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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark one)

For the quarterly period ended February 28, 2003

OR

For the transition period from                              to                             

Commission file number 1-9466

Lehman Brothers Holdings Inc.
(Exact name of registrant as specified in its charter)

(212) 526-7000
(Registrant's telephone number, including area code)

        Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý    No o

        As of March 31, 2003, 242,560,417 shares of the Registrant's Common Stock, par value $0.10 per share, were outstanding.

LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES

FORM 10-Q

FOR THE QUARTER ENDED FEBRUARY 28, 2003

CONTENTS

AVAILABLE INFORMATION

        Lehman Brothers Holdings Inc. ("Holdings") files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission ("SEC"). You may read and copy any document Holdings files with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains annual, quarterly and current reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. Holdings' electronic SEC filings are available to the public at http://www.sec.gov.

        Holdings' public internet site is http://www.lehman.com. Holdings makes available free of charge through its internet site, via a link to the SEC's internet site at http://www.sec.gov, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the SEC.

        In addition, Holdings currently makes available on http://www.lehman.com its most recent annual report on Form 10-K, its quarterly reports on Form 10-Q for the current fiscal year, its most recent proxy statement and its most recent annual report to shareholders, although in some cases these documents are not available on that site as soon as they are available on the SEC's site. You will need to have on your computer the Adobe Acrobat Reader software to view these documents, which are in the .PDF format. If you do not have Adobe Acrobat, a link to Adobe's internet site, from which you can download the software, is provided.

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LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
PART I—FINANCIAL INFORMATION

ITEM 1 Financial Statements

LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES

CONSOLIDATED STATEMENT of INCOME

(Unaudited)

(In millions, except per share data)

See notes to consolidated financial statements.

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LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES

CONSOLIDATED STATEMENT of FINANCIAL CONDITION

(Unaudited)

(In millions)

See notes to consolidated financial statements.

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See notes to consolidated financial statements.

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LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES

CONSOLIDATED STATEMENT of CASH FLOWS

(Unaudited)

(In millions)

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (in millions)
Interest paid totaled $2,423 and $2,682 for the three months ended February 28, 2003 and February 28, 2002, respectively.
Income taxes paid totaled $255 and $21 for the three months ended February 28, 2003 and February 28, 2002, respectively.

See notes to consolidated financial statements.

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LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
NOTES to CONSOLIDATED FINANCIAL STATEMENTS

1.    Basis of Presentation:

        The consolidated financial statements include the accounts of Lehman Brothers Holdings Inc. ("Holdings") and subsidiaries (collectively, the "Company" or "Lehman Brothers"). Lehman Brothers is one of the leading global investment banks serving institutional, corporate, government and high-net-worth individual clients and customers. The Company's worldwide headquarters in New York and regional headquarters in London and Tokyo are complemented by offices in additional locations in North America, Europe, the Middle East, Latin America and the Asia Pacific Region. The Company is engaged primarily in providing financial services. The principal U.S. subsidiary of Holdings is Lehman Brothers Inc. ("LBI"), a registered broker-dealer. All material intercompany accounts and transactions have been eliminated in consolidation. The Company's financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the "SEC") with respect to Form 10-Q and reflect all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Pursuant to such rules and regulations, certain footnote disclosures which are normally required under generally accepted accounting principles have been omitted. These consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and the notes thereto (the "2002 Consolidated Financial Statements") incorporated by reference in Holdings' Annual Report on Form 10-K for the twelve months ended November 30, 2002 (the "Form 10-K"). The Consolidated Statement of Financial Condition at November 30, 2002 was derived from the audited financial statements.

        The nature of the Company's business is such that the results of any interim period may vary significantly from quarter to quarter and may not be indicative of the results to be expected for the fiscal year. Certain prior period amounts reflect reclassifications to conform to the current period's presentation.

2.    Long-Term Debt:

        During the three months ended February 28, 2003, the Company issued $3,746 million of long-term debt of which $3,620 million were senior notes and $126 million were subordinated notes. These issuances were primarily utilized to refinance long-term debt maturing in 2003.

        The Company had $2,133 million of long-term debt ($2,130 million of senior notes and $3 million of subordinated notes) mature during the three months ended February 28, 2003. Long-term debt at February 28, 2003 scheduled to mature within one year totaled $7,512 million.

3.    Capital Requirements:

        The Company operates globally through a network of subsidiaries, with several subject to regulatory requirements. In the United States, LBI, as a registered broker-dealer, is subject to SEC Rule 15c3-1, the Net Capital Rule, which requires LBI to maintain net capital of not less than the greater of 2% of aggregate debit items arising from customer transactions, as defined, or 4% of funds required to be segregated for customers' regulated commodity accounts, as defined. At February 28, 2003, LBI's regulatory net capital, as defined, of $1,710 million exceeded the minimum requirement by $1,587 million.

        Lehman Brothers International (Europe) ("LBIE"), a United Kingdom registered broker-dealer and subsidiary of Holdings, is subject to the capital requirements of the Financial Services Authority ("FSA") of the United Kingdom. Financial resources, as defined, must exceed the total financial resources

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requirement of the FSA. At February 28, 2003, LBIE's financial resources of approximately $2,677 million exceeded the minimum requirement by approximately $629 million. Lehman Brothers Japan Inc.'s Tokyo branch, a regulated broker-dealer, is subject to the capital requirements of the Financial Services Agency and at February 28, 2003, had net capital of approximately $372 million which was approximately $96 million in excess of the specified levels required. Lehman Brothers Bank, FSB (the "Bank"), the Company's thrift subsidiary, is regulated by the Office of Thrift Supervision ("OTS"). The Bank exceeds all regulatory capital requirements and is considered well capitalized by the OTS. Certain other non-U.S. subsidiaries are subject to various securities, commodities and banking regulations and capital adequacy requirements promulgated by the regulatory and exchange authorities of the countries in which they operate. At February 28, 2003, these other subsidiaries were in compliance with their applicable local capital adequacy requirements. In addition, the Company's "AAA" rated derivatives subsidiaries, Lehman Brothers Financial Products Inc. ("LBFP") and Lehman Brothers Derivative Products Inc. ("LBDP"), have established certain capital and operating restrictions which are reviewed by various rating agencies. At February 28, 2003, LBFP and LBDP each had capital which exceeded the requirements of the rating agencies.

        The regulatory rules referred to above, and certain covenants contained in various debt agreements, may restrict Holdings' ability to withdraw capital from its regulated subsidiaries, which in turn could limit its ability to pay dividends to shareholders.

4.    Derivative Financial Instruments:

        In the normal course of business, the Company enters into derivative transactions both in a trading capacity and as an end-user. The Company's derivative activities (both trading and end-user) are recorded at fair value on the Company's Consolidated Statement of Financial Condition. As an end user, the Company utilizes derivatives to modify the market risk exposures of certain assets and liabilities. In this regard, the Company primarily enters into fair value hedges utilizing interest rate swaps to convert a substantial portion of the Company's fixed rate long-term debt and certain term fixed rate secured financing activities to a floating interest rate. The ineffective portion of the fair value hedges was included in "Interest expense" on the Consolidated Statement of Income and were immaterial for the three months ended February 28, 2003 and 2002.

