So JP Morgan has agreed to buy Bear Stearns at $2 a share. As others have already pointed out, this is, from the point of view of the shareholders, just barely better than bankruptcy.
McArdle comment:
Bear Stearns shareholders and employees are taking a bigger hit this way then they would in bankruptcy
Posted by: Bernard Yomtov | March 17, 2008 at 01:09 PM
Ha ha ha! Watching the house of financial cards collapse around the empty heads of those too blinded by avarice to see the true nature of the system is giving me a big thrill. More, more!
Ohh, great, another banking house for McCardle to proclaim in need of bailing out.
And please please please stop with the "run on the bank" nonsense. Hedge funds decided that Bear Stearns was not a safe bet, and obviously they were right because the actual value of the company was $2 INCLUDING a $33 billion guarantee by the Fed.
That's not some fleeting crisis of confidence needing a temporary liquidity fix (which is something the credit market provides every day). It's the fact that Bear Stearns was trading vastly more assets than it was worth! Had put its money into bad investments - namely mortgages and subprime paper - that, lo and behold, were worthless.
And please please, when you hear people on the Street tell you that this was a run on a bank, that's because they don't want to admit that Bear Stearns (like, I predict Citibank) has made a lot of very bad investments because they, in fact, are 1) not very smart and 2) gambling with, it turns out, the knowledge that the Fed will bail them the hell out.
Shorter Joe Strummer: "It's not a 'run' on the bank because the fleeing investors were riding Segways."
The $2/share price, turned around within just a couple days, IMO reflects the eyeblink mechanics of the vaguely fascistic salvage operation that transpired, rather than the value of the assets.
No, it's not a run on a bank because there was no bank to run on. Bear Stearns wasn't worth anything. You're assuming that there was some value to be had. Well the $2 was only worth $2 because the Fed guaranteed it.
No, it's a bank run because a financial insitution operating on a recognizable form of a fractional reserve model had a large number of creditors pull their money out of the institution in short time period on the basis of self-fulfilling negative expectations. The fact that the negative expectations had a real and valid basis doesn't change the mechanics by which the institution collapsed.
Valuing Bear Stearns right now is very difficult, because getting a handle on the liabilities is difficult.
However a few things to note;
- They own real estate worth anywhere from $230 Million to $1 Billion
- Their Prime Brokerage business did about $465 Million in 2006, and should be worth at least $3 Billion
- Even if a lot of their mortgage assets were written down, they are currently performing
If you were just buying the real estate and prime brokerage, without any existing liabilities, you could get a price around $20 a share.
Now the difficult part is unwinding the liabilities, and understanding what the mortgage assets will actually return over the medium-term. You can't sell them today, but most of them are performing loans.
My guess is that the market is over-reacting and in the end this will be an outstanding deal for JPM.
I'm afraid I must correct some of the errors in your otherwise fine comment.
First, Bear's real estate--it's office building--has a second mortgage on it, a balloon ARM due in 2011 to the tune of $985 million.
Second, their prime brokerage business didn't do $465 million of business in in 2006, it actually lost money.
Finally, even though Bear's mortgage assets were written down, currently they actually aren't performing as expected, given that the managers of the company feel a two-dollar per share price is a proper value for the company.
The sad thing is that you don't know what you're talking about. Worse than that, you're misleading Megan's devoted readers.
Here is the segment information for the global prime brokerage segment ("Global Clearing Services")
for the years 2006 2005 2004
PRE-TAX INCOME
Global Clearing Services 464,519 471,796 349,922
Wealth Management 69,160 36,770 62,344
As you can see they earned pre-tax $465 million dollars in 2006. This is an extremely high-margin and lucrative business. I don't know where you got that they lost money.
Like every segment analysis, you then have to put in some corporate overhead. But for a bank with a pre-existing prime brokerage business, one can assume this is minor.
As for the real estate, calculating its value is complicated for tax reasons. It does not have straightforward ownership, instead it has an operating lease agreement with an option to re-purchase in 2012 (it is nothing like an Option ARM).
It does this for tax reasons, by converting ownership into an operating lease, you can deduct 100% of those payments from your operating income and reduce your tax payments. So the exercise becomes then calculating the residual value of the option in 2012, by estimating what the real estate will be worth less the residual payment to the lessor. This is complex, but it is definitely worth more than 0, and under some scenarios as much as a billion. That is why I put in a range.
