Lehman Trading Book Migration 2-7-08

Confidential Presentation to:
SEC
Holistic Trading Book Migration
February 7, 2008
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC. LBEX-DOCID 3176398
Table of Contents
I. Risk Allowance Summary
II. Jump-to-Default III. Principal Investments IV. Securitized Products V. Market Neutral Strategies VI. Holistic Trading Book Implementation VII. Appendix A: Principal Investments Allowance Details VIII.Appendix B: Securitized Products Allowance Details
Risk Allowance Summary
FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.
LBEX-DOCID 3176398
Risk Allowance Summary

Pro-Forma Figures December 2007
(Risk Allowance in $Millions) Corporates/EM/Muni Principal Investments Securitized Products Market Neutral Strategies TOTAL Jump-toDefault Merton Model Jump-to-Gap Deal-break Risk Holistic Calculations Holding Period** Risk Allowance Specification Risk Allowance Holding Period Risk Allowance Confidence Level Risk Allowance 3m 2,358 1,859 3m 849 99% 91 6m 3,158 2,403 6m 1,108 99.9% 137 12m 1,453 12m 4,137 Proposed 3m 2,358 Model 1,859 12m 1,453 99.9% 137 5,806 91 9,834 136 Reg Y 3,461 400% RWA* 6,146 Reg Y Current Allowance
Model 250% RWA*
We propose
Corporates/EM/ Muni: JTD with one month holding period for investment grade exposures and 3-month holding period for non-investment grade exposure Principal Investments: Merton model with 12-month holding period Securitized Products: JTG with 12-month holding period Market Neutral Strategies: increase confidence level from the current 99% to 99.9%
*Grandfathered investments prior to DEC 2005 are risk-weighted at 100%. **Holding Period for investment grade exposures is set at 1-month.
Risk Allowance Summary (Contd.)

Pro-Forma Risk Allowance Figures for Three Months: October to December 2007
Proposed Holistic Risk Allowance Products October Corporates/EM/Muni Principal Investments Securitized Products Market Neutral Strategies Total October November Corporates/EM/Muni Principal Investments Securitized Products Market Neutral Strategies Total November December Corporates/EM/Muni Principal Investments Jump-to-Default Merton Model Jump-to-Gap 99.9% Deal-break Jump-to-Default Merton Model Jump-to-Gap 99.9% Deal-break Model Jump-to-Default Merton Model Jump-to-Gap 99.9% Deal-break Current Risk Allowance Allowance Rule/Model 2,422 1,651 1,568 128 5,769 2,227 1,869 1,369 92 5,557 2,358 1,859 1,453 137 5,806 Reg Y 400%/100% RWA* Reg Y 99% Deal Break Reg Y 400%/100% RWA* Reg Y 99% Deal Break Reg Y 400%/100% RWA* Reg Y 99% Deal Break Allowance 6,461 3,111 134 85 9,791 6,146 3,435 136 61 9,778 6,146 3,461 136 91 9,834 (4,039) (1,460) 1,434 43 (4,022) (3,919) (1,566) 1,233 31 (4,221) (3,788) (1,602) 1,317 46 (4,028) Change
Securitized Products Market Neutral Strategies Total December
*Grandfathered investments prior to DEC 2005 are risk-weighted at 100%.
Jump-To-Default
LBEX-DOCID 3176398
Jump-to-Default Capital Allowance
The model applies to all our trading book positions that are subject to single name default risks, including corporate, emerging markets, and municipal issuers: Bonds, loans, single name & index default swaps, CDO tranches, and default baskets
Reg Y charge figures are as reported, which are updated quarterly
Pro-Forma Figures for Three Months: October to December 2007