        Market or fair value is generally determined by either quoted market prices (for exchange-traded futures and options) or pricing models (for swaps, forwards and options). Pricing models utilize a series of market inputs to determine the present value of future cash flows, with adjustments, as required for credit risk and liquidity risk. Further valuation adjustments may be recorded, as deemed appropriate, for new or complex products or for positions with significant concentrations. These adjustments are integral components of the mark-to-market process. Credit-related valuation adjustments represent estimates of expected losses which incorporate business and economic conditions, historical experience, concentrations, and the character, quality and performance of credit sensitive financial instruments.

        Unrealized gains and losses on derivative contracts are recorded on a net basis in the Consolidated Statement of Financial Condition for those transactions with counterparties executed under a legally enforceable master netting agreement and are netted across products when such provisions are stated in the master netting agreement. Listed in the following table is the fair value of the Company's trading-related derivative activities. Assets and liabilities represent net unrealized gains (amounts receivable from counterparties) and net unrealized losses (amounts payable to counterparties), respectively.

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*

Amounts represent carrying value (exclusive of collateral) and do not include receivables or payables related to exchange-traded futures contracts.

        Assets included in the table above represent the Company's net receivable/payable for derivative financial instruments before consideration of collateral. Included within the $16,798 million fair value of assets at February 28, 2003 was $15,852 million related to swaps and other over-the-counter ("OTC") contracts and $946 million related to exchange-traded option and warrant contracts. Included within the $13,862 million fair value of assets at November 30, 2002 was $12,846 million related to swaps and other OTC contracts and $1,016 million related to exchange-traded option and warrant contracts.

        With respect to OTC contracts, including swaps, the Company views its net credit exposure to be $10,632 million at February 28, 2003, representing the fair value of the Company's OTC contracts in an unrealized gain position, after consideration of collateral. Presented below is an analysis of the Company's net credit exposure at February 28, 2003 for OTC contracts based upon actual ratings made by external rating agencies or by equivalent ratings established and utilized by the Company's Credit Risk Management Department.

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        The Company's net credit exposure from OTC contracts, by maturity, is set forth below:

        The Company is also subject to credit risk related to its exchange-traded derivative contracts. Exchange-traded contracts, including futures and certain options, are transacted directly on the exchange. To protect against the potential for a default, all exchange clearinghouses impose net capital requirements for their membership. Additionally, exchange clearinghouses require counterparties to futures contracts to post margin upon the origination of the contracts and for any changes in the market value of the contracts on a daily basis (certain foreign exchanges provide for settlement within three days). Therefore, the potential for losses from exchange-traded products is limited.

        For a further discussion of the Company's derivative related activities, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations—Off-Balance Sheet Arrangements—Derivatives" and the Notes 1 and 15 to the 2002 Consolidated Financial Statements, incorporated by reference in the Form 10-K.

5.    Securitizations:

        The Company is a market leader in mortgage- and asset-backed securitizations and other structured financing arrangements. In connection with these activities, the Company utilizes special purpose entities principally for (but not limited to) the securitization of commercial and residential mortgages, home equity loans, government and corporate bonds, and lease and trade receivables. The Company derecognizes financial assets transferred in securitizations provided that the Company has relinquished control over such assets. The Company may retain an interest in the financial assets it securitizes ("retained interests"), which may include assets in the form of residual interests in the special purpose entities established to facilitate the securitization. Any retained interests are included in Securities and other financial instruments owned (principally Mortgages and mortgage-backed) within the Company's Consolidated Statement of Financial Condition. For further information regarding the accounting for securitization transactions, see Note 1 to the 2002 Consolidated Financial Statements, incorporated by reference in the Form 10-K. During the three months ended February 28, 2003 and 2002, the Company securitized approximately $31 billion and $26 billion of financial assets, including: $27 billion and $15 billion of residential mortgages, $1 billion and $3 billion of commercial mortgages, and $3 billion and $8 billion of other asset-backed financial instruments, respectively ($1 billion and $2 billion, respectively, of securitizations were transacted on an agented basis).

        As of February 28, 2003 and November 30, 2002, the Company had approximately $535 million and $1,060 million, respectively, of non-investment grade retained interests from its securitization activities (principally junior security interests in securitizations) including $295 million of residential mortgages, $188 million of other asset-backed financial instruments and $52 million of commercial mortgages as of

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February 28, 2003 and $350 million of residential mortgages, $200 million of other asset-backed financial instruments and $510 million of commercial mortgages as of November 30, 2002. The Company records its trading assets on a mark-to-market basis, including those assets held prior to securitization, as well as any retained interests post securitization. Mark-to-market gains or losses are recorded in "Principal transactions" in the Consolidated Statement of Income. Fair value is determined based upon listed market prices, if available. When market prices are not available, fair value is determined based on valuation pricing models which take into account relevant factors such as discount, credit and prepayment assumptions, and also considers comparisons to similar market transactions.

        The tables below outline the key economic assumptions used in measuring the fair value of retained interests:

At February 28, 2003:

At November 30, 2002:

        The tables below outline the sensitivity of the fair value of the retained interests to immediate 10% and 20% adverse changes in the above assumptions (dollars in millions):

        The sensitivity analysis in the preceding table is hypothetical and should be used with caution as the above stresses are performed without consideration of the impact of hedges, which serve to reduce the Company's actual risk. In addition, these results are calculated by stressing a particular economic

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assumption independent of changes in any other assumption (as required by U.S. GAAP); in reality, changes in one factor often result in changes in another (for example, changes in discount rates will often impact expected prepayment speeds). Further, changes in the fair value based upon a 10% or 20% variation in an assumption should not be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear.

        The following table summarizes cash flows from securitization trusts for the quarter ended February 28, 2003:

6.    Financial Instruments:

        Securities and other financial instruments owned and Securities and other financial instruments sold but not yet purchased are recorded at fair value and were comprised of the following:

7.    Securities Pledged as Collateral:

        The Company enters into secured borrowing and lending transactions to finance trading inventory positions, obtain securities for settlement and meet customers' needs. The Company receives collateral in connection with resale agreements, securities borrowed transactions, customer margin loans and certain other loans. The Company is generally permitted to sell or repledge these securities held as collateral and use the securities to secure repurchase agreements, enter into securities lending transactions or deliver to

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counterparties to cover short positions. The Company carries secured financing agreements for financial reporting purposes on a net basis when permitted under the provisions of Financial Accounting Standards Board ("FASB") Interpretation No. 41 ("FIN 41").

        At February 28, 2003 and November 30, 2002, the fair value of securities received as collateral and securities owned that have not been sold, repledged or otherwise encumbered totaled approximately $59 billion and $51 billion, respectively. At February 28, 2003 and November 30, 2002, the gross fair value of securities received as collateral where the Company was permitted to sell or repledge the securities was approximately $319 billion and $345 billion, respectively. Of this collateral, approximately $308 billion and $338 billion at February 28, 2003 and November 30, 2002, respectively, has been sold or repledged, generally as collateral under repurchase agreements or to cover securities and other financial instruments sold but not yet purchased.