The funny thing about banks, is that loans can be performing, but you can still go out of business and make a $2 share valuation reasonable in the short-term.
Imagine that Bear has loans of $800 billion, all short-term which it needs to roll-over every month.
It has assets of $1 Trillion which are long-term.
Now imagine those assets get impaired, to say $900 million in value.
Now one would say that the business still has $100 Billion in value, but if it wasn't able to get fresh loans every month for the $800 Million because lenders were worried about further writedowns in the assets, the firm could go out of business even though it has positive asset value.
Further imagine that the writedowns are not occuring because the mortgages are not paying out cashflow, but because investors feel they might not payout cashflow in the future. Because of mark-to-market accounting, you can get a writedown in asset value even if the instrument you hold is still paying out.
They you would get the very odd circumstance of a solvent company going bankrupt, despite the fact that it has performing assets and positive book value.
This is a run on the bank scenario, and what is occuring with Bear Stearns.
With all due respect, the more you write the more your ignorance shows. You obviously simply do not understand finance, i.e., "the numbers."
Let me demonstrate. First, you give these numbers: "Wealth Management 69,160 36,770 62,344."
Once again you are misleading Megan's readers. The real numbers are not 69,160 36,770 62,344. Think about it. What about EBITDA? Those are the real numbers. Don't you even know what ROACE is? Those are the real numbers. Think with your brain.
Second, I do agree somewhat with you that my charictarization of Bear's building loan as an Option ARM was somewhat incorrect. Actually, the loan they have is with WaMU and it's a 30-year fixed, with a huge prepayment penalty and an APR of 11%. That's why the company is out of business. Stupid decisions like that.
Why would you use EBITDA to measure the performance of a financial company. I.E. a company that should have almost no CAPEX? Also to claim that EBITDA is a more real number than Pre-Tax Income doesn't really make sense. EBITDA is typically considered a worse number, because most business will eventually need to spend CAPEX equal to Depreciation.
And the numbers I showed were the pre-tax income for their various business segments before the allocation of corporate overhead. How is that not a real number?
As for their return on capital, in 2006 they had total stockholder equity of $12.129 billion with a net income of $2.053 billion. Or a return on capital of around 16%. 2007 was obviously much worse, with a return of around only 1.6%
Return on Capital is difficult to calculate for the Prime Brokerage Business separately, as they don't give you the book value of each segment separately. But it is clearly very high margin. As for the real estate, here is the info
"The Company has entered into an operating lease arrangement for its world
headquarters at 383 Madison Avenue in New York City (the "Synthetic Lease").
Under the terms of the Synthetic Lease, the Company is obligated to make monthly
payments based on the lessor's underlying interest costs. The Synthetic Lease
expires on August 10, 2012 unless both parties agree to a renewal prior to
expiration. At the expiration date of the Synthetic Lease, the Company has the
right to purchase the building for the amount of the then outstanding
indebtedness of the lessor or to arrange for the sale of the property with the
proceeds of the sale to be used to satisfy the lessor's debt obligation. If the
sale of the property does not generate sufficient proceeds to satisfy the
lessor's debt obligation, the Company is required to fund the shortfall up to a
maximum residual value guarantee. As of November 30, 2007, there was no expected
shortfall "
If you read that basically it is an operating lease with a call option on the building. The value of the option will depend on the value of the building in 2012. Clearly we don't know what that value is going to be, but as a call option its value is definitely worth more at least 0 and no less.
That is not exactly right for the real estate. If the value of the real estate falls below the value of the lessors debt obligation, then the firm is obligated to make them whole.
However, today their is no expected shortfall today and under any reasonable scenario there won't be one in the future.
With all due respect, I feel as though I am wasting my time with you, poor booby. You simply lack an understanding of how the "real world" of business works--which is understandable given your lack of experience and overall ignorance.
383 Mad Ave is not an appreciable asset; it's a depreciating obligation, offset by net cost qualifiers. If you knew anything you'd know it has an 8-to-1 over-cap ratio. The best in the business.
B/S had great management, which you know nothing about. That's why your numbers are wrong. I have had the honor of personally playing bridge with Mr. Cayne on numerous occasions. And that man always, I mean always, put the game of bridge before his obligations of running the company. Hear hear! Huzzah!
