Bear Stearns Rating Outlook Cut on Mortgage Concern (Update6)
By Yalman Onaran
Bear Sterns Cos. headquarters Aug. 3 (Bloomberg) -- Bear Stearns Cos., the manager of two hedge funds that collapsed last month, had its credit-rating outlook cut to negative by Standard & Poor's on concern declining prices for mortgage-backed securities will reduce earnings.
Shares of Bear Stearns fell 6 percent, bringing this year's decline to more than 33 percent. The perceived risk of owning the New York-based company's bonds rose to the highest in at least six years. Chief Executive Officer James E. Cayne said in a statement today that the company was ``solidly profitable' in June and July.
Bear Stearns, whose credit rating was increased last year to A+, now may be downgraded because of the debacle in residential mortgages that began in November. Chief Financial Officer Samuel Molinaro said the fixed-income market is ``as bad as I've seen it' in 22 years. A reduction would leave Bear Stearns with the lowest credit rating of the five biggest U.S. securities firms.
``This might cause the spread on their bonds to widen further,' said Tom Jalics, an analyst at National City Bank in Cleveland who helps manage $32 billion, including Bear Stearns shares. ``The biggest concern is whether there'll be big writedowns on the balance sheet.'
The rating could fall if Bear Stearns incurs large losses, S&P said in a statement, adding that the company has enough cash and other assets to meet short-term funding requirements.
Moody's Outlook
Moody's Investors Service said the mortgage crisis doesn't have ``negative rating implications at this time.' The New York- based rival to S&P said in a statement that its stable outlook remains unchanged for the biggest banks and securities firms because it's satisfied with their risk-management policies.
Bear Stearns's debt is rated A1 by Moody's, the equivalent of S&P's A+.
Shares of the company dropped $7.28 to $108.35 in composite trading on the New York Stock Exchange at 4:47 p.m., after reaching $106.55 earlier today. Shares of Lehman Brothers Holdings Inc., the largest underwriter of mortgage-backed bonds in the U.S., fell 7.7 percent to $55.78.
The perceived risk of owning Bear Stearns's bonds soared to the highest since at least November 2001, according to credit- default swap traders who bet on creditworthiness.
Credit swaps based on $10 million of its bonds surged $35,000 to $155,000, according to broker Phoenix Partners Group in New York. An increase signals deterioration in investor confidence.
`Overplayed' Reaction
S&P analyst Scott Sprinzen said the market reaction to today's rating announcement was ``overplayed.'
``If we had such grave concerns about the prospects here, we would have cut the rating,' Sprinzen said in an interview. Only the outlook was reduced, which many times doesn't lead to a downgrade, Sprinzen said.
Bank of America analyst Michael Hecht said in a report that the hedge fund failures at Bear Stearns were ``isolated issues,' and not indicative of a wider problem at the firm.
Bear Stearns' $1 billion of 5.55 percent subordinated notes due in 2017 fell about a cent to 90.4 cents on the dollar as of 4:12 p.m. in New York, according to Trace, the bond-price reporting system of the NASD. The extra yield, or spread, investors demand to own the debt instead of similar-maturity Treasuries widened 25 basis points to 226 basis points, Trace data show. The spread has more than doubled since the beginning of June. A basis point is 0.01 percentage point.
Bond Returns
Bear Stearns bonds lost 1.09 percent on average in July, compared with a 0.29 percent return for the typical investment- grade corporate bond, according to Merrill Lynch & Co. index data.
``Credit ratings are the top priority' for a finance company, said James Lyman, who helps manage $37 billion in fixed- income at Fischer Francis Trees & Watts, a unit of BNP Paribas Investment Partners. ``If they go below A, it's a serious problem. If they get downgraded a notch it's still a problem because people start to lose faith.'
S&P said Bear Stearns has a ``relatively high degree' of reliance on the U.S. mortgage and leveraged-finance markets, and its revenue and profit would be hurt if there were an extended downturn in those businesses.
KKR Deal
A flight from risky debt since the mortgage rout began has damaged efforts to fund leveraged buyouts. Banks underwriting loans for Kohlberg Kravis Roberts & Co.'s takeover of Alliance Boots Plc today canceled the sale of $2 billion of debt after failing to find investors. The aborted sale increases the amount of debt New York-based KKR's underwriters have been left holding to $16.8 billion.
At the end of the second quarter, Bear Stearns had the smallest number of unfunded commitments among the biggest five brokers to non-investment-grade companies being bought out, according to CIBC World Markets. Bear Stearns had $2.3 billion of commitments outstanding, compared with $54 billion at Lehman and $71 billion at Goldman Sachs Group Inc.
Return on equity for the current quarter may be near the historical lows for the firm, Molinaro said on the call. It has ranged between 12 percent and 20 percent, according to Merrill Lynch & Co. analyst Guy Moszkowski. Bear Stearns's ROE was 15.6 percent in the second quarter, which ended in May.
Subprime Loans
Late payments on subprime home loans, those made to the riskiest borrowers with lower credit scores, rose in the first quarter to the highest level since 2002, according to the Mortgage Bankers Association. At least 70 mortgage companies have halted operations, gone bankrupt or sought buyers since the start of 2006, Bloomberg data show.
``I've been out here for 22 years, and this is as bad as I've seen it,' Molinaro said on a conference call with analysts. He compared the crisis to 1998, when hedge fund Long-Term Capital Management collapsed and Russia defaulted on its debt.
The Bear Stearns funds that failed, the High-Grade Structured Credit Strategies Fund and the High-Grade Structured Credit Strategies Enhanced Leverage Fund, invested in subprime mortgage-related securities. Bear Stearns loaned $1.3 billion to one of the funds after lenders demanded their money back.
Cayne called their meltdown ``a body blow of massive proportion' in an interview with the New York Times in June.
Other hedge funds have also announced losses. Macquarie Bank Ltd., Australia's largest securities firm, said earlier this week that investors in two hedge funds may lose 25 percent of their money. Boston-based hedge fund manager Sowood Capital Management LP said it lost $1.5 billion in July after declines in the corporate debt markets.
Banks, Insurers
Banks and insurers ranging from UBS AG in Zurich to CNA Financial Corp. in Chicago have reported losses related to subprime mortgage debt. UBS, the world's biggest money manager, replaced Peter Wuffli as chief executive officer in July after three quarters of declining earnings and losses at one of its hedge funds that invested in securities linked to subprime loans.
Subprime loans make up less than 3 percent of Bear Stearns's revenue, according to the company. Still, the firm is more reliant than its rivals on the U.S. markets for revenue. In the second quarter, 80 percent of Bear Stearns's revenue came from the U.S., compared with less than half for Goldman Sachs Group Inc., the largest securities firm by market value. |