        The Company also pledges its own assets, principally to collateralize certain financing arrangements. These pledged securities, where the counterparty has the right, by contract or custom, to rehypothecate the financial instruments are classified as securities and other financial instruments owned, pledged as collateral, on the Company's Consolidated Statement of Financial Condition as required by Statement of Financial Accounting Standards ("SFAS") 140.

        The carrying value of securities and other financial instruments owned that have been pledged to counterparties where those counterparties do not have the right to sell or repledge were approximately $34 billion and $39 billion at February 28, 2003 and November 30, 2002, respectively.

8.    Other Commitments and Contingencies:

        In the normal course of business the Company enters into various commitments and guarantees, including lending commitments to high grade and high yield borrowers, liquidity commitments and other guarantees. In all instances, the Company marks-to-market these commitments and guarantees with changes in fair value recognized in Principal transactions revenue.

Lending Related Commitments

        In connection with its financing activities, the Company had outstanding commitments under certain lending arrangements of approximately $3.5 billion and $1.5 billion at February 28, 2003 and November 30, 2002, respectively. These commitments require borrowers to provide acceptable collateral, as defined in the agreements, when amounts are drawn under the lending facilities. Advances made under the above lending arrangements are typically at variable interest rates and generally provide for over-collateralization based upon the borrowers' creditworthiness. In addition, at February 28, 2003 the Company had commitments to enter into forward starting secured reverse repurchase and repurchase agreements, principally secured by government and government agency obligations, of $105.6 billion and $64.2 billion, respectively, as compared to $89.9 billion and $50.3 billion, respectively, at November 30, 2002.

        The Company, through its high grade and high yield sales, trading and underwriting activities, makes commitments to extend credit in loan syndication transactions. The Company utilizes various hedging and funding strategies to actively manage its market, credit and liquidity exposures on these commitments. In addition, total commitments are not indicative of actual risk or funding requirements, as the commitments may not be drawn or fully utilized. These commitments and any related draw downs

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of these facilities typically have fixed maturity dates and are contingent upon certain representations, warranties and contractual conditions applicable to the borrower.

        The Company had credit risk associated with lending commitments to investment grade borrowers (after consideration of hedges) of $3.1 billion and $3.2 billion at February 28, 2003 and November 30, 2002, respectively. In addition, the Company had credit risk associated with lending commitments to non-investment grade borrowers (after consideration of hedges) of $1.7 billion at both February 28, 2003 and November 30, 2002. Before consideration of hedges, the Company had commitments to investment and non-investment grade borrowers of $7.2 billion and $1.9 billion as compared to $7.1 billion and $1.8 billion at February 28, 2003 and November 30, 2002, respectively. The Company had available undrawn borrowing facilities with third parties of approximately $5.4 billion and $5.2 billion at February 28, 2003 and November 30, 2002, respectively, which can be drawn upon to provide funding for these commitments. These funding facilities contain limits for certain concentrations of counterparty, industry or credit ratings of the underlying loans.

        In addition, the Company provided high yield contingent commitments related to acquisition financing of approximately $0.5 billion and $2.8 billion at February 28, 2003 and November 30, 2002, respectively. The Company's intent is, and its past practice has been, to sell down significantly all the credit risk associated with these loans, if closed, through loan syndications consistent with the Company's credit facilitation framework. These commitments are not indicative of the Company's actual risk as the borrower's ability to draw is subject to there being no material adverse change in either market conditions or the borrower's financial condition, among other factors. In addition, these commitments contain certain flexible pricing features in order to further adjust for changing market conditions.

        As of February 28, 2003 and November 30, 2002, the Company had pledged securities, primarily fixed income, having a market value of approximately $42.0 billion and $41.6 billion, respectively, as collateral for securities borrowed having a market value of approximately $41.5 billion and $40.6 billion, respectively.

        At February 28, 2003 and November 30, 2002, the Company had commitments to invest up to $407 million and $672 million, respectively, directly and through partnerships in private equity related investments. These commitments will be funded as required, in whole or in part, through the end of the respective investment periods, principally expiring in 2004.

Other Commitments and Guarantees

        In accordance with FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees including Indirect Guarantees of Indebtedness of Others" ("FIN 45"), the Company is required to disclose certain guarantees, including derivative contracts that require the Company to make payments to a counterparty based on changes on an underlying (e.g. security prices, interest rates, and currency rates). Derivatives that meet the FIN 45 definition of a guarantee include credit default swaps, written put options, written foreign exchange ("FX") options and written interest rate caps and floors. According to FIN 45, derivatives are not considered guarantees if such contracts are cash settled and the Company has no basis to determine that it is probable that the derivative counterparty held the related underlying instrument. Accordingly, if these conditions were met, the Company has not included such derivatives contracts in its guarantee disclosures.

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        At February 28, 2003, the maximum payout value of derivative contracts deemed to meet the FIN 45 definition of a guarantee was approximately $257 billion. For purposes of determining maximum payout, notional values were utilized; however, the Company believes that the fair value of these contracts is a more relevant measure of these obligations. At February 28, 2003, the fair value of such derivative contracts approximated $4.5 billion. The Company believes that the notional amounts greatly overstate the Company's expected payout. In addition, all amounts included above are before consideration of hedging transactions. These derivative contracts are generally highly liquid and the Company has substantially mitigated its risk on these contracts through hedges, such as other derivative contracts and/or cash instruments. The Company manages risk associated with derivative guarantees consistent with the Company's global risk management policies. The Company records derivative contracts, including those considered to be guarantees under FIN 45, on a fair value basis with related gains/losses recognized in Principal transactions revenues.

        The Company had liquidity commitments of approximately $3.7 billion related to trust certificates backed by investment grade municipal securities at February 28, 2003, as compared to $4.4 billion at November 30, 2002. The Company's obligation under such liquidity commitments is generally less than one year and is typically further limited by the fact that the Company's obligation ceases if the underlying assets are downgraded below investment grade or default. In addition, the Company had certain other commitments and guarantees associated with special purpose entities of approximately $5.0 billion at February 28, 2003 and November 30, 2002, respectively. These commitments consist of liquidity facilities and other default protection to investors, which are principally overcollateralized with investment grade collateral.

        As of both February 28, 2003 and November 30, 2002, the Company was contingently liable for $0.8 billion of letters of credit, primarily used to provide collateral for securities and commodities borrowed and to satisfy margin deposits at option and commodity exchanges.

        In the normal course of business, the Company provides guarantees to securities clearinghouses and exchanges. These guarantees are generally required under the standard membership agreements, such that members are required to guarantee the performance of other members. To mitigate these performance risks, the exchanges and clearinghouses often require members to post collateral. The Company's obligation under such guarantees could exceed the collateral amounts posted; however the potential for the Company to be required to make payments under such guarantees is deemed remote.

        In connection with certain asset sales and securitization transactions, the Company often makes representations and warranties about the assets conforming to specified guidelines. If it is later determined that the underlying assets fail to conform to the specified guidelines, the Company may have an obligation to repurchase the assets or indemnify the purchaser against any losses. To mitigate these risks, to the extent that the assets being securitized may have been originated by other third parties, the Company seeks to obtain appropriate representations and warranties from these third parties upon acquisition of such assets.