Prime New York real estate is not an appreciating asset? Options to buy appreciating assets at a fixed cost are not appreciating financial assets?
So would you give me a free call option to buy 1000 shares of Wells Fargo at $30 in 2012? If you want to write that I will give you at least $5 per share.
Bear Stearns had great management, therefore the numbers in their financial reports are wrong? How does that make sense?
"At the expiration date of the Synthetic Lease, the Company has the
right to purchase the building for the amount of the then outstanding
indebtedness of the lessor"
This is a call option.
If the value of the real estate appreciates beyond the amount outstanding, the firm makes money in proprtion to the increase in underlying valuation. As long as the value of the real estate is above the obligation in 2012, then they whoever holds the option, probably JPM will make money.
lannychiu, lannychiu, lannychiu,
lannychiu, If I were not a libertarian, I would almost feel sorry for you, and all those like you who suffer from feeblemindedness--it's genetic, don't you know. I'm sure your parents are stupids, too. Me, I'm 75 years of age and fit as a fiddle, so to speak. I'm a 100% vegan who loves vegan chocolate chip pancakes with smoked salmon. Mmmm.
You need to find a better hobby than cyberstalking me on MM's webswite. I've been commentating for seven years on this site. You, however, are a novice. That is not right. I understand that you are not very smart--many people say you're dumb--but the comments on Megan's website need to transcend idiots like you.
Therefore, from this day forward, I shan't either engage with you, nor have any sort of intercourse with you, until I receive an appropriate apology.
1) Frank Rizzo is pulling your leg.
2) Bear's prime brokerage business is not a going concern if Bear loses its ability to borrow funds. The PB business basically consists of making margin loans to hedge funds and pocketing the spread between what you charge in interest and your cost of funds.
3) Bear's "Global Clearing Services" also includes their correspondent clearing business. 400 or so smaller brokerages use Bear Stearns to clear trades. As far as I know (which isn't too far) this business should be able to go forward barring Bear's complete collapse. If anyone knows differently, I'd be happy to be corrected.
McArdle post:
So JP Morgan has agreed to buy Bear Stearns at $2 a share. As others have already pointed out, this is, from the point of view of the shareholders, just barely better than bankruptcy.
McArdle comment:
Bear Stearns shareholders and employees are taking a bigger hit this way then they would in bankruptcy
Posted by: Bernard Yomtov | March 17, 2008 at 01:09 PM
Ha ha ha! Watching the house of financial cards collapse around the empty heads of those too blinded by avarice to see the true nature of the system is giving me a big thrill. More, more!
You caught me, Rick--I changed my mind.
Ohh, great, another banking house for McCardle to proclaim in need of bailing out.
And please please please stop with the "run on the bank" nonsense. Hedge funds decided that Bear Stearns was not a safe bet, and obviously they were right because the actual value of the company was $2 INCLUDING a $33 billion guarantee by the Fed.
That's not some fleeting crisis of confidence needing a temporary liquidity fix (which is something the credit market provides every day). It's the fact that Bear Stearns was trading vastly more assets than it was worth! Had put its money into bad investments - namely mortgages and subprime paper - that, lo and behold, were worthless.
And please please, when you hear people on the Street tell you that this was a run on a bank, that's because they don't want to admit that Bear Stearns (like, I predict Citibank) has made a lot of very bad investments because they, in fact, are 1) not very smart and 2) gambling with, it turns out, the knowledge that the Fed will bail them the hell out.
Shorter Joe Strummer: "It's not a 'run' on the bank because the fleeing investors were riding Segways."
The $2/share price, turned around within just a couple days, IMO reflects the eyeblink mechanics of the vaguely fascistic salvage operation that transpired, rather than the value of the assets.
No, it's not a run on a bank because there was no bank to run on. Bear Stearns wasn't worth anything. You're assuming that there was some value to be had. Well the $2 was only worth $2 because the Fed guaranteed it.
No, it's a bank run because a financial insitution operating on a recognizable form of a fractional reserve model had a large number of creditors pull their money out of the institution in short time period on the basis of self-fulfilling negative expectations. The fact that the negative expectations had a real and valid basis doesn't change the mechanics by which the institution collapsed.
Valuing Bear Stearns right now is very difficult, because getting a handle on the liabilities is difficult.
