Red Flags Case Study

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Red Flags:
1) The significant unusual increase in long-term assets
From 2003 to 2007, we can see that Bear Stearns’s long-term assets increased $170,836 (124.96%), while its current assets increased only 16.38%. This is a red flags because long-term assets are usually funded by long-term debts or stockholders’ equity. If a company put too many assets in its long-term categories, its financial flexibility will be impaired.
2) The significant increase in current and long-term liabilities
From 2003 to 2007, Bear Stearns’ current liabilities increased $140,326 (80.32%), and its long-term liabilities increased $38,545 (128.51%). With too many liabilities on hand could be a red flag. As we already know, debts usually have covenants restrict companies’
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This tells us that Lehman Brothers may have higher risk than Bear Stearns.
4) From 2003 to 2007, Lehman Brothers’ current ratio decreased more sharply than that of Bear Stearns, from 63.98% to 11.61%. For Bear Stearns, it only declined from 43.19% to 27.88%. This result consistent with above conclusion that Lehman Brothers may have higher risk than Bear Stearns.
5) In 2003 and 2007, Bear Stearns relied more on debt than Lehman Brothers, since its debt/equity ratios are 27.40 and 32.53, higher than those of Lehman Brothers’, 22.69 and 29.73.
Similarities:
1) These two banks had a huge increase in long-term assets and a decrease in current ratio, which could lead to liquidity risks. Further, both Bear Stearns and Lehman Brothers are investment bank, they need to maintain certain amounts of current asset to meet customers’ withdraw requirements.
2) These two banks increased their current and long-term liabilities and debt/equity ratio, which could lead to solvency problems.
3) Both banks relied more on debt than equity to raise capital, which could lead to financing mismatch

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