Litigation

        In the normal course of its business, the Company has been named a defendant in a number of lawsuits and other legal proceedings. After considering all relevant facts and established reserves, in the opinion of the Company such litigation will not, in the aggregate, have a material adverse effect on the Company's consolidated financial position or cash flows, but may be material to the Company's operating results for any particular period, depending on the level of income for such period.

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Other Off-Balance-Sheet Arrangements

        Special purpose entities ("SPEs") are corporations, trusts or partnerships which are established for a limited purpose. SPEs by their nature generally do not provide equity owners with significant voting powers, as the SPE documents govern all material decisions. The Company's primary involvement with SPEs relates to securitization transactions in which transferred assets, including mortgages, loans, receivables and other assets, are sold to an SPE and repackaged into securities (i.e., securitized). SPEs may also be utilized by the Company to create securities with a unique risk profile desired by investors and as a means of intermediating financial risk. In summary, in the normal course of business, the Company may establish SPEs; sell assets to SPEs; underwrite, distribute and make a market in securities issued by SPEs; transact derivatives with SPEs; own securities or residual interests in SPEs and provide liquidity or other guarantees for SPEs.

        The majority of the Company's involvement with SPEs relates to securitization transactions meeting the SFAS 140 definition of a qualifying special purpose entity ("QSPE"). Based upon the guidance in SFAS 140, the Company is not required to and does not consolidate such QSPEs. Rather, the Company accounts for its involvement with QSPEs under a financial components approach in which the Company recognizes only its retained involvement with the QSPE.

        Certain special purpose entities do not meet the QSPE criteria due to their permitted activities not being sufficiently limited, or because the assets are not deemed qualifying financial instruments (e.g., real estate). In instances in which the Company is either the sponsor of or transferor to a non-qualifying special purpose entity, the Company follows the accounting guidance provided by Emerging Issues Task Force ("EITF") Topic D-14 and FASB Interpretation No. 46, "Consolidation of Variable Interest Entities—an interpretation of ARB No. 51" ("FIN 46") (for a discussion of FIN 46, see below) to determine whether consolidation is required. Under this guidance, the Company would not be required to, and does not consolidate such SPE if a third party investor made a substantive equity investment in the SPE, was subject to first dollar risk of loss of such SPE, and had a controlling financial interest. The Company's principal involvement with non-QSPEs relates to Collateralized Debt Obligations ("CDOs"), synthetic credit transactions and other structured financing transactions to facilitate customers' investment and/or funding needs.

        With respect to CDO transactions, in which a diversified portfolio of securities and/or loans are owned by a SPE and managed by an independent asset manager, the Company's role is principally limited to acting as structuring and placement agent, warehouse provider, underwriter and market maker in the related CDO securities. In a typical CDO, at the direction of the asset manager, the Company will warehouse securities or loans on its balance sheet pending the transfer to the SPE once the capital markets permanent financing is completed. During the first quarter of 2003, the Company acted as warehouse provider and underwriter for approximately $300 million of CDO transactions. At February 28, 2003 the Company did not have any significant continuing involvement in the CDOs arranged by the Company other than acting as market maker, and as such the Company is not required to consolidate the transactions.

        The Company is a dealer in credit default swaps and, as such, makes a market in buying and selling credit protection on single issuers as well as on portfolios of credit exposures. One of the mechanisms used by the Company to mitigate credit risk is synthetic credit transactions entered into with SPEs. In these transactions, the Company purchases credit protection in the form of a credit default swap from the SPE on referenced obligations (single issuer or portfolio). The Company pays a premium to the SPE for this protection and is secured by high quality collateral purchased by the SPE. Third party investors in these

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SPEs are subject to default risk associated with the referenced obligations under the default swap as well as credit risk to the assets held by the SPE. The Company's maximum loss associated with its involvement with such synthetic credit transactions is the fair value of the Company's credit default swaps with such SPEs which approximated $779 million at February 28, 2003 (while this amount represents the maximum loss the Company could potentially lose on such agreements, it is highly unlikely since the underlying collateral held by the SPEs was $5.9 billion and was investment grade quality).

        The Company also enters into certain structured financing transactions with SPEs to facilitate customers' investment and/or funding needs. The Company's involvement in these transactions is generally limited to providing liquidity or other default protection to investors. At both February 28, 2003 and November 30, 2002, the Company had approximately $5.0 billion of such commitments, which represented the Company's maximum loss; however, the Company's expected exposure for these commitments is significantly less as these commitments were principally overcollateralized with investment grade collateral.

        On January 17, 2003, the FASB issued FIN 46. This interpretation provides consolidation accounting guidance for entities involved with SPEs. This guidance does not impact the accounting for securitizations transacted through QSPEs, but rather will replace EITF Topic D-14. as it is applied to non-QSPEs. This interpretation will require a primary beneficiary, defined as an entity which participates in either a majority of the risks or rewards of such SPE, to consolidate the SPE. An SPE would not be subject to this interpretation if such entity has sufficient voting equity capital (presumed to require that total voting equity is at least 10% of total assets), such that the entity is able to finance its activities without the additional subordinated financial support from other parties. The interpretation became effective for all new transactions after January 31, 2003 and will be effective for all other existing transactions with SPEs beginning in the Company's fourth quarter of 2003. While the Company has not yet completed its analysis of the impact of the new interpretation, the Company does not anticipate that the adoption of this interpretation will have a material impact to the Company's financial condition or its results of operations.

9.    Segments:

        The Company operates in three segments: Investment Banking, Capital Markets and Client Services.

        The Investment Banking Division provides advice to corporate, institutional and government clients throughout the world on mergers, acquisitions and other financial matters. This Division also raises capital for clients by underwriting public and private offerings of debt and equity securities.

        The Capital Markets Division includes the Company's institutional sales, trading, research and financing activities in equity and fixed income cash and derivatives products. Through this Division, the Company is a global market-maker in numerous equity and fixed income products, including U.S., European and Asian equities, government and agency securities, money market products, corporate high grade, high yield and emerging market securities, mortgage- and asset-backed securities, municipal securities, bank loans, foreign exchange and derivatives products. This Division also includes the Company's risk arbitrage and secured financing businesses, as well as realized and unrealized gains and losses related to the Company's private equity investments. The financing business manages the Company's equity and fixed income matched book activities, supplies secured financing to institutional clients and customers, and provides secured funding for the Company's inventory of equity and fixed income products.

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        Client Services revenues reflect earnings from the Company's Private Client and Private Equity businesses. Private Client revenues reflect the Company's high-net-worth retail customer flow activities as well as asset management fees earned from these clients. Private Equity revenues include the management and incentive fees earned in the Company's role as general partner for thirty-three Private Equity partnerships.

        The Company's segment information for the three months ended February 28, 2003 and February 28, 2002 is prepared utilizing the following methodologies:

•

Revenues and expenses directly associated with each segment are included in determining pre-tax earnings.



•

Expenses not directly associated with specific segments are allocated based upon the most relevant measures applicable, including each segment's revenues, headcount and other factors.