However a few things to note;
- They own real estate worth anywhere from $230 Million to $1 Billion
- Their Prime Brokerage business did about $465 Million in 2006, and should be worth at least $3 Billion
- Even if a lot of their mortgage assets were written down, they are currently performing
If you were just buying the real estate and prime brokerage, without any existing liabilities, you could get a price around $20 a share.
Now the difficult part is unwinding the liabilities, and understanding what the mortgage assets will actually return over the medium-term. You can't sell them today, but most of them are performing loans.
My guess is that the market is over-reacting and in the end this will be an outstanding deal for JPM.
Of course you should never take financial advice from random bloggers.
lannychiu,
I'm afraid I must correct some of the errors in your otherwise fine comment.
First, Bear's real estate--it's office building--has a second mortgage on it, a balloon ARM due in 2011 to the tune of $985 million.
Second, their prime brokerage business didn't do $465 million of business in in 2006, it actually lost money.
Finally, even though Bear's mortgage assets were written down, currently they actually aren't performing as expected, given that the managers of the company feel a two-dollar per share price is a proper value for the company.
The sad thing is that you don't know what you're talking about. Worse than that, you're misleading Megan's devoted readers.
Here is the segment information for the global prime brokerage segment ("Global Clearing Services")
for the years 2006 2005 2004
PRE-TAX INCOME
Global Clearing Services 464,519 471,796 349,922
Wealth Management 69,160 36,770 62,344
As you can see they earned pre-tax $465 million dollars in 2006. This is an extremely high-margin and lucrative business. I don't know where you got that they lost money.
Like every segment analysis, you then have to put in some corporate overhead. But for a bank with a pre-existing prime brokerage business, one can assume this is minor.
As for the real estate, calculating its value is complicated for tax reasons. It does not have straightforward ownership, instead it has an operating lease agreement with an option to re-purchase in 2012 (it is nothing like an Option ARM).
It does this for tax reasons, by converting ownership into an operating lease, you can deduct 100% of those payments from your operating income and reduce your tax payments. So the exercise becomes then calculating the residual value of the option in 2012, by estimating what the real estate will be worth less the residual payment to the lessor. This is complex, but it is definitely worth more than 0, and under some scenarios as much as a billion. That is why I put in a range.
The funny thing about banks, is that loans can be performing, but you can still go out of business and make a $2 share valuation reasonable in the short-term.
Imagine that Bear has loans of $800 billion, all short-term which it needs to roll-over every month.
It has assets of $1 Trillion which are long-term.
Now imagine those assets get impaired, to say $900 million in value.
Now one would say that the business still has $100 Billion in value, but if it wasn't able to get fresh loans every month for the $800 Million because lenders were worried about further writedowns in the assets, the firm could go out of business even though it has positive asset value.
Further imagine that the writedowns are not occuring because the mortgages are not paying out cashflow, but because investors feel they might not payout cashflow in the future. Because of mark-to-market accounting, you can get a writedown in asset value even if the instrument you hold is still paying out.
They you would get the very odd circumstance of a solvent company going bankrupt, despite the fact that it has performing assets and positive book value.
This is a run on the bank scenario, and what is occuring with Bear Stearns.
lannychiu,
With all due respect, the more you write the more your ignorance shows. You obviously simply do not understand finance, i.e., "the numbers."
Let me demonstrate. First, you give these numbers: "Wealth Management 69,160 36,770 62,344."
Once again you are misleading Megan's readers. The real numbers are not 69,160 36,770 62,344. Think about it. What about EBITDA? Those are the real numbers. Don't you even know what ROACE is? Those are the real numbers. Think with your brain.
Second, I do agree somewhat with you that my charictarization of Bear's building loan as an Option ARM was somewhat incorrect. Actually, the loan they have is with WaMU and it's a 30-year fixed, with a huge prepayment penalty and an APR of 11%. That's why the company is out of business. Stupid decisions like that.
Why would you use EBITDA to measure the performance of a financial company. I.E. a company that should have almost no CAPEX? Also to claim that EBITDA is a more real number than Pre-Tax Income doesn't really make sense. EBITDA is typically considered a worse number, because most business will eventually need to spend CAPEX equal to Depreciation.
And the numbers I showed were the pre-tax income for their various business segments before the allocation of corporate overhead. How is that not a real number?
