Posted tagged ‘JPM’

A Recounting of Recent History

July 28, 2009

Yes, I’m alive! I’m terribly sorry for the extended silence, but I’ve had some big changes going on in my personal life and have been out of the loop for a while (honestly, my feed reader needs to start reading itself–I have over 1,000 unread posts when looking at just 4 financial feeds). So, here’s what I haven’t had a chance to post…

1. I totally missed the most recent trainwreck of a P.R. move at Citi. There is so much crap going on around Citi… I really intend to write a post that is essentially a linkfest of Citi material that stitches together the narrative of how Citi got into this mess and how Citi continues to do itself no favors. There was also a completely vapid opinion piece from Charlie Gasperino that said absolutely nothing new, save for one sentence, and then ended with a ridiculous comparison that was clearly meant to generate links. I’m not even going to link to it… It was on the Daily Beast, if you must find it.

2. I haven’t really had the opportunity to comment on the Obama administration’s overhaul of the financial regulatory apparatus. Honestly, it sucks. It doesn’t do much and gives too much power to the Fed. You’d think that after that recent scandal within the ranks of the Fed there would be a political issue with giving it more power. Even more interestingly, all other major initiatives from the Obama administration have been drafted by congress. Here, the white paper came from the Whitehouse itself. That won’t do too much to quiet the critics who are claiming that the Whitehouse is too close to Wall St. Honestly, if one is to use actions instead of words to measure one’s intentions, then it’s hard to point to any evidence that the Obama administration isn’t in the bag for the financial services industry.

3. The Obama administration did an admirable job with G.M. and Chrysler. They were both pulled through bankruptcy, courts affirmed the actions, and there was a minimal disruption in their businesses. Stakeholders were brought to the table, people standing to lose from the bankruptcy, the same people (I use that word loosely–most are institutions) who provided capital to risky enterprises, were forced to take losses, and the U.S.A. now has something it has never had: an auto industry where the U.A.W. has a stake and active interest in the companies that employ its members. Perhaps the lesson, specifically that poorly run firms that need to be saved should cause consequences for the people who caused the problems (both by providing capital and providing inadequate management), will take hold in the financial services sector too–I’m not holding my breath, though.

4. Remember this problem I wrote about? Of course not, that is one of my least popular posts! However, some of the questions are being answered. Specifically, the questions about how and when the government will get rid of its ownership stakes, and at what price, are starting to be filled in. It was rather minor news when firms started paying T.A.R.P. funds back. However, the issue of dealing with warrants the government owns was a thornier issue. Two banks have dealt with this issue–Goldman purchased the securities at a price that gives the taxpayers a 23% return on their investment and JP Morgan decided that it would forgo a negotiated purchase and forced the U.S. Treasury to auction the warrants.

On a side note: From this WSJ article linked to above, its a bit maddening to read this:

The Treasury has rejected the vast majority of valuation proposals from banks, saying the firms are undervaluing what the warrants are worth, these people said. That has prompted complaints from some top executives. [...] James Dimon raised the issue directly with Treasury Secretary Timothy Geithner, disagreeing with some of the valuation methods that the government was using to value the warrants.

(Emphasis mine.)

If I were on the other end of the line, my response would be simple: “Well, Jamie, I agree. The assumptions we use to value securities here at the U.S. government can be, well … off. So, we’ll offer you what you think is fair for the warrants if you’ll pay back the $4.4 billion subsidy we paid when we initially infused your bank with T.A.R.P. funds.” Actually, I probably would have had a meeting with all recipients about it and quoted a very high price for these warrants and declared the terms and prices non-negotiable–does anyone really think that, in the face of executive pay restrictions, these firms wouldn’t have paid whatever it would take to get out from under the governments thumb? As long as one investment banker could come up with assumptions that got the number, they would have paid it. Okay, that’s all for my aside.

5. I’m dreadfully behind on my reading… Seriously. Here’s a list of articles I haven’t yet read, but intend to…

I hope to get more time to post in the coming days. Also, I am toying with the idea of writing more frequent, much shorter posts. On the order of a paragraph where I just toss out a thought. Not really my style, but maybe it would be good. Feedback appreciated.