•

Net revenues include allocations of interest revenue and interest expense to securities and other positions in relation to the cash generated by, or funding requirements of, the underlying positions.



•

Segment assets include an allocation of indirect corporate assets which have been fully allocated to the Company's business segments, generally based on each segment's respective headcount figures.

Segments (Three Months Ended):

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        The following are net revenues by geographic region:

10.  Earnings Per Common Share:

        Earnings per share was calculated as follows (in millions, except for per share data):

19

ITEM 2

LEHMAN BROTHERS HOLDINGS INC. and SUBSIDIARIES
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL
CONDITION and RESULTS of OPERATIONS

Forward-Looking Statements

        Some of the statements contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations, including those relating to the Company's strategy and other statements that are predictive in nature, that depend upon or refer to future events or conditions or that include words such as "expects," "anticipates," "intends," "plans," "believes," "estimates" and similar expressions, are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These statements are not historical facts but instead represent only the Company's expectations, estimates and projections regarding future events. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict, which may include, but are not limited to, market fluctuations and volatility, industry competition and changes in the competitive environment, investor sentiment, liquidity risks, credit ratings changes, credit exposure and legal and regulatory changes. (For further discussion of these risks, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Certain Factors Affecting Results of Operations" incorporated by reference in the Form 10-K.). The Company's actual results and financial condition may differ, perhaps materially, from the anticipated results and financial condition in any such forward-looking statements and, accordingly, readers are cautioned not to place undue reliance on such statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Business Environment

        The principal business activities of Lehman Brothers Holdings Inc. ("Holdings") and subsidiaries (collectively, the "Company" or "Lehman Brothers") are investment banking and capital markets facilitation, which by their nature are subject to volatility, primarily due to changes in interest and foreign exchange rates and security valuations, global economic and political trends and industry competition. Through the Company's investment banking, trading, research, structuring and distribution capabilities in equity and fixed income products, the Company continues to build on its client/customer business model. This model focuses on "customer flow" activities. The "customer flow" model is based upon the Company's principal focus of facilitating customer transactions in all major global capital markets products and services. The Company generates customer flow revenues from institutional and high-net-worth clients/customers by (i) advising on and structuring transactions specifically suited to meet client needs, (ii) serving as a market maker and/or intermediary in the global marketplace, including having securities and other financial instrument products available to allow clients to rebalance their portfolios and diversify risks across different market cycles and (iii) acting as underwriter to clients.

        Marketplace uncertainties experienced throughout 2002 continued into the first quarter of 2003, in which fundamentals in both the macroeconomy and the broader capital markets took on a more negative tone as the quarter progressed. The U.S. markets exhibited additional weakness in the first quarter of 2003, as economic indicators including manufacturing activity, consumer spending and retail sales continued to show deterioration.

        These conditions, coupled with higher oil prices and reduced investor confidence resulting from the impending war in Iraq and continuing corporate governance scandals, continued to weigh on the markets resulting in declines across all major equity indices during the first quarter of 2003, as compared to the first quarter of 2002 and the year ended November 30, 2002. The Standard & Poor's 500 Index declined by 24% as of the end of the first quarter of 2003 from the end of the first quarter of 2002 and 10% from the end of fiscal year 2002. The NASDAQ also experienced deterioration, closing the first quarter of 2003 down 23% from a year ago and 10% from November 30, 2002.

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        Globally, other world markets experienced similar declines as investors continued to look to invest in more defensive asset categories. The FTSE 100 decreased 28% as of the end of the first quarter of 2003 from the end of the first quarter of 2002 and 12% from November 30, 2002, while the DAX decreased 49% from the end of the first quarter of 2002 and 23% from November 30, 2002. In Asia, the Nikkei was down 21% from the end of the first quarter of 2002, and 9% from November 30, 2002, hitting lows established in 1983.

        Global equity origination market volume declined 23% during the first quarter of 2003 from the already impaired levels during the fourth quarter of 2002, and 54% from the first quarter of 2002, resulting in the lowest volume experienced since the second fiscal quarter of 1995. However, fixed income markets continued to benefit from investors' extreme risk aversion. In the U.S., the short end of the treasury curve rallied by over 50 basis points during the first quarter of 2003, leaving Treasuries at rates last seen in the 1950's. These dynamics led to improved secondary trading volumes from the already high volumes of 2002, and a tightening of credit spreads, with high grade credit spreads improving by approximately 30 basis points from November 30, 2002 levels, and high yield spreads tightening by approximately 70 basis points over the same period. These conditions led to improved global debt origination activity in the first quarter of 2003 up 23% as compared to the first quarter of 2002 and up 11% as compared to the fourth quarter ended November 30, 2002. (Statistics according to Thomson Financial Securities Data Corp. ("TFSD").)

        Merger and acquisition ("M&A") advisory activity continued to be lackluster during the period as economic and geopolitical concerns continued to hamper activity. Global market volume for completed transactions ended the first quarter of 2003 at its lowest level in seven years.

Results of Operations
For the Three Months Ended February 28, 2003 and February 28, 2002

        The Company reported net income of $301 million for the quarter ended February 28, 2003, an increase of 1% as compared to $298 million for the first quarter of 2002. Earnings per common share (diluted) for the first quarter of 2003 were $1.15 as compared to $0.99 for the first quarter of 2002. The Company's pre-tax operating margin for the first quarter of 2003 was 25.6%, and return on common equity was 13.9%. These results reflect the highest level of earnings per share the Company has reported since the second quarter of 2001. During the first quarter of 2003, the Company continued its disciplined approach with regard to its core competencies in expense, risk and liquidity management. The Company believes that these results demonstrate the depth and breadth of the Company's franchise in managing through the extended downturn.

Net Revenues

        Net revenues were $1,711 million for the first quarter of 2003 as compared to $1,606 million for the first quarter of 2002. Revenues increased 7% compared to the prior year's levels, reflecting a strong performance in what remains a very difficult operating environment.

Principal Transactions, Commissions and Net Interest Revenues

        The Company evaluates the performance of its Capital Markets and Client Services revenues in the aggregate, including Principal transactions, Commissions and net interest. Decisions relating to these activities are based on an overall review of aggregate revenues, which includes an assessment of the potential gain or loss associated with a transaction, including associated commissions, and the interest revenue and expense associated with financing or hedging the Company's positions. Therefore, the Company evaluates its net revenues from Principal transactions, Commissions and Interest revenue, offset by Interest expense, in the aggregate. Caution should be used when analyzing these revenue categories

21

individually, as they may not be indicative of the performance of the Company's overall Capital Markets and Client Services activities.

        Principal transactions, Commissions and net interest revenues increased 18% to $1,328 million for the first quarter of 2003 as compared to $1,124 million for the first quarter of 2002, reflecting robust fixed income customer flow activities, offset by continued weakness in the equities markets. Fixed income products benefited from the rally in U.S. Treasuries and the narrowing of credit spreads, as investors continued to be risk averse. These conditions contributed to strong customer flow activity and improved results, particularly in interest rate products and high grade and high yield bonds. In addition, there was improved performance from mortgage products driven by continued strength in securitization activity as a result of historically low interest rate levels. Revenues from equity products were negatively impacted by declines in global equity indices, which decreased approximately 10% on average during the first quarter of 2003, and reduced customer trading volumes as investors remained sidelined from the equity markets. Despite these negative conditions, the Company continued to improve its market share in both listed and NASDAQ trading volumes during the first quarter of 2003.