As for their return on capital, in 2006 they had total stockholder equity of $12.129 billion with a net income of $2.053 billion. Or a return on capital of around 16%. 2007 was obviously much worse, with a return of around only 1.6%
Return on Capital is difficult to calculate for the Prime Brokerage Business separately, as they don't give you the book value of each segment separately. But it is clearly very high margin. As for the real estate, here is the info
"The Company has entered into an operating lease arrangement for its world
headquarters at 383 Madison Avenue in New York City (the "Synthetic Lease").
Under the terms of the Synthetic Lease, the Company is obligated to make monthly
payments based on the lessor's underlying interest costs. The Synthetic Lease
expires on August 10, 2012 unless both parties agree to a renewal prior to
expiration. At the expiration date of the Synthetic Lease, the Company has the
right to purchase the building for the amount of the then outstanding
indebtedness of the lessor or to arrange for the sale of the property with the
proceeds of the sale to be used to satisfy the lessor's debt obligation. If the
sale of the property does not generate sufficient proceeds to satisfy the
lessor's debt obligation, the Company is required to fund the shortfall up to a
maximum residual value guarantee. As of November 30, 2007, there was no expected
shortfall "
If you read that basically it is an operating lease with a call option on the building. The value of the option will depend on the value of the building in 2012. Clearly we don't know what that value is going to be, but as a call option its value is definitely worth more at least 0 and no less.
That is not exactly right for the real estate. If the value of the real estate falls below the value of the lessors debt obligation, then the firm is obligated to make them whole.
However, today their is no expected shortfall today and under any reasonable scenario there won't be one in the future.
lannychiu,
With all due respect, I feel as though I am wasting my time with you, poor booby. You simply lack an understanding of how the "real world" of business works--which is understandable given your lack of experience and overall ignorance.
383 Mad Ave is not an appreciable asset; it's a depreciating obligation, offset by net cost qualifiers. If you knew anything you'd know it has an 8-to-1 over-cap ratio. The best in the business.
B/S had great management, which you know nothing about. That's why your numbers are wrong. I have had the honor of personally playing bridge with Mr. Cayne on numerous occasions. And that man always, I mean always, put the game of bridge before his obligations of running the company. Hear hear! Huzzah!
Prime New York real estate is not an appreciating asset? Options to buy appreciating assets at a fixed cost are not appreciating financial assets?
So would you give me a free call option to buy 1000 shares of Wells Fargo at $30 in 2012? If you want to write that I will give you at least $5 per share.
Bear Stearns had great management, therefore the numbers in their financial reports are wrong? How does that make sense?
"At the expiration date of the Synthetic Lease, the Company has the
right to purchase the building for the amount of the then outstanding
indebtedness of the lessor"
This is a call option.
If the value of the real estate appreciates beyond the amount outstanding, the firm makes money in proprtion to the increase in underlying valuation. As long as the value of the real estate is above the obligation in 2012, then they whoever holds the option, probably JPM will make money.
lannychiu, lannychiu, lannychiu,
lannychiu, If I were not a libertarian, I would almost feel sorry for you, and all those like you who suffer from feeblemindedness--it's genetic, don't you know. I'm sure your parents are stupids, too. Me, I'm 75 years of age and fit as a fiddle, so to speak. I'm a 100% vegan who loves vegan chocolate chip pancakes with smoked salmon. Mmmm.
So as a libertarian you have no sympathy for those who suffer from feeblemindedness?
My parents are also quite stupid and clearly produced a child with no ability to analyze financial statements, think critically or read.
Look lammyshoo,
You need to find a better hobby than cyberstalking me on MM's webswite. I've been commentating for seven years on this site. You, however, are a novice. That is not right. I understand that you are not very smart--many people say you're dumb--but the comments on Megan's website need to transcend idiots like you.
Therefore, from this day forward, I shan't either engage with you, nor have any sort of intercourse with you, until I receive an appropriate apology.
lannychiu:
1) Frank Rizzo is pulling your leg.
2) Bear's prime brokerage business is not a going concern if Bear loses its ability to borrow funds. The PB business basically consists of making margin loans to hedge funds and pocketing the spread between what you charge in interest and your cost of funds.
3) Bear's "Global Clearing Services" also includes their correspondent clearing business. 400 or so smaller brokerages use Bear Stearns to clear trades. As far as I know (which isn't too far) this business should be able to go forward barring Bear's complete collapse. If anyone knows differently, I'd be happy to be corrected.
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