J.P. Morgan Rescues Bear Stearns
U.S. Pushed Deal
To Avert Crisis;
A Fire-Sale Price
By DENNIS K. BERMAN, SUSANNE CRAIG and KATE KELLY
March 17, 2008
Bear Stearns Cos. reached an agreement to sell itself to J.P. Morgan Chase & Co., as worries grew that failing to find a buyer for the beleaguered investment bank could cause the crisis of confidence gripping Wall Street to worsen.
The deal calls for J.P. Morgan to pay $2 a share in a stock-swap transaction, with J.P. Morgan Chase exchanging 0.05473 share of its common stock for each Bear Stearns share. Both companies' boards have approved the transaction, which values Bear Stearns at just $236 million based on the number of shares outstanding as of Feb. 16. At Friday's close, Bear Stearns's stock-market value was about $3.54 billion. It finished at $30 a share in 4 p.m. New York Stock Exchange composite trading Friday.
Effective immediately, J.P. Morgan Chase is guaranteeing the trading obligations of Bear Stearns and its subsidiaries and is providing management oversight for its operations. The deal isn't subject to any conditions, except shareholder approval. It is expected to close before the end of the second quarter.
Government regulators, including the Federal Reserve and the Office of the Comptroller of the Currency, have given their blessing to the transaction
Many well-known investors, from billionaire Joe Lewis to Bruce Sherman, the head of Legg Mason Inc.'s Private Capital Management Inc. money-management firm, have seen the value of their stakes in Bear Stearns plummet. The pain could be most acute for Bear Stearns's employees, who are steeped in a culture of personal ownership -- and hold about a third of the firm's shares outstanding.
Through the weekend, Bear Stearns bankers were summoned to the company's headquarters on New York's Madison Avenue, where they were told to prepare lists of ongoing deals and business relationships. Representatives from prospective buyers circulated through conference rooms, with J.P. Morgan executives asking questions of Bear Stearns's senior management. A separate bidding group, including J.C. Flowers & Co. and Kohlberg Kravis Roberts & Co., also was in the mix, said a person familiar with the discussions.
Bear Stearns shares, which traded as high as $170 in January 2007, fell 47% on Friday after the firm was forced to seek emergency funding from the Federal Reserve and J.P. Morgan to stay afloat amid a severe cash crunch.
One stumbling point for a sale appeared to be the amount of risk that J.P. Morgan would absorb in any type of transaction. While J.P. Morgan was eager to snap up some of Bear Stearns assets -- such as its prime brokerage business that caters to hedge funds -- Chief Executive Officer James Dimon was reluctant to pursue the deal without certain assurances that would protect his firm's exposure, said people familiar with the matter. Spokesmen for Mr. Dimon couldn't be reached yesterday.
Despite the emergency funding from J.P. Morgan and the Federal Reserve that was announced Friday and gives Bear access to cash for an initial period of 28 days, the clock is ticking on the 85-year-old firm. Late Friday, credit-ratings firms downgraded Bear Stearns to two or three levels above junk status. The downgrades also had a big impact on Bear Stearns's viability, as they severely crimped the firm's number of potential trading partners.
Regulators, bankers and investors are concerned Bear Stearns's stock could plummet even further when the stock market opens today. A continued exodus by parties with which the investment bank trades could even cause it to collapse. Still, unwinding Bear Stearns could be a nightmare because of the plethora of Wall Street firms with which it has dealings.
Analysts and investors are bracing for more bad news as securities firms report earnings this week, though Bear Stearns's results are expected to surpass the average estimate from analysts surveyed by Thomson Financial, say people familiar with the matter. A Bear spokesman declined to comment.
Meanwhile, worries are deepening that other securities firms and commercial banks might be on shaky ground. Lehman Brothers Holdings Inc. Chief Executive Richard Fuld, concerned about the markets and possible fallout from Bear Stearns's troubles, cut short a trip to India and returned home Sunday, ahead of schedule, according to people familiar with the matter. The decision came after a series of calls Saturday to both senior executives at the firm and Treasury Secretary Henry Paulson, these people say.
Investors' concerns that the flight of worried Bear Stearns customers last week might spread to other firms is likely to make for a tense opening today on Wall Street. Yesterday, Mr. Paulson said in a TV interview that the government "would do what it takes" to protect the integrity of the financial system.
On several occasions over the weekend, Mr. Paulson spoke about the Bear Stearns negotiations with Federal Reserve Chairman Ben Bernanke and New York Federal Reserve Bank President Timothy Geithner, according to people familiar with the matter.
The takeover agreement signals an abrupt and crushing end for Bear Stearns, one of Wall Street's best-known firms. Though it had survived many previous market swoons, it was savaged by the crisis in the nation's mortgage market, which began last August.