        Within these amounts, Principal transactions revenues were $768 million for the first quarter of 2003 as compared to $569 million for the first quarter of 2002. Commissions revenues were $262 million for the first quarter of 2003 as compared to $289 million for the first quarter of 2002. Interest and dividend revenues were $2,687 million for the first quarter of 2003 as compared to $2,886 million for the first quarter of 2002. Interest expense was $2,389 million for the first quarter of 2003 as compared to $2,620 million for the first quarter of 2002.

        The increase in Principal transactions revenues reflects improved trading revenue in nearly all fixed income products. The decrease in Commissions revenues is principally a result of lower customer flow activity in equity trading volumes, as investors continued to exit equity products for more defensive asset classes during the first quarter of 2003.

        Interest and dividends revenues and Interest expense are a function of the level and mix of total assets and liabilities, principally financial instruments owned and secured financing activities, the prevailing level of interest rates, as well as the term structure of the Company's financings. Interest and dividends revenues and Interest expense are integral components of the Company's overall customer flow activities. The decline in interest revenue and interest expense from the previous year is principally due to a decline in interest rates over the period. The increase in net interest revenue of 12% to $298 million in the first quarter of 2003 from $266 million in the first quarter of 2002 was due to the steepening yield curve, which resulted in lower short-term financing costs as well as a change in inventory mix to higher levels of interest bearing assets in response to continued shifts in customer asset preferences.

Investment Banking

        Investment Banking revenues were $371 million for the first quarter of 2003 as compared to $470 million for the first quarter of 2002. Investment Banking revenues result mainly from fees earned by the Company for underwriting public and private offerings of fixed income and equity securities, advising clients on M&A activities and other services. Investment Banking revenues decreased 21% from the first quarter of 2002 reflecting the continued significant market weakness in equity underwriting and continued low levels of M&A advisory activities, partially offset by strong debt underwriting levels.

22

Non-Interest Expenses

        Non-interest expenses were $1,274 million for the first quarter of 2003, up 9% from $1,166 million for the first quarter of 2002. Compensation and benefits expense of $873 million increased 7% from $819 million in the first quarter of 2002 as a result of the 7% increase in net revenues over the same period. Compensation and benefit expense, as a percentage of net revenues, remained at 51% for the quarter, consistent with the first quarter of 2002. Higher levels of revenues in 2003 resulted in higher variable compensation expenses, which increased by 15% from the first quarter of 2002. Fixed compensation, consisting primarily of salaries and benefits, remained relatively flat, as a decrease in salaries, resulting from a slight decline in average headcount, was offset by increases in pension expense, which is expected to increase to $49 million for fiscal 2003 from $26 million in fiscal 2002.

        Nonpersonnel expenses were $401 million for the first quarter of 2003, up 16% compared to the first quarter of 2002. Technology and communication expense increased to $143 million for the first quarter of 2003 from $122 million for the first quarter of 2002, primarily due to amortization of new technology assets at the Company's new facilities and increased spending made to enhance the Company's capital markets trading platforms and technology infrastructure. Occupancy expense increased to $82 million during the first quarter of 2003 from $69 million during the first quarter of 2002, principally attributable to additional space to accommodate the growth in headcount resulting from the Company's expansion during the past several years as well as the increased cost of the Company's new corporate headquarters. Brokerage and clearance fees increased 15% in the first quarter of 2003 as a result of higher volumes in certain fixed income structured products.

Income Taxes

        The Company recorded an income tax provision of $122 million for the first quarter of 2003 versus $128 million for the first quarter of 2002. These provisions resulted in effective tax rates of 28% and 29% respectively. The decrease in the effective tax rate is primarily due to a more favorable mix of geographic earnings.

International Revenues

        International net revenues of $592 million for the first quarter of 2003 increased 8% as compared to $549 million in the first quarter of 2002. International net revenues as a percentage of total consolidated revenues remained relatively unchanged at 35%. European and Asian revenues were consistent with consolidated revenues, with strong results in fixed income capital markets, partially offset by weaknesses in equity revenues.

Segment Results—Three Months Ended February 28, 2003 and February 28, 2002

        The Company is segregated into three business segments (each of which is described below): Investment Banking, Capital Markets and Client Services. Each segment represents a group of activities and products with similar characteristics. These business activities result in revenues from both institutional and high-net-worth retail clients, which are recognized across all revenue categories contained in the Company's Consolidated Statement of Income. (Segment net revenues also contain certain internal allocations, including funding costs, which are centrally managed. For further discussion of these allocations, see Note 9 to the Consolidated Financial Statements included in this Report.)

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(1)

Before dividends on preferred securities

        The following discussion provides an analysis of the Company's results by segment for the above periods.

        In assessing the performance of Capital Markets and Client Services, the Company evaluates Principal transactions, Commissions and net interest revenues in the aggregate. Decisions relating to Capital Markets and Client Services activities are based on an overall review of aggregate revenues, which includes an assessment of the potential gain or loss associated with a transaction including associated commissions, and the interest revenue and expense associated with financing or hedging the Company's positions. Therefore, the Company evaluates its net revenues from Principal transactions, Commissions and Interest revenue, offset by related Interest expense, in the aggregate, because the revenue classifications, when analyzed individually, may not be indicative of the performance of the Company's Capital Markets and Client Services activities.

        Investment Banking    This segment's net revenues result from fees earned by the Company for underwriting public and private offerings of fixed income and equity securities, and advising clients on merger and acquisition activities and other services.

        Investment Banking's net revenues decreased 20% during the first quarter of 2003 to $366 million from $459 million in the first quarter of 2002, as robust fixed income underwriting activity was more than offset by a decrease in equity underwriting activity. M&A advisory activity remained relatively flat.

INVESTMENT BANKING NET REVENUES

        Debt underwriting revenues increased 5% to $215 million in the first quarter of 2003 as compared to $205 million in the first quarter 2002. Fixed income originations remained at robust levels as low interest rates and the narrowing of credit spreads caused corporations to accelerate their financing activity, particularly ahead of a possible war with Iraq. Investment grade underwriting activity was particularly strong, with market volumes increasing 24% from the first quarter of 2002, as issuers took advantage of a 30 basis point tightening of credit spreads during the first quarter of 2003. (Statistics according to TFSD.)

        Equity underwriting revenues were $59 million in the first quarter of 2003, down 64% from the first quarter of 2002. The decrease in equity origination was due to the continued weakness in the global equity markets,

24

as industry-wide volumes dropped to their lowest quarterly levels in seven years. Industry-wide global equity market volumes decreased 54% during the first quarter of 2003 as compared to the first quarter of 2002, with particular weakness in the IPO sector as corporations delayed deals amid the slumping equity markets. (Statistics according to TFSD.)