Risk Allowance ($Millions) Current Reg Y Add-on 1/3 October November December 6,461 6,146 6,146 2,422 2,227 2,358 JTD Computation Holding Period in Months: IG / Non IG 1/6 3,159 2,950 3,158 1/12 4,085 3,911 4,137
Jump-to-Default Model Assumptions
Holding Period One month for investment grade exposures Proposed 3-month for non-investment grade exposures
Probability of Default Scaled to Holding Period linearly from annual PDs Our annual PDs are rating agency long term default rates with the 3bp-floor, the same as those applied in the counterparty credit risk allowance calculations
Correlation Basel Banking Book one-year asset correlation
Jump-to-Default Model Assumptions (Contd)
Recovery CDS based on CDS pricing Cash tiered Name-specific recovery uses market and/or internal research available Otherwise sector-based and product (loans vs. bonds) recovery Lastly generic conservative assumption (currently loans 75%, bonds 25%)
Long and short risks of the same issuer are netted Treatment of CDS indices and synthetic corporate CDO tranches Decomposed into per-name CDS exposures Tranche capital structure reflected in the decomposed exposures
Confidence level = 99.9%
Principal Investments
LBEX-DOCID 3176398
Principal Investments Capital Allowance
The capital charge for the Principal Investment portfolio is calculated using the Merton Model of valuing a firms equity; it applies to our investments in Private equity funds; individual private equity investments Investments and seed money in hedge funds; minority stakes in hedge funds
Pro-Forma Figures for Three Months: October to December 2007
Risk Allowance ($Millions) Current October November December 3,111 3,435 3,461 250% Flat RWA* 2,161 2,380 2,403 Proposed Model 1,651 1,869 1,859
[Additional detail on the Principal Investment allowance can be found in Appendix A on pp. 26-28]
*Grandfathered investments prior to December 2005 are risk-weighted at 100%.
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Principal Investments Model Assumptions