Citi’s Earnings: Even Cittier Than You Think

April 20, 2009

Well, Citi reported earnings this past week. And, as many of you know, there are a few reasons you’ve heard to be skeptical that this was any sort of good news. However, there are a few reasons you probably haven’t heard… (oh, and my past issues on poor disclosure are just as annoying here)

On Revenue Generation: First, here are some numbers from Citi’s earnings report and presentation, Goldman’s earnings report, and JP Morgan’s earnings report:

Revenues from 1Q09 Earnings Reports

These numbers should bother Citi shareholders. Ignoring the 1Q08 numbers, Citi–whose global business is much larger and much more diverse than it’s rivals–generates no more, if not slightly less, revenue than the domestically focused JP Morgan and much, much less than Goldman. But it gets worse. Goldman’s balance sheet was $925 billion vs. Citi’s $1.06 trillion in assets within it’s investment banking businesses, roughly 10% larger.  I’d compare JP Morgan, but they provide a shamefully small amount of information. As an entire franchise, however, Citi was able to generate their headline number: $24.8 billion in revenue, on assets of $1.822 trillion. JP Morgan, as a whole, was able to generate $26.9 billion, on assets of $2.079 trillion. JP Morgan, then is 14% larger, by assets, and generstes 8% higher revenue.

These numbers should be disconcerting to Citi, it’s no better at revenue generation than it’s rivals, despite having a larger business in higher growth, higher margin markets. Further, in an environment rife with opportunity (Goldman’s results support this view, and anecdotal support is strong), Citi was totally unable to leverage any aspect of it’s business to get standout results… and we’re only talking about revenue! Forget it’s cost issues, impairments and other charges as it disposes assets, etc.

On The Magical Disappearing Writedowns: Even more amazing is the lack of writedowns. However, this isn’t because there aren’t any. JP Morgan had writedowns of, approximately, $900 million (hard to tell, because they disclose little in the way of details). Goldman had approximately $2 billion in writedowns (half from mortgages). Citi topped these with $3.5 billion in writedowns on sub-prime alone (although they claim only $2.2 billion in writedowns, which seems inconsistent). But, that isn’t close to the whole story. Last quarter, in what I could find almost no commentary on during the last conference call and almost nothing written about in filings or press releases, Citi moved $64 billion in assets from the “Available-for-sale and non-marketable equity securities” line item to the “Held-to-maturity” line item. In fact, $10.6 billion of the $12.5 billion in Alt-A mortgage exposure is in these, non–mark-to-market accounts. There was only $500 million in writedowns on this entire portfolio, surprise! Oh, and the non–mark-to-market accounts carry prices that are 11 points higher (58% of face versus 47% of face). What other crap is hiding from the light? $16.1 billion out of $16.2 billion total in S.I.V. exposure, $5.6 billion out of $8.5 billion total in Auction Rate Securities exposure, $8.4 billion out of $9.5 billion total in “Highly Leveraged Finance Commitments,” and, seemingly, $25.8 billion out of $36.1 billion in commercial real estate (hard to tell because their numbers aren’t clear), are all sitting in accounts that are no longer subject to writedowns based on fluctuations in market value, unlike their competitors. These are mostly assets managed off the trading desk, but marked according to different rules than traded assets. If one doesn’t have to mark their assets, then having no writedowns makes sense.

On The Not-so-friendly Trend: This is a situation where, I believe, the graphs speak for themselves.

credittrendsconsumertrendsmortgagetrends

Do any of these graphs look like things have turned the corner? Honestly, these numbers don’t even look like they are decelerating! Compare this with the (relatively few) graphs provided by JP Morgan.

jpmsubprimetrendshomeequitytrendjpmprimemortgagetrend

These aren’t directly comparable, as the categories don’t correspond to one another, and JP Morgan uses the more conservative 30-day delinquent instead of Citi’s 90+-day delinquent numbers. However, JP Morgan’s portfolio’s performance seems to be leveling out and even improving (with the possible exception of “Prime Mortgages”). Clearly, the pictures being painted of the future are very different for these institutions.

On the Stuff You Know About: I’ll be honest, this business about Citi benefiting from it’s own credit deterioration was confusing. Specifically, there is more going on when Citi refers to “credit value adjustments” than just profiting from it’s own Cittieness. However, Heidi Moore, of Deal Journal fame helped set me straight on this–the other things going on are dwarfed by the benefit I just mentioned. Here’s the relevant graphic from the earnings presentation:

cva-graphic

And, via Seeking Alpha’s Transcript, the comments from Ned Kelly that accompanied this slide:

Slide five is a chart similar to one that we showed last quarter which shows the movement in corporate credit spreads since the end of 2007. During the quarter our bond spreads widened and we recorded $180 million net gain on the value of our own debt for which we’ve elected the fair value option. On our non-monoline derivative positions counterparty CDS spreads actually narrowed slightly which created a small gain on a derivative asset positions.

