rate. The deal is based on a notional amount of $100 million, so these interest payments, which were to be netted every March and September from 2008 to 2013, were potentially quite large.

In short, a purely speculative transaction. But why didn't Lehman get any "up front" collateral from its corporate counterparty? If the deal went it Lehman's favor, it was to receive more than $2 million every six months. Yet it essentially allowed itself to have an unsecured exposure of that amount to a counterparty located in jurisdiction not know for strong legal institutions. 

Lehman made the first payment on the swap -- a bit over $400,000, which only highlights how speculative the deal was from the counterparty's perspective. After that, the deal went in Lehman's favor and the payments stopped coming. But according to the complaint, it seems Lehman didn't notice until two years latter.

Full post as published by Credit Slips on October 05, 2010 (boomark / email).