Equity is modeled as call option on the assets of the investment struck at the face value of the debt The capital charge is a function of: 1. Holding Period, representing the horizon over which capital is invested 2. Leverage, defined as the current ratio of the value of the assets to the value of the equity 3. Volatility of the underlying assets 4. Asset value correlation
The model allows us to assign each individual investment a volatility and leverage commensurate with the risk/return profile of the underlying asset and calculate the capital contribution of each individual investment
12
Principal Investments Model Assumptions (Contd)
The total portfolio is grouped by strategy based on business cut and volatility/leverage characteristics Hedge fund investments by strategy Private equity investments by business cut/asset class For hedge fund investments the volatility depends on the investment strategy of the fund. The fund value of the volatility for each strategy is benchmarked against the historical performances listed in the Credit Suisse Tremont Hedge Fund Index Private Equity volatility and leverage are assigned levels that are based on our experience of the historic risk/return profile of these investments The volatility, leverage and holding period for each investment strategy is assigned to one of three levels: Low, Medium, and High. Each level is defined by a range used in the calculation as follows
Volatility
Definition Low Medium High Range 0% - 10% 10% - 20% 20% + Value 5% 15% 25% Definition Low Medium High
Leverage
Range 1 1.5 1.5 - 3 3+ Value 1.25 2.25 4 Definition Low Medium High
Holding Period
Range 0 6 months 6 12 months 12 + months Value 3 6 12
13
Principal Investments Model Assumptions (Contd)
The correlation of the model has been calibrated to produce a risk weight of 300% for highest risk investment with a high volatility, high leverage, and high holding period For the pro-forma results shown here, the holding period is kept at 12 months for all our investments, in line with the buy and hold strategy of the Principal Investment portfolio
Large investments presenting concentration risk are floored to a risk weight of 250% If an investment in a given strategy is more than 3 standard deviations away from the average investment amount for this strategy, it is subject to the concentration floor All hedge fund investments, individual private equity investments and publicly listed investments held in the Principal Investments portfolio are subject to the concentration test
14
Securitized Products
LBEX-DOCID 3176398
Securitized Products Capital Allowance
We propose to adopt the SIFMA Framework for Securitizations/Tranched Products (December 2007)
Employ jump-to-gap (JTG) model to calculate capital allowance for all our trading book RMBS, CMBS, and ABS exposures, including: Securities, whole loan pools, index swaps, ABS CDOs, ABS CDS Positions of all credit ratings
Currently a small Reg Y capital add-on is charged against the sub-investment grade secondary and trading book retained interest positions
Following table shows three months of pro-forma JTG risk allowances vs. current reg Y charges
Risk Allowance ($Millions) Current Reg Y Add-on 12-month October November December 134 136 136 1,568 1,369 1,453 JTG Computation Holding Period 6-month 1,213 1,032 1,108 3-month 875 777 849
[Additional detail on the Securitized Products allowance can be found in Appendix B on pp. 30-33]
16
Securitized Products Model Assumptions
We adopt the approach described in Method B: Multistep threshold model in the SIFMA Framework
The model is a two-factor model where the asset value is driven by two systematic factors together with an idiosyncratic factor : ~ ~ ~ 2 2 ~ Ai G ,i X M ,i Y 1 G ,i M ,i Z i where
~ Ai ~ X ~ Y ~ Zi
is the value of asset i is the overall macro (global) risk factor is the systematic risk factor dependent on asset is collateral type is the originator shelf-specific (idiosyncratic) risk factor for asset i
The asset value is subject to three down gaps, a small (S), medium (M), or large (L) gap the gap sizes are different by ratings and reflect the recent market experiences the annual gap probabilities are calibrated by setting: 1) the expected total gap loss (expressed as percentage price drops) is the same as the expected annual default loss (with zero recovery): p s S p m M p L L PD 1 2) the expected gap loss from all three gaps are equal: p s S p m M p L L
17
Securitized Products Model Assumptions (Contd.)
Calibration of the correlations The global factor loadings G ,i are calibrated to the corporate A-IRB RWAs by setting the calculated JTG model capital charge on a portfolio of diversified asset-backed bonds with all different collateral types and all different originator shelves to the corporate A-IRB RWAs of zero recovery The collateral type factor loadings M ,i are calibrated to the Basel Securitization Framework (SF) RWAs by setting the calculated JTG model capital charge on a portfolio of one type of collateral bonds with all different originator shelves to the SF RWAs The Basel SF RWAs are modified for the calibration purposes for crediting ratings below BB. The calibration SF RWAs are as follows:
AAA to AA15% CCC- & below 1075%
Credit Rating Calibration SF RWA
A+
A- BBB+ BBB BBB- BB+ BB
BB-
B+
B- CCC+ CCC
18% 20% 32% 64% 75% 135% 250% 425% 650% 750% 880% 950% 1000% 1050%
18
Securitized Products Model Assumptions (Contd.)
We have classified our portfolios into categories by collateral type (RMBS which includes home equity loans, CMBS, ABS, CDO) in combination with region (US and Europe).
There are a small number of trades in our Securitized Products line of business that are corporate issuers; these positions are not included in the JTD calculation so they are included in JTG calculation as a separate category
Whole loans are included in the JTG calculation by splitting the loans into shadow bonds with expected securitization capital structure
The model is currently a one time step model; potential future developments include the implementation to multi-time stop for a given holding period
19
Market Neutral Strategies
LBEX-DOCID 3176398
Market Neutral Strategies Capital Allowance
In addition to VaR-based capital charge, positions in our M&A market neutral strategies are currently subject to a capital add-on, calculated only using the portfolio distribution deal-break losses, at 99% confidence level
We propose to increase the confidence level to 99.9% confidence level In the following table the pro-forma numbers are estimated by scaling the current (99%) capital charges; future implementation, to be completed shortly, will cut the 99.9% tail directly from the portfolio loss distribution
Risk Allowance ($Millions) Current October November December 128 92 137 Proposed 191 137 205
21
Market Neutral Strategies Model Assumptions
Deal Break Risk for Merger Arbitrage Strategies
If deal breaks, target and acquirer are assumed to experience the reverse of percentage price movements at deal announcement Probability of deal break is estimated by assuming that current target price is the expected value of deal complete value and deal break value
Deal Complete, Prob 1-p Current Target Price Deal Break, Prob p Downside Value of Target Current Deal Value of Target
S T arg et (1 p ) current _ deal _ value pS T arg et (1 initial _ premium ) p
Events across different M&A deals are assumed independent Portfolio loss distribution as well as at the desired confidence level
22
Holistic Trading Book Implementation
LBEX-DOCID 3176398
Holistic Trading Book Implementation
Timeframe New Holistic Trading Book methodologies can be commenced upon SEC approval JTD implementation to be automated and integrated Other methodologies somewhat manual with automation to be implemented in the near future JTD for corporate, emerging market, and municipal issuer default exposures - Automated system currently in UAT Principal Investments - Model implemented in Excel spreadsheets - No immediate plan for further automation prior to automation of position feed JTG for asset-backed securitized products - Model implemented in Excel spreadsheets, positions exported from VaR engine Market neutral strategies - Deal-break risk model has been implemented and running in LehmanRisk prior to CSE inception at Lehman (December 2005) - Change confidence level from 99% to 99.9% should be completely before end of February 2008
24
Appendix A: Principal Investments Allowance Details
LBEX-DOCID 3176398
Principal Investments: Pro-Forma Results