Our own CDS spreads widened significantly which created substantial gain on our derivative liability positions. This resulted in a $2.7 billion net mark to market gain. We’ve shown on the slide the five-year bond spreads for illustrative purposes. CVA on our own fair value debt is calculated by weighting the spread movements of the various bond tenors corresponding to the average tenors of debt maturities in our debt portfolio. The debt portfolio for which we’ve elected the fair value options is more heavily weighted towards shorter tenures.

Notice that Citi’s debt showed a small gain, but it’s derivatives saw a large gain (the additional $166 million in gains related to derivatives was due to the credit of it’s counterparties improving). Why is this? Well, notice the huge jump in Citi’s CDS spread over this time period versus cash bonds, which were relatively unchanged. Now, from Citi’s 2008 10-K:

CVA Methodology

SFAS 157 requires that Citi’s own credit risk be considered in determining the market value of any Citi liability carried at fair value. These liabilities include derivative instruments as well as debt and other liabilities for which the fair-value option was elected. The credit valuation adjustment (CVA) is recognized on the balance sheet as a reduction in the associated liability to arrive at the fair value (carrying value) of the liability.

Citi has historically used its credit spreads observed in the credit default swap (CDS) market to estimate the market value of these liabilities. Beginning in September 2008, Citi’s CDS spread and credit spreads observed in the bond market (cash spreads) diverged from each other and from their historical relationship. For example, the three-year CDS spread narrowed from 315 basis points (bps) on September 30, 2008, to 202 bps on December 31, 2008, while the three-year cash spread widened from 430 bps to 490 bps over the same time period. Due to the persistence and significance of this divergence during the fourth quarter, management determined that such a pattern may not be temporary and that using cash spreads would be more relevant to the valuation of debt instruments (whether issued as liabilities or purchased as assets). Therefore, Citi changed its method of estimating the market value of liabilities for which the fair-value option was elected to incorporate Citi’s cash spreads. (CDS spreads continue to be used to calculate the CVA for derivative positions, as described on page 92.) This change in estimation methodology resulted in a $2.5 billion pretax gain recognized in earnings in the fourth quarter of 2008.

The CVA recognized on fair-value option debt instruments was $5,446 million and $888 million as of December 31, 2008 and 2007, respectively. The pretax gain recognized due to changes in the CVA balance was $4,558 million and $888 million for 2008 and 2007, respectively.

The table below summarizes the CVA for fair-value option debt instruments, determined under each methodology as of December 31, 2008 and 2007, and the pretax gain that would have been recognized in the year then ended had each methodology been used consistently during 2008 and 2007 (in millions of dollars).

cvatable

Got all that? So, Citi, in it’s infinite wisdom, decided to change methodologies and monetize, immediately, an additional 290 bps in widening on it’s own debt. This change saw an increase in earnings of $2.5 billion prior to this quarter.  In fact, Citi saw a total of $4.5 billion in earnings from this trick in 2008. However, this widening in debt spreads was a calendar year 2008 phenomenon, and CDS lagged, hence the out-sized gain this quarter in derivatives due to FAS 157 versus debt. Amazing.

And, while we’re here, I want to dispel a myth. This accounting trick has nothing to do with reality. The claim has always been that a firm could purchase it’s debt securities at a discount and profit from that under the accounting rules, so this was a form of mark-to-market. Well, unfortunately, rating agencies view that as a technical default–S&P even has a credit rating (“SD” for selective default) for this situation. This raises your cost of borrowing (what’s to say I’ll get paid in full on future debt?) and has large credit implications. I’m very, very sure that lots of legal documents refer to collateral posting, and other negative effects if Citi is deemed in “default” by a rating agency, and this would be a form of default. This is a trick, plain and simple–in reality, distressed tender offers would cost a firm money.

The Bottom Line: Citi isn’t out of the woods. In this recent earnings report I see a lot of reasons to both worry and remain pessimistic about Citi in the near- and medium-term. If you disagree, drop me a line… I’m curious to hear from Citi defenders.