Over the weekend, some Bear Stearns employees were hoping a foreign bank would emerge as the winning suitor, since that might mean fewer job cuts than in a domestic acquisition. But those prospects dwindled, leaving J.P. Morgan in the prime position to acquire the firm.
For J.P. Morgan, a Bear Stearns deal essentially would be one of convenience. The big New York bank hadn't planned on buying a Wall Street firm. It was focusing instead on the prospect of buying a large regional bank. But people familiar with the matter said that the Bear acquisition doesn't preclude J.P. Morgan from pursuing that strategy.
One of Bear's biggest attractions for J.P. Morgan is its prime brokerage business which caters to hedge fund clients. J.P. Morgan doesn't have such a business and executives there have long said that they would like to add those operations to the bank's portfolio. J.P. Morgan has been one of the banks eyeing the prime brokerage business of Bank of America Corp. That business reportedly is on the auction block.
J.P. Morgan executives, however, are far less interested in the rest of Bear's operations, including its investment-banking unit. J.P. Morgan already has a substantial investment-banking operation with ties to many high-profile clients. Indeed, executives have scoffed at the idea that J.P. Morgan would buy a large Wall Street firm despite repeated speculation that the bank would ultimately buy a rival such as Morgan Stanley.
"Fill-ins, piecemeals, joint ventures, small purchases, where they're filling gaps, [we are] absolutely, always open, always interested. But on doing something major that would create a dramatically different landscape, not in my lifetime," Steve Black, co-head of J.P. Morgan's investment bank, said last year.
Over time, Bear Stearns's misfortune could bear fruit for J.P. Morgan. Bear Stearns's investment-banking unit, which underwrites stocks and bonds and advises on mergers, and its fixed-income and capital-markets trading businesses have been badly bruised by the credit crunch but still have some value.
Likely even more valuable are Bear Stearns's clearing unit, which settles trades and also services and lends to hedge funds, and an investment-advisory business catering to wealthy customers. Both of those operations have suffered from withdrawals in recent days.
The probable sale of Bear Stearns is the latest in the cascading mortgage-related blows that began last summer and have resulted in staggering losses and write-downs on Wall Street, the ouster of several high-profile CEOs and an epidemic of worry that the financial system faces even more turmoil.
On Friday, Bear Stearns sought and received emergency funding backed by the federal government. Both the Fed and J.P Morgan stepped in to keep Bear afloat as investors moved to pull assets out of the firm. In stepping in, the Fed was trying to move aggressively to prevent the firm's from spreading to the broader economy. The lifeline gave Bear access to cash for an initial period of 28 days -- but it was widely believed Bear would be sold within days to keep it from going under.
The Fed's unusual intervention was motivated by a concern that a rapid and disorderly failure of Bear Stearns would wreak havoc on the markets in which the firm is an intermediary, particularly the huge and important securities-repurchase, or "repo" market.
Bear Stearns risked defaulting on extensive "repo" loans, on which firms pledge securities as collateral for overnight loans from money-market funds. If that happened, other securities dealers would find their access to repo loans restricted. The pledged securities behind those loans could be dumped in a fire sale, deepening the plunge in securities prices.
As a result, one of regulators' priorities in any deal for Bear Stearns or its parts is to minimize the risk to the financial system. That suggests that they want those counterparties furthest removed from Bear Stearns itself to know immediately where they stand in any deal, and for a buyer to have sufficient financial strength to reassure those counterparties.
Bankruptcy experts said filing for bankruptcy protection wouldn't have been an attractive option for Bear Stearns, partly due to recent changes in the federal Bankruptcy Code relating to financial instruments like derivatives and repurchasing trades. Unlike most parties in bankruptcy, lenders in such transactions aren't stayed or prevented from acting to seize or control the assets involved in those deals.
"They can send you a letter saying the value of the assets is falling, so either pay us back or we will liquidate the asset," said Holly Etlin, a managing director at AlixPartners, a turnaround and business advisory firm.
Financial regulators, which had been monitoring the situation at Bear on a daily basis leading up to Friday, beefed up their presence inside the firm over the weekend. Staff from the Securities and Exchange Commission's examinations group and trading and markets division, which monitors capital levels for soundness, worked with representatives from Wall Street's self-regulator, the Financial Industry Regulatory Authority, and Federal Reserve.
The SEC and Finra staff inspected Bear's books to ensure that if customers began pulling their accounts that there was a process to unwind the positions fairly, so as to prevent additional losses.
The regulators also had staff at other firms to monitor the brokerage firm's capital level amid speculation it could face liquidity problems. A person familiar with regulators said their presence wasn't to suggest that any particular firm was in trouble, rather it was to examine whether there was enough cash on hand to deal with potential problems.
--Robin Sidel, Michael M. Phillips, Greg Ip, Gregory Zuckerman, Kara Scannell, Heidi N. Moore, Jenny Strasburg and Jeffrey McCracken contributed to this article.
Write to Kate Kelly at kate.kelly@wsj.com1
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