Results for Month Ended October 2007
Risk Allowance ($Millions)
Investment Strategy / Asset Class Hedge Fund - Convertible Arbitrage Hedge Fund - Emerging Markets Hedge Fund - Equity Market Neutral Hedge Fund - Event Driven - Multi-Strategy Hedge Fund - Fixed Income Arbitrage Hedge Fund - Long-Short Equity Hedge Fund - Managed Futures Hedge Fund - Multi-Strategy Hedge Fund - Other Private Equity - CDO Private Equity - Merchant Banking Private Equity - Mezz Private Equity - MLP Private Equity - Private Equity Funds Private Equity - Real Estate Private Equity - Venture Capital Private Equity - Individual Investments Private Equity - Other Publicly Traded Equity Grand Total EAD ($Millions) 54 282 40 695 203 408 18 1,365 117 897 469 353 628 1,459 1,558 177 2,237 409 691 12,063 Current 17 90 13 217 60 85 4 387 6 207 115 94 201 448 247 24 673 87 132 3,111 250% Flat RWA* 11 56 8 136 38 59 3 248 23 169 76 61 126 282 245 19 426 60 113 2,161 Proposed Model 2 42 2 48 9 56 2 187 16 155 63 32 93 196 209 26 361 37 114 1,651 Avg Model Risk Weight 58% 185% 58% 87% 58% 171% 168% 171% 168% 216% 168% 113% 185% 168% 168% 185% 202% 113% 206% 171%
26

Results for Month Ended November 2007
Investment Strategy / Asset Class Hedge Fund - Convertible Arbitrage Hedge Fund - Emerging Markets Hedge Fund - Equity Market Neutral Hedge Fund - Event Driven - Multi-Strategy Hedge Fund - Fixed Income Arbitrage Hedge Fund - Long-Short Equity Hedge Fund - Managed Futures Hedge Fund - Multi-Strategy Hedge Fund - Other Private Equity - CDO Private Equity - Merchant Banking Private Equity - Mezz Private Equity - MLP Private Equity - Private Equity Funds Private Equity - Real Estate Private Equity - Venture Capital Private Equity - Individual Investments Private Equity - Other Publicly Traded Equity Grand Total EAD ($Millions) 54 277 39 647 150 399 18 1,371 421 725 505 62 609 1,499 1,854 185 3,133 354 1,060 13,362 Current 17 89 13 202 46 84 4 398 114 153 126 15 195 460 311 28 948 69 162 3,435 250% Flat RWA* 11 55 8 127 29 58 3 254 84 135 83 10 122 290 299 21 599 49 143 2,380 Proposed Model 2 41 2 46 7 55 2 185 61 125 68 6 90 201 249 27 493 32 176 1,869 Avg Model Risk Weight 58% 185% 58% 89% 58% 172% 168% 169% 181% 216% 168% 113% 185% 168% 168% 185% 197% 113% 208% 175%
27

Results for Month Ended December 2007
Investment Strategy / Asset Class Hedge Fund - Convertible Arbitrage Hedge Fund - Emerging Markets Hedge Fund - Equity Market Neutral Hedge Fund - Event Driven - Multi-Strategy Hedge Fund - Fixed Income Arbitrage Hedge Fund - Long-Short Equity Hedge Fund - Managed Futures Hedge Fund - Multi-Strategy Hedge Fund - Other Private Equity - CDO Private Equity - Merchant Banking Private Equity - Mezz Private Equity - MLP Private Equity - Private Equity Funds Private Equity - Real Estate Private Equity - Venture Capital Private Equity - Individual Investments Private Equity - Other Publicly Traded Equity Grand Total EAD ($Millions) 54 278 41 595 121 403 18 1,420 458 186 501 58 586 1,544 2,209 194 3,132 493 1,157 13,449 Current 17 89 13 187 36 84 4 414 120 40 125 15 187 476 374 31 946 114 188 3,461 250% Flat RWA* 11 56 8 117 23 58 3 264 92 27 82 10 117 300 373 23 598 77 164 2,403 Proposed Model 3 41 2 44 6 55 2 187 67 32 67 5 87 207 297 29 493 45 191 1,859 Avg Model Risk Weight 58% 185% 58% 93% 58% 172% 168% 164% 183% 216% 168% 113% 185% 168% 168% 185% 197% 113% 206% 173%
28
Appendix B: Securitized Products Allowance Details
LBEX-DOCID 3176398
Securitized Products: Pro-Forma Results