Dear Pundits: Citi isn’t Proof of Financial Supermarket Viabilty

January 17, 2009

Let’s be honest, Citi has some serious problems it has to fix. I’ve touched on many of them on this blog. But Citi’s failure is hardly an indictment of the “one stop” business model. It stands to reason that Citi is the example of how one cannot merely staple business together, allocate capital according to best returns for shareholders, and hope that a finance company can be run like a portfolio (ala G.E.).

One need only look at two competitors (and I’m sure Jamie Dimon thinks about this right before he lulls himself to sleep)–JP Morgan Chase and Citi. JP Morgan Chase has had a recent history of successful integrations, merging of businesses, stable leadership, and a cohesive corporate culture. No one at JPM sits around wondering how they can squeeze out the “other guys.” If you’re a Chase person you’re not trying to get all the JP Morgan people fired. Citi, on the other hand, has had management change after management change–each one is followed by an exodus of top, experienced executives. Guess what happens when one cobbles together a management team of people who are holdovers, new guard, and new hires… Citi! Guess what happens when no one takes the time to integrate businesses that have redundant product lines and systems, but rather let them operate all on their own… Citi!

In fact, one could be forgiven for thinking that standalone institutions are the business model in peril. Merrill, Lehman, and Bear, all pillars in the stand-alone investment bank community have disappeared from the landscape. Goldman and Morgan Stanley, the two remaining firms that were stand-alone investment banks six months ago, now include consumer banking in their business lines–much closer to the business mix of Citibank plus Salomon Brothers. Indeed, I would argue Citi’s investment bank performed like the lower tier of standalone investment banks, and ther mere existence of the consumer bank and deposit base “added in” allowed it to survive.

My theory is further bolstered by what Citi hopes to become and why. CitiCorp (Citi Corp? Citicorp?) is essentially a bank, an investment bank, and a brokerage all put together… And it’s half the size of Citi today. If that doesn’t say, we got the execution wrong but the model correct then I don’t know what does.

Oh, and don’t use BofA as a counter example… It was doing just fine on its own before swallowing Stan O’Neil’s mess whole (although the Ken Lewis negotiating tactics didn’t help). Further, Wachovia and Washington Mutual are examples for the opposite side of the equation–banks hoping to make money through capital markets operations and doing it poorly. Think of their problems as having evolved from having singularly focused, very poorly run investment banks attached to them.

The basic point: We’ve seen two financial supermarkets emerge here in the U.S. Both are still alive, and one is still profitable (The WSJ news alert shouldn’t have been “J.P. Morgan Chase’s Net Income Falls 76%” it should have been “J.P. Morgan Chase’s Net Income is Positive!”). The other’s problems are widely acknowledged as being cultural and borne of historical shortsightedness. Declaring the business model dead now would be silly.

More Bear! (Part Three)

May 30, 2008

Kate Kelly drops the finale on us today. My thoughts:

1. Why, in the name of anything or anyone, didn’t Bear use it’s leverage? No one wanted them to file. They bent Jamie Dimon over (well, $10 per share isn’t bending him over, but paying five times the original price seems to be…) when they saw an opening. Everyone fought to ensure they didn’t have to file for bankruptcy, they must have known that it would be a disaster scenario that no one wanted to see played out… so why didn’t they use that more? “Make the J.C. Flowers bid work, or find a way to match it, otherwise I’ll be filing tomorrow. I’ll fax over the preliminary bankruptcy filing in five minutes.” Why not, right? If Bear’s position could deteriorate further then they can pass some form of legal test that they did what they were also looking out for creditors… Would the Fed and U.S. Treasury Secretary let them file and throw the world into disarray? If it looked like they caused, or stopped something that could have prevented, financial market Armageddon then they would be blamed. Seems like they balked on using this tactic, and I don’t understand why.

2. Oh, yeah… where is 2,000 DJIA points coming from?

At their gloomiest, regulators believed a bankruptcy filing could stoke global fears, threatening to topple other financial institutions and to send the Dow Jones Industrial Average into a 2,000-point nose dive.

