We contacted the DealBreaker energy trading desk this afternoon for a report on the state of the market, but the celtic tigers who are supposed to watch that market for us were already out getting drunk for Saint Patrick’s Day.
We rifled through the desk anyway, and came up with a few notes on what we think was supposed to be a report on the state of the market today. “Still haunted by the sudden loss of liquidity when Enron collpased, the nation’s energy markets remained stable with normal volumes Monday but traders admitted they are waiting for bad news from the financial sector which rescued it post-Enron,” the note said. At least that’s what we think it said. It was hard to tell because the page was stained with beer.
When we checked the screens we saw that April NYMEX gas futures contract had dropped like a rock. We called up and asked about it.
“Is this related to Bear Stearns? Is it because they’re selling off their energy portfolio?” we shouted trying to make ourselves heard above the din of the midtown dive.
“Get a life Carney. Not everything that happens today has to be because of Bear Stearns! Nobody thinks the price drops are related to BSC. When are you coming out and getting drunk?” our covert energy reporter said.
Soon, we answered. But the phone had already gone dead. And then we decided we’d attach a Bear Stearns tag to this post anyway.
Bear Stearns
Angry Bear Stearns shareholders and class-action lawyers eager to represent them in the inevitable lawsuits of Bear’s sale to JP Morgan Chase are already sounding off against the deal. As soon as the deal was announced, a Bear Stearns investor asked JP Morgan executives “Why is this better for shareholders of Bear Stearns than a Chapter 11 filing?”
In the eyes of many on Wall Street, the answer is obvious. In the first place, they see Bear’s investors as risk-takers who deserve to bear the brunt of the collapse of the company. The enormous trading volume on Friday suggests that many of the investors of those currently holding shares of Bear Stearns bought the stock after news of trouble spread last week.
What’s more, the deal is seen as an important effort to stop a ripple effect from bringing down other financial institutions. It extends the guarantee of JP Morgan over Bear Stearns’s trading positions, giving Bear clients and counterparties the reassurance of a backstop in JP Morgan’s balance sheet. The Fed was desperate to avoid a bankruptcy, according to many reports, and actively encouraged Bear Stearns to accept this deal. In a statement, Bear Stearns Chief Executive Alan Schwartz said the deal “represents the best outcome for all of our constituencies based upon the current circumstances.”
That’s a strange way of looking at a deal for a Delaware company, Gordon Smith points out. After the jump, find out why.
Lehman Brothers led the pack of financial stocks downward this morning, falling to six-year low as investors speculated that the firm might be vulnerable to a run-on-the bank similar to the one that brought down Bear Stearns. This worry continues despite Lehman having announced a new 3-year credit facility of $2 billion dollars and the Federal Reserve opening up the discount window to brokerages houses, a move many regard as specifically aimed at providing liquidity to avoid the fears that fueled the collapse of Bear.
But the pressure on Lehman’s stock continues. Lehman is leveraged more heavily than its Wall Street peers and it is a major player in the mortgage market, the source of much of the pain for Bear Stearns. It recently completed a round of 10% across-the-board layoffs, a move intended to show capital markets that the bank is serious about improving efficiency and cutting costs.
Lehman has yet to report any truly bad news . Its write-offs on the last two quarters of 2007 added up to about $1.6 billion, far below the write-off numbers of some of its peers. But this has ironically fueled market fears—many wonder if Lehman has more exposure than it has let on. Lehman chief executive Dick Fuld has attempted to reassure investors and employees. But the Wall Street Journal’s headline—Lehman Says Liquidity Is Fine—only served to remind investors of similar assurances from Bear last week.
More after the jump.
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Bear Stearns
Why JP Morgan Did It
Leverage Loans and Client Exposure To Shaky Financial Instruments Held By Bear Gave JP Morgan Strong Incentives To Rescue Bear’s Portfolio
By Bess Levin Bankers at JP Morgan Chase sounded very confident that their shareholders would approve the deal to buy Bear Stearns. Speaking on a conference call with analysts and investors, JP Morgan chief financial officer Michael Cavanaugh repeatedly told questioners that he believed the deal would benefit JP Morgan and meet with shareholder approval. Clearly the low price—and lack of other bidders who could secure the kind of fire-proof financing from the Federal Reserve—encouraged JP Morgan to do the deal. But the price to JP Morgan far exceeds the purchase price thanks to the guarantee extended to Bear Stearns counterparties and clients. Last night, JP Morgan estimated deal costs could reach $6 billion.
