more on the BSC deal
J.P. Morgan to buy Bear Stearns for $2 a share
By Alistair Barr
Greg Morcroft
Last Updated: 3/17/2008 12:18:00 AM
NEW YORK (MarketWatch) -- J. P. Morgan Chase & Co. said Sunday evening that it is buying battered broker Bear Stearns Cos. for $236 million in a Federal Reserve-backed bailout unprecedented in scope and execution.
The Federal Reserve, which cut the discount rate in a coordinated move with its announced backing of the deal, is taking the extraordinary step of providing special financing in connection with this transaction. See full story.
The Fed has agreed to provide financing of up to $30 billion of Bear Stearns' (BSC) less liquid assets. Roughly $20 billion of that funding will back mortgage securities held by the beleaguered brokerage firm.
J.P. Morgan (JPM) will exchange 0.05473 shares of its common stock for one share of Bear Stearns stock. Both boards have approved the transaction. See full story.
The deal offers Bear investors $2 a share, a massive discount to the firm's closing price of $30 on Friday. A week ago the stock was trading above $60 and a year ago it was at more than $150. On Friday, Bear executives told analysts and investors that the firm's book value - a measure of assets minus liabilities -- was still at least $80 a share.(yes, and pigs with lipstick really DO fly! )
The destruction of billions of dollars worth of value in a matter of days shows how vulnerable even the biggest brokerage firms are to the current credit crunch. Bear's business quickly crumbled last week as counterparties and clients lost confidence and stopped trading with the firm. Since being founded in 1923, Bear managed to survive all other crises, including the Great Depression.
"During a crisis of confidence, earnings, book value and liquidity don't matter much," Prashant Bhatia, an analyst at Citigroup, wrote in a note to investors on Sunday. "Clients and counterparties vote with their money and if confidence breaks down rapid deterioration will likely follow."
There's "nothing good about current situation," the analyst added. "A crisis of confidence does not benefit any of the industry participants. No firm that is reliant on the secured funding marketplace and short term borrowings is immune to a crisis of confidence (that includes every investment bank)."
Systemic stopper
J.P. Morgan executives said during a conference call that the bank will guaranty all of Bear's trading obligations immediately. The guarantee will remain in place until the acquisition is completed in roughly 90 days, they noted.
That may reduce the risk of the broader financial system freezing up. Bear was one of the largest U.S. brokerage firms and the second-largest underwriter of mortgage-backed securities. It was also very active in derivatives markets. If a firm with this many tentacles in the markets failed to meet its obligations to a lot of counterparties, other financial-services firms could also collapse.
"The Fed obviously acted to stopper systemic risk and its actions did keep the Bear portfolio of troubled securities from being dumped on the market," Robert Brusca, chief economist at Fact and Opinion Economics, said.
Hedge fund business
If the deal goes through, J.P. Morgan will get Bear's prime brokerage business, which lends securities and money to hedge funds. Bear is the third-largest prime broker, behind Morgan Stanley (MS) and Goldman Sachs (GS).
Prime brokerage is a lucrative business, but like many of Bear's other businesses, it relies partly on the confidence of clients to keep trading with the firm. It's not clear whether some of Bear's hedge fund clients may have already moved their accounts to rivals.
"Despite recent events, the health of franchise and the prime brokerage and clearing business is in good shape," a J.P. Morgan executive said on Sunday. He didn't give any more details.
J.P. Morgan also gets Bear's investment banking business, which works with some clients that the bank doesn't advise. It also gets an equities business and a commodities unit with a focus on energy trading.
Mortgage exposures
But J.P. Morgan is also taking on some of Bear's large mortgage exposures. The troubled broker had $33 billion of mortgage-related holdings at the end of February. Roughly $2 billion of that was tied to subprime home loans, while $15 billion is backed by prime and so-called Alt-A mortgages, according to a J.P. Morgan presentation on Sunday. The rest -- $16 billion -- are commercial mortgage-backed securities.
"In doing our due diligence, that was an area we needed to get comfort on," Dimon said during the conference call on Sunday. (LOL!!!gotta love it)
About $20 billion of Bear's mortgage exposure will now be covered by the financing provided by the Federal Reserve, leaving J.P. Morgan exposed to roughly $13 billion of mortgage securities, he noted.
Bear also has about $9 billion of exposure to leveraged loans, which are used to finance leveraged buyouts, he added.
J.P. Morgan plans to "de-lever" Bear's balance sheet after the acquisition, executives at the bank said. That means assets that Bear bought, partly with borrowed money, will be sold and loans repaid with the proceeds.
Selling illiquid mortgage securities during a credit crunch could generate huge losses. J.P. Morgan said on Sunday that the deal will likely cost roughly $6 billion before taxes. That includes the impact of selling some of Bear's assets and de-leveraging the balance sheet, plus litigation and other costs.
Zero chance
The $2-a-share offer is so low that other bidders could, in theory, emerge. Earlier in the weekend, other suitors appeared to be vying for Bear Stearns, including private-equity firms J.C. Flowers & Co. and Kohlberg Kravis Roberts & Co., the Wall Street Journal reported on Sunday.
But according to one investor, other bidders are unlikely because there's so much uncertainty surrounding Bear's mortgage-related and derivatives positions.
"There's absolutely zero chance of another bidder because Bear is a huge black box," Whitney Tilson, founder of investment firm T2 Partners LLC, said.
"When a highly leverage financial institution loses the confidence and backing of the market, all its liabilities accelerate and a lot of the assets become very illiquid. No one wants to trade with you. In a matter of days that's what happened to Bear."
Other large financial institutions that might be capable of handling Bear's liabilities and restoring confidence in the markets have their own problems, Tilson noted.
Citigroup (C) is struggling with its own mortgage-related exposures and Bank of America (BAC) is trying to complete its acquisition of Countrywide Financial (CFC), a big mortgage lender that almost went bust.
J.P. Morgan is one of the few large financial institutions that is capable of trying to resuscitate Bear, partly because Dimon extricated the bank from a lot of its subprime mortgage exposures a few years ago, Tilson explained.
"That was a great move and that's the only reason he's able to buy Bear now," he said. "This deal could still be a complete disaster for J.P. Morgan, but the most likely scenario is that the bank is big and strong enough, along with the Fed's $30 billion insurance policy, to restore confidence."
J.P. Morgan, part of the Dow Jones Industrial Average, and the Federal Reserve Bank of New York announced a historic agreement early Friday that gave a liquidity-starved Bear Stearns access to the Fed's discount window. See full story.
Shares of Bear Stearns closed at $57.00 Thursday, before that agreement was announced.
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