Ugh. Please, stop guessing at stupid crap. If I said 500 would that be okay? Dimensioning the problem in terms of stock market movements is stupid. Hopefully this wasn’t their actual thought process. None of the agencies involved should be setting policy or taking action to prop up the stock markets. Jeeze…

3. I’ve been told by a whole bunch of reliable people that Ken Griffin, of Citadel fame, has a brother that heads up a large group at Bear Stearns (errr… did…). If Alan Schwartz can call a Morgan Stanley banker to get some Fed help why couldn’t Bear leverage Ken’s own brother, who would be very sympathetic to Bear, to figure out their “Citadel is shorting us” problem. Maybe they didn’t know? I could be missing something, I suppose…

4. We all know that Jamie Dimon manhandled Vikram Pandit on the call. I won’t re-hash it. Seems a bit… unnecessary, but it’s an interesting statement on each man’s demeanor.

5. Okay, this amazes me…

The next day, March 21, was Good Friday. J.P. Morgan turned up the heat, telling Mr. Cohen that if Bear Stearns didn’t make the desired concessions, the bank didn’t see how it could provide funding for the brokerage to trade the following Monday. In an ugly replay of the weekend before, Bear Stearns was imperiled again.

If J.P. Morgan wouldn’t guarantee Bear Stearns’s trades on Monday, the firm would most likely have to file for bankruptcy protection.

The article isn’t specific, but weren’t they required to provide financing? Or is this not the 28-day loan? the article isn’t specific here, but I can’t imagine that if J.P. Morgan was providing funding that it wasn’t somewhere in the terms they had agreed to at some point. Something is missing, and the missing facts probably makes the above passage “kosher” … however, since it’s not there, it just seems weird that J.P. Morgan was refusing monies to Bear when it had an interest in their survival, or, perhaps, even had an obligation to fund them.

6. I anticipate many people will chime in on this…

But this time around, Bear Stearns’s business was so weak, it wasn’t eligible for a Chapter 11 reorganization filing. Instead it faced a Chapter 7 liquidation, in which a court-appointed trustee would take over the firm, likely throwing out management and launching a sale of its assets to repay debts.

Many people great legal minds have opined on how Bear could only ever file for Chapter 7 … yet there is constantly mention of Chapter 11.

7. The last few sentences are just… hoaky. Why are those in there? I don’t know.

Well.. an interesting chain of events. An interesting take on it from the WSJ. Honestly, these are the kinds of things I think allows the WSJ to add the most value. Anyone can reshash the trading day, but this is where financial sources and real reporting shines. Good job WSJ!

More Bear! (Part Two)

May 29, 2008

The next installment in the WSJ’s look at Bear’s Collapse hit today. To be honest, nothing interesting stood out. Well, except the following..

1. Why was a Moodys downgrade of Bear Stearns–branded RMBS bonds cause the stock to drop? Something there makes no sense. These are insulated from the credit of Bear Stearns itself and the bonds are issued by a SPV. Seems off, or, perhaps, smacks of normal financial journalism that takes a fact and conflates it with the cause of the markets moving on that day.

2. I have to profess not knowing a ton about prime brokerage, but it seems that if, as it normal to do, Bear provided leverage on trades for prime broker clients, they need to borrow that money and as funds fled they would be able to require repayment of those loans. Also, since most funds are loathe to keep a lot of cash, as it hurts their performance, there shouldn’t be much cash fleeing with these funds.

3. Spitzer hosed Alan Schwartz. There is Alan Schwartz, talking about how super awesome Bear Stearns is, and Spitzer’s scandal starts interrupts him from saying things like, “Bear made money this past quarter.”

4. They had their lawyer call the Fed. I guess I’m not sure why the chairman of Sullivan & Cromwell was charged with calling the Fed to talk about Bear Stearns situation. Seems very odd. And why was it that when Alan Schwartz called the Fed, he struck a less alarmist tone?

5. J.P. Morgan representatives arrived and were shocked at Bear’s books. We don’t know what that means (their liquidity position? the marks they had on their positions?) exactly. But here’s an odd thing: The JPM crew asked for the Fed–and they were already there! Setup in a conference room was the Fed, having already been there for several hours. Maybe it’s completely logical that the Fed would be there, even if they hadn’t been asked for help yet… Just seems to not jive with Alan Schwartz being cautiously optimistic earlier.’

Ok, like I warned earlier, no much to really talk about in this one…. Soon, part three! The conclusion awaits.

Amusing Financial Quoatation: Bear Stearns Shareholders

May 15, 2008

From the ever indispensable Steven Davidoff (on May 9th):

According to the latest filings with the Securities and Exchange Commission, JPMorgan now owns 49.43 percent of Bear Stearns, and so a “yes” vote to approve the combination is a virtual certainty.