Results for Month Ended October 2007
October ($Millions) US RMBS CMBS ABS CDO Corp TOTAL EUROPE RMBS CMBS ABS CORP Other TOTAL TOTAL Long 71,731 36,601 2,194 2,496 979 114,001 14,247 12,915 345 254 88 27,848 141,850 Hedge (51,226) (14,847) (105) (3,977) (2,115) (72,270) (5,375) 0 0 (539) (6) (5,921) (78,191) Net 20,504 21,754 2,089 (1,481) (1,135) 41,731 8,871 12,915 345 (285) 82 21,928 63,659 JTG Risk Allowance 873 529 261 33 45 1,128 457 483 58 (0) 88 806 1,568
30

Results for Month Ended November 2007
November ($Millions) US RMBS CMBS ABS CDO Corp TOTAL EUROPE RMBS CMBS ABS CORP Other TOTAL TOTAL Long 69,187 35,590 2,555 1,987 1,569 110,889 15,427 11,571 343 260 90 27,692 138,581 Hedge (50,662) (17,275) (122) (3,091) (2,977) (74,128) (5,525) 0 0 (463) 0 (5,988) (80,116) Net 18,525 18,315 2,433 (1,104) (1,408) 36,761 9,903 11,571 343 (203) 90 21,704 58,465 JTG Risk Allowance 634 494 261 29 48 949 421 452 58 8 90 643 1,369
31

Results for Month Ended December 2007
December ($Millions) US RMBS CMBS ABS CDO Corp TOTAL EUROPE RMBS CMBS ABS CORP Other TOTAL TOTAL Long 65,711 35,216 4,039 1,714 1,625 108,306 14,194 12,085 373 255 0 26,907 135,213 Hedge (49,759) (17,984) (118) (2,580) (2,999) (73,440) (3,513) (364) 0 (691) 0 (4,568) (78,008) Net 15,953 17,232 3,921 (866) (1,374) 34,866 10,681 11,721 373 (436) 0 22,339 57,204 615 1,453 JTG Risk Allowance 577 422 753 29 50 1,080 431 440 57 (0)
32

Lehman Trading Book Migration 2-7-08

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Lehman Trading Book Migration 2-7-08

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Confidential Presentation to:

Holistic Trading Book Migration

Risk Allowance Summary

FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.

Risk Allowance Summary

Model 250% RWA*

Risk Allowance Summary (Contd.)

Securitized Products Market Neutral Strategies Total December

*Grandfathered investments prior to DEC 2005 are risk-weighted at 100%.

FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.

Jump-to-Default Capital Allowance

Reg Y charge figures are as reported, which are updated quarterly

Pro-Forma Figures for Three Months: October to December 2007

Jump-to-Default Model Assumptions

Correlation Basel Banking Book one-year asset correlation

Jump-to-Default Model Assumptions (Contd)

Confidence level = 99.9%

FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.

Principal Investments Capital Allowance

Pro-Forma Figures for Three Months: October to December 2007

Principal Investments Model Assumptions

Principal Investments Model Assumptions (Contd)

Principal Investments Model Assumptions (Contd)

FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.

Securitized Products Capital Allowance

Securitized Products Model Assumptions

Securitized Products Model Assumptions (Contd.)

Credit Rating Calibration SF RWA

A- BBB+ BBB BBB- BB+ BB

Securitized Products Model Assumptions (Contd.)

Market Neutral Strategies

FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.

Market Neutral Strategies Capital Allowance

Market Neutral Strategies Model Assumptions

Deal Break Risk for Merger Arbitrage Strategies

S T arg et (1 p ) current _ deal _ value pS T arg et (1 initial _ premium ) p

Holistic Trading Book Implementation

FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.

Holistic Trading Book Implementation

Appendix A: Principal Investments Allowance Details

FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.

Principal Investments: Pro-Forma Results

*Grandfathered investments prior to December 2005 are risk-weighted at 100%.

Principal Investments: Pro-Forma Results

*Grandfathered investments prior to December 2005 are risk-weighted at 100%.

Principal Investments: Pro-Forma Results

*Grandfathered investments prior to December 2005 are risk-weighted at 100%.

Appendix B: Securitized Products Allowance Details

FOIA CONFIDENTIAL TREATMENT REQUESTED BY LEHMAN BROTHERS HOLDINGS INC.

Securitized Products: Pro-Forma Results

Securitized Products: Pro-Forma Results

Securitized Products: Pro-Forma Results

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