        M&A advisory fees were essentially flat for the first quarter of 2003 as compared to the first quarter of 2002. M&A activity continued to be hampered by lackluster economic data and geopolitical concerns, resulting in market volume for completed transactions in the first quarter of 2003 at its lowest in over five years.

        Investment Banking pre-tax earnings of $60 million in the first quarter of 2003 decreased 49% from $118 million in the first quarter of 2002, as a 20% decrease in net revenues was only partially offset by a 10% decrease in non-interest expenses. The decrease in non-interest expenses primarily reflected reduced compensation and benefits associated with lower revenue levels and reduced headcount. Nonpersonnel expenses were down slightly as compared to the first quarter of 2002 as the Company continued to focus on minimizing discretionary spending in the current market environment.

        Capital Markets    This segment's earnings reflect institutional customer flow activities and secondary trading and financing activities related to fixed income and equity products. These products include a wide range of cash, derivative, secured financing and structured instruments. This segment also includes the Company's risk arbitrage business, as well as realized and unrealized gains and losses related to the Company's private equity investments.

CAPITAL MARKETS NET REVENUES

        Capital Markets net revenues were $1,167 million for the first quarter of 2003, an increase of 23% from the first quarter of 2002, reflecting record performance in fixed income but continued weakness in equities. Institutional customer flow activity was concentrated in high quality fixed income products, as investors continued to seek out more defensive asset classes in the current global economic environment, which continues to be hampered by geopolitical concerns, rising fuel costs and lackluster economic data.

        The fixed income component of Capital Markets in the first quarter of 2003 realized a second consecutive quarter of record results as net revenues increased 31% from the first quarter of 2002 and 22% from the fourth quarter of 2002. The increase was principally driven by a strong level of institutional customer flow activity, as historically low interest rates and narrowing credit spreads contributed to increased trading activity and revenues from interest rate, high grade, high yield and mortgage products. Revenues from the mortgage business continued to be bolstered by a strong volume of refinancings and heavy investor demand for secondary products. Credit and interest rate derivative products were also strong as investors sought to diversify and hedge their risks.

        Net revenues from the equities component of Capital Markets were $276 million in the first quarter of 2003, up 5% from first quarter of 2002. Favorable performance in convertible and derivative products contributed to the increase in revenues (convertible bonds, a more defensive asset class, benefited from tightening credit spreads and higher secondary trading activity resulting from strong new issuance activity). In addition,

25

equity capital markets revenues improved as revenues on private equity investments were relatively flat in 2003 versus losses in 2002. Offsetting these results were reduced performance in cash products, which were negatively impacted by declining global equity market valuations and reduced trading volumes. Despite the reduced volume, the Company continued to increase its secondary market share in both listed and NASDAQ securities to 7.3% and 3.8%, respectively, from 6.6% and 3.7% in the first quarter of 2002.

        Capital Markets pre-tax earnings of $342 million in the first quarter of 2003 increased 24% from pre-tax earnings of $276 million in the first quarter of 2002, driven by a 23% increase in net revenues. Capital Markets non-interest expenses increased 23% during the first quarter of 2003 to $825 million from $669 million in the first quarter of 2002, primarily due to an increase in compensation and benefits expense associated with the increase in net revenues coupled with an increase in nonpersonnel expenses, particularly occupancy costs associated with the Company's new corporate headquarters and technology spending to enhance the Company's trading platforms and technology infrastructure.

        Interest and Dividends    The Company evaluates the performance of its Capital Markets business revenues in the aggregate, including Principal transactions, Commissions and net interest. Substantially all of the Company's net interest is allocated to its Capital Markets segment. Decisions relating to these activities are based on an overall review of aggregate revenues, which includes an assessment of the potential gain or loss associated with a transaction, including associated commissions, and the interest revenue and expense associated with financing or hedging the Company's positions; therefore caution should be utilized when analyzing revenue categories individually.

        Interest and dividend revenues for Capital Markets businesses decreased by 7% from the first quarter of 2002, while interest expense decreased by 9% over this same period, reflecting the decline in interest rates from the previous year's first quarter of 2002. Net interest revenue increased 13% to $295 million in the first quarter of 2003, benefiting from the steepening yield curve environment, which reduced short-term financing costs, coupled with a change in inventory mix to higher levels of interest-bearing assets and lower equity inventory levels.

        Client Services    Client Services net revenues reflect earnings from the Company's Private Client and Private Equity businesses. Private Client net revenues reflect the Company's high-net-worth retail customer flow activities as well as asset management fees. Private Equity net revenues include the management and incentive fees earned in the Company's role as general partner for thirty-three private equity partnerships.

        Client Services net revenues were $178 million in the first quarter of 2003, compared to $202 million in the first quarter of 2002. Private Client net revenues decreased 10% to $172 million in the first quarter of 2003 from the first quarter of 2002, as economic and geopolitical uncertainties led to reduced levels of equity activities by clients. However, customer flow in fixed income products reached record levels, as customers remained invested through re-positioning their portfolios into more defensive asset classes.

CLIENT SERVICES NET REVENUES

        Private Equity net revenues declined by $5 million in the first quarter of 2003 from the first quarter of 2002 primarily due to a decrease in management fees as the commitment period expired on two of the Company's funds.

        Client Services pre-tax earnings of $35 million decreased 24% in the first quarter of 2003 from $46 million in the first quarter of 2002 as a 12% decrease in net revenues was partially offset by a decrease in non-

26

interest expenses. Non-interest expenses decreased 8% to $143 million in the first quarter of 2003 as compared to $156 million in the first quarter of 2002, primarily due to a decrease in compensation expenses as a result of a decline in average headcount from the previous year's first quarter.

Liquidity, Funding and Capital Resources

        Liquidity Risk Management    Liquidity and liquidity management are of paramount importance to the Company, providing a framework which seeks to ensure that the Company maintains sufficient liquid financial resources to continually fund its balance sheet and meet all of its funding obligations in all market environments. The Company's liquidity management philosophy incorporates the following principles:

•

Liquidity providers are credit and market sensitive and quick to react to any perceived market or firm specific risks. Consequently, firms must be in a state of constant liquidity readiness.



•

During a liquidity event, certain secured lenders will require higher quality collateral, resulting in a lower availability of secured funding for "hard to fund" asset classes. Firms must therefore not overestimate the availability of secured financing, and must fully integrate their secured and unsecured funding strategies.



•

Firms should not rely on asset sales to generate cash or believe that they can increase unsecured borrowings or funding efficiencies in a liquidity crisis.



•

A firm's legal entity structure may constrain liquidity. Regulatory requirements can restrict the flow of funds between regulated and unregulated group entities and this should be explicitly accounted for in liquidity planning.

        The Company's Funding Framework incorporates the above principles and seeks to mitigate liquidity risk by helping to ensure that the Company maintains sufficient funding resources to withstand a severe liquidity event, including:

•

Sufficient cash capital (i.e., liabilities with remaining maturities of over one year) to fund: 1) secured funding "haircuts," (i.e., the difference between the market value of the available inventory and the estimated value of cash that would be advanced to the Company by counterparties against that inventory in a stress environment), 2) less liquid assets (including fixed assets, goodwill, deferred taxes and prepaid assets), 3) operational cash at banks and unpledged assets regardless of collateral quality and 4) anticipated draws of unfunded commitments.