I just can’t believe that 0.57 percent of Bear’s shareholders don’t vote yes for whatever reason, including just simple confusion. And the broker votes may even have the bravery to go JPMorgan’s way. Game over for Bear.

(Emphasis mine.)

Update: Some weirdness with the URL and title. Probably from editing in multiple places. Sorry.

Bear Stearns: Where We Are, Some Little Known Facts, and Opinions

March 21, 2008

Well, it looks like the dust has settled on the situation. My predictions have actually fared quite well–lawsuits, retention bonuses, brokers jumping ship, and some interesting rumblings about management seeking out new bidders.

Bloomberg even highlighted Jamie Dimon’s greenmail:

Dimon made the proposal to several hundred Bear Stearns senior managing directors at a meeting yesterday evening in the securities firm’s Manhattan headquarters, according to two people who attended. He said members of the group who are asked to stay after the acquisition is complete will get additional JPMorgan shares, according to the attendees, who asked not to be identified because the meeting was private.

Bear Stearns employees own about a third of its stock, with a large concentration in the hands of senior managing directors. Their support may help JPMorgan counter opposition from billionaire Joseph Lewis, who owns 8.4 percent of Bear Stearns and said yesterday he may seek an alternative to the bank’s proposed purchase.

“He’s basically bribing them for their votes,” said Richard Bove, an analyst at Punk Ziegel & Co., referring to Dimon’s presentation. “In this environment, there are no jobs on Wall Street, so he can bribe them by letting them keep their jobs and they’ll vote for him.”

Lots of people have opined on the merger terms and the possibilities for other bidders, and even some odd provisions that suggest no one knows the entire story yet. Everyone who reads my blog knows what I think on the obvious points. Here’s an interesting fact, too, that I haven’t seen elsewhere. From the Times Online:

A counter-offer for Bear Stearns would face a series of hurdles. Part of the JPMorgan Chase offer, which values Bear at $2 a share, includes the financial support of the Federal Reserve Bank of New York, which has underwritten $30 billion of the most toxic of Bear Stearns’s investments. The New York Fed also extended special financing to JPMorgan to cover the cost of Bear Stearns redundancies and impending litigation. Any new bidder would have to convince the central bank that it should transfer its underwriting to support a new offer.

(emphasis mine).

Wow. Talk about a sweet deal! I’m not sure what that sentence means, but I know I haven’t seen that anywhere else, so I remain skeptical, but it wouldn’t surprise me. So, with this heavy handed approach, here’s a question: Why does the Fed care so much about ensuring the specific deal they got JPM to ink goes through? In the above Deal Journal post, it’s made clear that the Fed wants this deal to go through. So, if there is another bidder out there, at a higher price, then why does it matter who gets Bear? Certainly the crisis they were talking about ha been avoided, no? Let’s examine the facts (from a myriad of sources):

  • Bear Stearns had gotten a 28 day loan, via JPM, from the Fed.
  • The Fed had decided toget Bear sold A.S.A.P., this left other bidders out, as reported by the media.
  • The Fed decided to guarantee, essentially, $30 billion in assets on Bear’s balance sheet.
  • The Fed has now decided to open up it’s discount window to securities firms, to avoid this situation in the future.

These actions seem inconsistent. Why would you force a securities firm to be bought, but then allow other to borrow at the discount window? Why would you make a 28 day loan, and then, with not much else changing, force another alternative? Why would you try to get JPM to accurately asses the value of Bear, and then, when they are unable to do so, both guarantee the most troublesome assets and allow JPM to lock in a very low bid price?

Now, I hate to be trite, but the taxpayers now own $30 billion dollars of stuff that is nearly impossible to value and, simultaneously, not going up in value (leaving only flat or down). JPM shareholders are getting roughly $1 billion in incremental earnings (I, obviously, would claim that when all is said and done that number will be lower, but that’s their number and we have no reason to believe that they don’t believe it to be accurate) for a fraction of the outlay in cash (and potentially not even the legal expenses, if indeed the above statement from The Times Online is true). And all the while, the Fed is standing guard over the gasping, bleeding body of Bear Stearns warding off further bidders? This isn’t the kind of intervention that I can honestly say sounds “above board.” To me, one either let’s Bear file for bankruptcy protection or they are bailed out–forcing a suitor onto them seems a bit weird.

Now begins the next chapter in this saga, exploring who profited from the demise of Bear and the source of the rumors that caused this whole mess.