Sources close to the deal say JP Morgan found the deal—even at that elevated cost—attractive in part because the potential fall-out from a Bear Stearns bankruptcy would have had a serious negative impact of JP Morgan’s balance sheet, both through its direct exposure to leveraged loans, mortgages and mortgage based securities and through exposure of JP Morgan clients who are counterparties in Bear Stearns positions.
A fire-sale of Bear Stearns assets—or a lock-up of the assets in bankruptcy proceedings—would have seriously damaged JP Morgan’s balance sheets and those of its clients. Many clients have direct exposure to Bear Stearns through various trades, and a bankruptcy would have forced them to cut-back elsewhere—including deals in which JP Morgan seeks to participate. JP Morgan holds hundreds of millions in leveraged loans and loan commitments, which may have suffered if a Bear Stearns bankruptcy had worsened the credit crunch. Exact numbers, or even estimated losses, were not made available to DealBreaker.
“People compare this to JP Morgan himself bailing out the NYSE, and that’s exactly right. It’s just that both are different than people think. Neither was a work of charity. It was self-interest all the way,” said a senior banker close to the deal.
“People who want to call this a bailout should think about how the ripples from Bear going under could have become a rogue wave flooding places with leveraged balance sheets, even those as well-situated as JP Morgan,” another banker who was working Sunday night said.
The market seemed to appreciate that this deal lowers “ripple effect” risk to JP Morgan, sending shares higher. The move surprised many market-watchers. The share price of buyers typically moves down after a major M&A deal is announced. Here, however, investors seem to understand the logic behind this as a risk-averting deal.
The barely above nothing per share price JP Morgan Chase agreed to pay to acquire Bear Stearns has many questioning whether Bear Stearns owns its headquarters at 383 Madison avenue. The soaring skyscraper on prime midtown real estate occupies about 1.1 million square feet on 45 floors. It was selected in 2001 as one of the best new skyscrapers by an industry group. It cost upward of $280 million to build and, despite recent pressure in global real-estate markets, is presumably still worth more than the $236 million price tag JP Morgan agreed to pay.
This has led some, including an analyst on the conference call hosted by JP Morgan last night, to ask whether or not Bear Stearns owns this building. The answer is a bit complicated. In its 10K for 2007, Bear said it had entered into a “synthetic lease” arrangement for 383 Madison Avenue, under which it is obliged to make lease payments based on the lessors underlying interest costs. Companies put synthetic leases in place for accounting and tax reasons. They are meant to allow a company to achieve the tax benefits of ownership without the accounting burdens of ownership. Companies are allowed to treat payments made under synthetic leases as operating costs, which reduce corporate taxes they pay. The terms of the lease typically allow them to also achieve the tax savings of ownership through reduced payments
But because Bear Stearns retains an option to repurchase at the end of the term of the lease, for practical purposes it retains many of the benefits of ownership. It stands to eventually capture the appreciation in the value of the building. So although the building is considered “off balance sheet” for accounting purposes, Bear likely retains much of what is considered “owernship” of the building. In 2007, Bear Stearns said the maximum residual value of the option to purchase was approximately $570 million.
Effectively, this means that Bear Stearns was sold JP Morgan Chase for less than the value of its real estate assets. This negative valuation, in turn, suggests JP Morgan is accepting huge liabilities from Bear.
Update: Choire Sicha points out that the Federal Reserve claims the building is worth $1.2 billion. He thinks that’s a low-ball estimate. “And it’s gotta be worth more. The MetLife building sold for $1.72 billion in 2005; 666 Fifth Avenue was bought (for better or for worse!) at the end of 2006 for $1.8 billion,” he says.
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Bear Stearns
JP Morgan Agees To Buy Bear Stearns In Stock Deal
Deal Values Bear Stearns At $2 Per Share
By Bess Levin J.P. Morgan Chase has agreed to buy Bear Stearns for $2 a share in an all stock deal. Bear Stearns shareholders will get 0.05473 shares of J.P. Morgan in exchange for their shares, which puts a value of $236 million on Bear. The boards of directors of both companies have approved the transaction.
Update: Articles up at the Wall Street Journal and the New York Times.
Update II: JP Morgan Chase is having a conference call at 8 PM to review the acquisition of Bear Stearns. Call (800) 214-0745 (domestic) / (719) 457-0700 (international), with the access code 614424, or listen via live audio webcast. Thanks to Mr. Pink for the details.
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