Monday, 17 March 2008

Bear Stearns Gives Itself Away

Back in August last year in "Bear Stearns - a cry for help?" I noted that we were likely to see more dramas unfolding at the company. Then just a month later in "A first look at broker's earnings" I noted:

"A buyout or even Chapter 11 is still very much a possibility for BSC."
Since then I have consistently maintained that should one of the large US brokers go belly up, Bear Stearns would be the most likely candidate. If it sounds like I'm giving you a case of I told you so, that's because I am, from Bloomberg:

JPMorgan Buys Bear Stearns for $240 Million in Fed-Backed Deal

JPMorgan Chase & Co. agreed to buy Bear Stearns Cos. for $240 million, about 90 percent less than its value last week, after a run on the company ended 85 years of independence for Wall Street's fifth-largest securities firm.

Shareholders of New York-based Bear Stearns will get stock in JPMorgan equivalent to about $2 a share, compared with $30 at the close on March 14, the two companies said in a statement today. The U.S. Federal Reserve will provide financing for the transaction, including support for as much as $30 billion of Bear Stearns's ``less-liquid assets.''

JPMorgan Chief Executive Officer Jamie Dimon bought Bear Stearns, once the biggest underwriter of U.S. mortgage bonds, for less than the value of its real estate after clients, alarmed by rumors of a cash shortage, withdrew $17 billion in two days. Faced with the prospect of bankruptcy, Bear Stearns CEO Alan Schwartz was forced to accept the deal as part of an effort by the central bank to stave off a broader market panic.

``Bear Stearns shareholders are at the short end of the stick,'' said CreditSights Inc. analyst David Hendler. ``This was done in the market's best interests. They had to get this done or they would risk runs on other companies.''

Without a resolution this weekend, the company's situation would have continued to deteriorate when markets resumed trading, according to analysts and investors. Yet the value placed on Bear Stearns, which employs about 14,000 people, raised questions about share prices for the rest of Wall Street.

``This is a serious crisis,'' said David Goldman, portfolio strategist at Asteri Capital. ``For Bear's stock price to go to effectively zero, contrary to market expectations, even at the close on Friday, tells us that something is systemically very wrong and we're at a very dangerous moment.''
I highlighted two passages above in bold. Let's deal with the second one first. The much regaled Bear Stearns building is worth more than the $240 million price tag JP Morgan paid for the whole company. So taking the building out of the equation means that Bear Stearns business was worth less than nothing. That is, they gave the business away and the building went for a discount.

The second paragraph is even more disturbing. Whilst JP Morgan paid a paltry $240 million they need up to a possible $30 billion in funding to support the nasty crap that noone wants on the BSC balance sheet. Nasty crap is my interpretation of the term "less-liquid assets"

What does this "support" from the Fed actually mean? From another Bloomberg article:

....In order to strike a deal before the opening of Tokyo trading, the Fed agreed to help JPMorgan finance up to $30 billion of Bear Stearns's ``less liquid assets.''

The Fed is in effect assuming responsibility for managing the assets, a Fed official told reporters in a conference call. The central bank will manage the positions to minimize any market strains and maximize long-term value, said the official, who spoke on condition of anonymity....

So at the end of the day, Bear Stearns was nothing more than one big liability with a nice building which JP Morgan paid $2 a share for. Meanwhile the Fed will stand behind the crappy assets that noone wants. Remember that BSC stock traded at $150 just a year ago.

This raises another question. If Bear Stearns business was worth nothing, then what is Lehman Brothers Worth? How about Merrill Lynch and god forbid the darling of Wall Street Goldman Sachs?

A lot of punditry has centered on the the issue of confidence. Once counter-party confidence is gone they say, your business can vanish into thin air just like BSC's did. However I don't buy it, these guys just totally omitted the concept of risk management from their business model.

Of course they are not the only ones. Lehman Brothers looks very shaky and if another broker falls over I believe it will be them. In addition to watching the brokers keep an eye on Washington Mutual as it is likely to be taken out or file for Chapter 11 at some point.


Glen said...

I dip me hat to ye.

Deano said...

Hi there, Ive only just stumbled across this blog and am finding it quite informative/insightful.

Can i ask you though, are the Lehman fears justified? I hear conflicting reports of people saying that are one of the more capitalised and liquid shops on walll st, yet other people are saying we will see another bear sterns. Then another angle i have heard is that it is actually a rumour propagated by hedge funds who are short Lehman.

The Fundamental Analyst said...

Hi deano,

Noone can say defintively that there will be another Bear Stearns and even if there is, noone knows whether that someone will be Lehman or anyone else.

The key issue for me is leverage and the kind of assets that they leveraged up on. Bear Sterns was leverged (assets/equity) approximately 32 times as was Carlyle Capital which also went bust in the last week.

Lehman is leveraged approximately 31 times. Other IB's have similar gearings levels. Bear Stearns was always the most likely candidate because not only was it highly ge ared but it;s business was heavily skewed towards structured products of the mortgage variety that now, noone wants. Lehman's book is not as bad but it still contains truck loads of crap.

It has since come to light that JP Morgan will take on substantial losses at the outset by taking on Bear's business, even with a $30 billion backstop from the Fed. Add to that that the BSC building is worth approximately $1.5 billion and you can see this company was just one big liability waiting to explode.

The fact that the Federal Reserve is now engaged in corporate welfare and is allowing IB's to front up at the discount window makes it less likely that another Bear Steans will happen.

However if we see another bout of fear, IMO if there is to be a run on another IB such as we saw with Bear, Lehman is the most likely candidate.