Good News or Bad News First? (And Some Bear Links)

March 19, 2008

The good, for continuity. I spent about an hour chatting over IM with Felix Salmon and Equity Private (with a quick guest appearance by DealBreaker’s Bess Levin). It was quite an interesting time, to say the least!

The bad, now. They actually killed my post ideas. Yes, you heard me right, killed them dead. Well, it was a bit conspiratorial. I had conjectured that JPM’s option to purchase 20% of Bear at $2.00 and their “locking up” Bear’s building meant that they were happy to have someone else come in higher (earn the difference between the higher bid and $2 on 20% of Bear’s shares, and get the building). Alas, the fly in the ointment? Felix pointed out Section 6.9 of the merger agreement (Tidbit: Section 3.2 … “please provide”). I still believe that Bear’s advisory and Leveraged Finance business have value to, say, a P.E. buyer.

Well, even if it wasn’t likely, the markets must be assuming that a higher bid was likely, right? To that end, I had a post all ready! Bear closed at $5.91 today. If you assume that premium is due to a higher price, then there’s a 50/50 chance Bear get’s bought at $9.50 ($5.91 – $2.00 is approx 50% * ($9.50 – $2.00), essentially assuming the share price premium is a probability times a premium from a higher priced deal). I had all the numbers crunched. Alas, Felix has quashed that one too. I’m not 100% sure I buy the “debt holders are buying the stock” argument, but my other theories are all killed.

Unfortunately, then, I have no clever post. Although, here is one question answered.

Bear Stearns: Notes and Predictions

March 17, 2008

Wow. What a difference a day makes. Bear Stearns is now, apparently, being fire-sold for $2 a share to avoid being fire-sold for the values of it’s assets minus it’s liabilities.

I was reading the WSJ piece on the topic, and it seems like there was a lot of pressure applied by the Fed to ensure Bear got sold, with no regard for shareholders (the article states this, in essence). So counterparty risk is now secure. Great! But wouldn’t it have been better to run a real process and determine the value of the company? Wouldn’t it have been more valuable to not send the message that the “health of the financial markets” is more important than a firm’s sale occurring at their true equity value? (And aren’t both of those, taken together, a contradiction? Mis-valued assets was how this mess got started.)  So, let’s make some bold predictions! I don’t think they will all be right, but they are obviously all reasonable to me. I’ll show my hand and give the probability I ascribe to the prediction coming true, as well.

Prediction: Lots of shareholder lawsuits. K.K.R. was looking a bidding, so was J.C. Flowers, and the Fed says the deal needs to be done today, so they get crammed out. Who do you sue? Everybody of course! Hence JPM estimates $6b in costs for this transaction, first item listed–litigation. Probability: 100% (Bonus prediction: Someone notable from Bear joins in a lawsuit or files one themself! Probability: 50%)

Prediction: The price gets raised. A process wasn’t run, shareholders will demand more, and the Fed is taking $30 billion in risk. For $1 billion in accretion to earnings, and not even being in the first loss position on the toxic assets Bear is holding, why pay such a low price? This will become a problem for JPM. Keep in mind, this can be raised (the pruchase price) by having to pay out certain shareholders more than the bid price. For example, employees they wish to retain might have shares made whole at a higher level than the sale (you have 40k shares of BSC, you get $40 in JPM stock for each share if you stay, for example). Probability: 70%

Prediction: JPM will never see some of those assets add to their franchise. If the prime brokerage business really saw the kinds of outflows reported by the media (from Bear, that is) JPM could already be finding itself over-paying for that asset. And the mortgage and securitization business at Bear? Management for that business are at the top of that market in terms of knowledge and relationships–watch that business experience brain drain quickly. Probability: 70%

Prediction: Integration will be a nightmare. Culture clash will occur at many points in the process and within many businesses. JPM and Bear’s cultures aren’t compatible. Bear is a very raw environment and is very cut-throat. You’ll see this get ugly, fast. Big names on both sides will leave and power struggles will be common. Perhaps this is normal merger behavior, but it will be worse because the Bear employee have already been financially destroyed. You’ll see resentment for JPM from ex-Bear employees and silos form within the firm. It will be difficult to interact with certain parts of the firm depending on where you worked when JPM bought Bear. Ouch. Probability: 60%

Well, that’s it for now. I’m sure much more information will leak out as this deal develops. If this drags on or lots of game-changing information comes to light, I might revisit these later.


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