•

Sufficient "Reliable Secured Funding" capacity to fund the Company's liquid inventory on a secured basis.



•

Sufficient liquidity to withstand a liquidity event characterized by:

The Company's inability to issue any unsecured short-term and long-term debt for one year.

Haircut widening for secured funding.

Funding requirements resulting from a credit rating downgrade (e.g., the increased collateral requirements for over-the-counter derivative transactions).

27

        To provide liquidity to Holdings during periods of adverse market conditions, the Company maintains a portfolio of cash and unencumbered liquid assets, comprised primarily of U.S. Government and agency obligations, investment grade securities and listed equities, which can be sold or pledged to provide liquidity to Holdings, where most of the unsecured debt is issued.

        As of February 28, 2003, the estimated pledge value of this portfolio, along with the undrawn portion of Holdings' committed credit facility (see "Credit Facilities" below) amounted to approximately $16.7 billion. Cash and unencumbered liquid assets that are presumed to be "trapped" in a regulated entity or required for operational purposes, and are therefore not seen as a completely reliable source of cash to repay maturing unsecured debt in a liquidity stress event, are not included in this portfolio.

        For further discussion of these principles refer to the Liquidity, Funding and Capital Resources section of Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated by reference in the Form 10-K.

        Total Capital    The Company's Total Capital (defined as long-term debt, preferred securities subject to mandatory redemption and stockholders' equity) increased 6% to $51.1 billion at February 28, 2003, compared to $48.3 billion at November 30, 2002. The Company believes total capital is useful to investors as a measure of the Company's financial strength. The increase in Total Capital resulted from a net increase in long-term debt as well as an increase in equity from the retention of earnings.

        During the first quarter of 2003, the Company issued $3,746 million in long-term debt securities, which was $1,613 million in excess of maturing debt securities. The Company issued debt in advance of future maturities in order to take advantage of the current interest rate environment. The Company had $2,130 million of senior notes and $3 million of subordinated notes mature during the three months ended February 28, 2003. Long-term debt increased to $41.2 billion at February 28, 2003 from $38.7 billion at November 30, 2002, with a weighted-average maturity of 4.1 years at February 28, 2003 and 4.0 years at November 30, 2002.

        Credit Facilities    Holdings maintains a Revolving Credit Agreement (the "Credit Agreement") with a syndicate of banks. Under the Credit Agreement, the banks have committed to provide up to $1 billion through April 2005. The Credit Agreement contains covenants that require, among other things, that the Company maintain a specified level of tangible net worth. The Company views the Credit Agreement as

28

one of its many sources of liquidity available through its funding framework, and as such the Company utilizes this liquidity for general business purposes from time to time.

        The Company also maintains a backstop $750 million Committed Securities Repurchase Facility (the "Facility") for Lehman Brothers International (Europe) ("LBIE"), the Company's major operating entity in Europe. The Facility provides secured multi-currency financing for a broad range of collateral types. Under the terms of the Facility, the bank group has agreed to provide funding for up to one year on a secured basis. Any loans outstanding on the commitment termination date may be extended for up to an additional year at the option of LBIE. The Facility contains covenants which require, among other things, that LBIE maintain specified levels of tangible net worth. This commitment expires at the end of October 2003.

        There were no borrowings outstanding under either the Credit Agreement or the Facility at February 28, 2003. The Company has maintained compliance with the applicable covenants for both the Credit Agreement and the Facility at all times.

        Balance Sheet and Financial Leverage    The Company's balance sheet consists primarily of cash and cash equivalents, securities and other financial instruments owned, and collateralized financing agreements. The liquid nature of these assets provides the Company with flexibility in financing and managing its business. The majority of these assets are funded on a secured basis through collateralized financing agreements.

        The Company's total assets increased to $268 billion at February 28, 2003 from $260 billion at November 30, 2002. Total assets excluding matched book ("net balance sheet") were $174 billion at February 28, 2003, an increase of 5% as compared to $166 billion at November 30, 2002. Matched book represents the lesser of securities purchased under agreements to resell ("reverse repos") and securities sold under agreements to repurchase ("repos"). The Company believes that net balance sheet is a more meaningful measure to evaluate balance sheet usage when comparing companies in the securities industry because such assets are considered to have a low risk profile. The Company utilizes its net balance sheet primarily to carry inventory necessary to facilitate customer flow activities. As such, the Company's mix of net assets is subject to change depending principally upon customer demand. In addition, due to the nature of the Company's customer flow activities and based upon the Company's business outlook, the overall size of the Company's balance sheet fluctuates from time to time and, at specific points in time, may be higher than the fiscal year-end or quarter-end amounts.

        The increase of $8 billion in both the Company's gross and net assets at February 28, 2003 was primarily due to an increase in fixed income inventory and securities borrowed associated with customer flow activity. Mortgage and mortgage-backed securities inventory increased by approximately $4.7 billion principally due to higher assets associated with securitization activities resulting from high levels of mortgage refinancings.

        Balance sheet leverage ratios are one measure used to evaluate the capital adequacy of a company. Leverage ratios are calculated as total assets divided by stockholders' equity. The Company considers total stockholders' equity plus preferred securities subject to mandatory redemption to be a better measure of the Company's equity for purposes of calculating leverage because such preferred securities have the characteristics of equity as they are of a long-term nature and are subordinated to the Company's long-term debt obligations. (See Note 7 to the 2002 Consolidated Financial Statements incorporated by reference in the Form 10-K). Accordingly, the Company believes that net leverage (i.e., net balance sheet divided by preferred securities subject to mandatory redemption and total stockholders' equity) is useful to investors as a more meaningful measure of the Company's leverage and for comparing companies in the securities industry. The Company's gross leverage ratios were 29.3x and 29.1x as of February 28, 2003 and November 30, 2002, respectively. The Company's net leverage ratios for these periods were 17.6x and 17.2x, respectively. Consistent with maintaining a single A credit rating, the Company targets a net leverage ratio of under 20.0x. The Company continues to operate below this level.

29

Credit Ratings

        The Company, like other companies in the securities industry, relies on external sources to finance a significant portion of its day-to-day operations. The cost and availability of unsecured financing generally are dependent on the Company's short-term and long-term credit ratings. Factors that may be significant to the determination of the Company's credit ratings or otherwise affect the ability of the Company to raise short-term and long-term financing include its profit margin, its earnings trend and volatility, its cash liquidity and liquidity management, its capital structure, its risk level and risk management, its geographic and business diversification, and its relative positions in the markets in which it operates. A deterioration in any of the previously mentioned factors or combination of these factors may lead rating agencies to downgrade the credit ratings of the Company, thereby increasing the cost to the Company of, or possibly limiting the access of the Company to, certain types of unsecured financings. In addition, the Company's debt ratings can impact certain capital markets revenues, particularly in those businesses where longer-term counterparty performance is critical, such as over-the-counter derivative transactions, including credit derivatives and interest rate swaps. As of February 28, 2003, the short- and long-term debt ratings of Holdings and LBI were as follows: