One foot in the Bear trap: Part 2, all better now?
[Continued from yesterday’s Part 1.]
Symbols of fidelity and chastity abound
Yesterday’s post covered the basics of the JP Morgan Chase/ Bear Stearns shotgun wedding, and the sudden discovery that JP Morgan had paid over the dowry before the vows were exchanged. Thus, as reported in The New York Times, Morgan had to boost its price, and that set off a chain reaction of renegotiations:
JPMorgan was also in negotiations with the Fed on Sunday to assume the first $1 billion in losses on Bear assets before the Fed’s $30 billion cushion kicks in. However, the Fed may now be seeking to raise that number.
‘Right,’ we can imagine the Fed saying. ‘You’re using our credit to buy Bear Stearns on the cheap, and in your haste to get it, you overlooked an elementary precaution, the extrication from which has caused you to quintuple the price.’
As CNN put it:
Also complicating matters for a rival bidder is the Fed. Regulators have gone out on a limb, politically, to make this deal happen, including a $30 billion guarantee to help finance it. The New York Times reported earlier Monday that the Fed wasn’t happy with a higher price for Bear Stearns stockholders because it wanted to avoid being seen as having bailed out equity holders with taxpayer money.
Continues the Fed, in our imagined scene, ‘Look, you morons, we just put our necks right on the chopping block, and you’re the private beneficiary, and you just did something so monumentally blockheaded? Do you realize that in backing you, who at this instant look like idiots, we look like idiots too?‘
‘We’ll fix it,” says Mr. Dimon, grimly.
To placate regulators, JPMorgan agreed to take on the first $1 billion of losses from Bear Stearns’ bond portfolio - a move that likely eased Fed worries.
It’s a fundamental principle of good hard-debt lending that the originator takes first loss – because the originator or sponsor has more knowledge before the event, and more control after it. The $1 billion of cushion not only makes the Fed’s position way safer, it effectively doubles JP Morgan’s exposure, because the stock purchase will cost about $1.18 billion.
‘There’s a silver lining, sir,’ says the imagined Wachtell lawyer, wringing his bristle-board binder in his hands.’
It also presents another hurdle for potential bidders.
‘You mean,’ replies Mr. Dimon, ‘that nobody else will make a One-L mistake and get their asses in a sling like we just did?’
The Fed, in a statement, said it would set up a limited liability company to control $30 billion worth of Bear Stearns assets. Those assets, in turn, will be pledged as collateral for the Fed’s guarantee, now valued at $29 billion.
‘All right,’ says Mr. Dimon when he is no longer apoplectic – and he being a very shrewd and experienced trader, that probably took him all of ten seconds – ‘you had damn well better make certain that we are not getting whipsawed again, do you hear me?‘
What’s more, the structure of the revised merger agreement suggests it’s unlikely that JPMorgan would sweeten the pot yet again. The new pact calls for JPMorgan to buy 95 million Bear Stearns shares at $10 apiece within two weeks. That will give JPMorgan a nearly 40% stake in Bear before shareholders vote on the deal.
If it’s still a bargain at $10 a share, if you’re still on the hook for 100% of Bear’s trades, why stop at 39.5%?
In an unusual move, Bear’s board was seeking to authorize the sale of 39.5% of the firm to JPMorgan in an effort to move closer to majority shareholder approval. Under state law in
‘Forty percent, sir,’ says the by-now-thoroughly-miserable lawyer, ‘is as much as we can get without going to the shareholders.’
Mr. Dimon glares at him. ‘A third of whom are Bear employees who already hate us, and another 10% of which is a rogue British billionaire.’
[Joe] Lewis, the billionaire currency trader, […] is Bear’s second-biggest shareholder. Lewis had called the deal “derisory” and, in a regulatory filing last week, vowed that he and other members of his group would “take whatever action that they deem necessary and appropriate to protect the value of their investment in the shares.”
‘Then get the directors’ votes as well!’
If Bear’s board sells JPMorgan 39.5% of the firm, as it was attempting to do on Sunday night, that would leave JPMorgan needing only slightly more than 10.5% of shareholder support to complete the transaction. And the individuals on Bear’s board, who were supportive of the deal on Sunday night, own a total of about 5% of outstanding shares.
The $1 billion first-loss guarantee, the 39.5% + 5.0%, and the sidelining of management, all add up to a likely closure:
Bear’s directors have agreed to vote in favor of the deal as well, throwing cold water on the notion that Jimmy Cayne, the bank’s chairman and former CEO, might put together a rival bid.
‘Now, sir, you need to speak to the markets. Statesmanlike, sir, that’s the ticket.’
“We believe the amended terms are fair to all sides and reflect the value and risks of the Bear Stearns franchise,” Dimon said in Monday’s press release, “and bring more certainty for our respective shareholders, clients, and the marketplace.”
Or maybe not. Some investors are betting that we haven’t heard the last from Lewis. Bear Stearns shares doubled in heavy trading Monday, to $12 each, showing that some on Wall Street believe even the revised deal isn’t high enough.
I love markets because they’re so cynical, they put Michael Corleone to shame. Having gouged JP Morgan Chase for a 5x on its bid, and a 10x on its exposure, they’re betting it will go to 11:
So what accounts for the 20% premium that Bear Stearns shares were fetching midday Monday? Perhaps traders have observed that speculating on a better buyout price worked once - so why not try it again?
“Who knows exactly what it is that’s causing it,” Paul Hickey at Bespoke Investment Group in
Personally, I think it’ll close at $10. Not everybody in Bear has to sell, and those who stay in may be betting that the post-Morgan Bear will roar again. Some people will sell:
Further adding to the mix is the hefty short position in Bear Stearns, which Hickey estimated at 20% as of Monday morning. Investors who have been betting the shares would fall will be inclined to buy the stock Monday to close out those trades now that it’s clear what the stock might be worth.
Out of all this roller-coaster ride, who loses and who wins?
Losers are holders of Bear common stock – the largest chunk of whom are Bear’s employees.
Winners include JP Morgan/ Chase – probably – because even $10 a share looks like a fire-sale bargain relative to Bear’s price as recently as three months ago. Tort lawyers are likely winners too, as the collapse of Bear’s share price, and the very nasty negotiations over the last few days, will offer a fertile documentary and communication trail to uncover, imagine, or impute impropriety.
Interested bystanders are all of us taxpayers, and beyond us, the global economy.
My spidey-sense is starting to tingle that we’re at the bottom of the credit gridlock. As I posted on Monday, Ben Bernanke’s Big Bet on Value may do its job of both backstopping the capital markets and also creating a value point under which liquidity will once again flow.
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