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Bear Stearns (BSC)
Should the Bulls Really be Deserting Bear Stearns (BSC)?
Wall Street was brimming with glee on Monday on news of the downfall of one of its biggest nemesis, Elliot Spitzer. Now, some folks on the street have set their sights on taking down another icon, one that has been around since 1923 - Bear Stearns. Since the start of the week, Bear has been dealing with rumors not of massive mortgage related write-downs but of severe liquidity issues. The stock was down as much as 11% at one point on Tuesday, the same day that the Fed announced liquidity injection measures that some analysts speculate were at least, in part, aimed at bailing out Bear Stearns. If the central bank is apparently looking out for you and your stock is still down double-digits, then something is up. But is the hyperbole around Bear exaggerating the negative leaving some investors with a buying opportunity?
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'How the mighty have fallen' is an oft-used clichéd phrase that is thrown around a lot. That doesn't mean it doesn't apply to Bear Stearns. The facts are staggering. In less than 12 months, Bear Stearns has gone from being the premier and savviest bond trader in the country to being a counterparty risk. That's right - reportedly, some financial institutions are refusing to enter into contracts with Bear citing concerns over the bank's ability to meet its obligations. The numbers paint an ugly picture too. At this time last year, Bear was trading comfortably in the $150-$160 range. It is now changing hands in the $62-$65 region. The market cap is now under $8 billion, 8 times less than that of Goldman Sachs' (GS: Charts, News, Offers) current cap (and that's after the recent hammering that Goldman has taken). The sentiment on Bear took a much sharper negative tone this week. Options activity suggests that traders are looking for the stock to be much further south of $62 soon. For example, on Monday, according to the Wall Street Journal, more than 17,000 put options were traded in Bear at a strike price of, get this, $30. That is an awful lot of money expecting Bear's stock to be halved in the coming weeks. Credit default swaps on Bear Stearns have risen more than 400 points over the last three days which indicates that the cost of protecting Bear's debt against default is rising and that is starting to give rise to Chapter 11 talk.
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What is the counter-argument to all this bearish talk you ask? Bear Stearns is too big to fail would be one. Oh, you were looking for something more substantive? In that case, it would be a good idea to try to cut through the exaggeration and look at the facts. Bear is in trouble, no doubt. It survived the implosion of two of its hedge funds last summer and billion dollar markdowns in its sub-prime mortgage portfolio. By now, a lot of the really weak mortgages are off the books. The problem is that defaults are spreading to what were considered to be safer mortgages (e.g. Moody's just cut the rating on a number of Alt-A mortgages held by one of Bear's subsidiaries. Alt-A mortgages are issued to customers with stronger credit records than subprime borrowers but not as strong as prime borrowers) and to other areas such as commercial and LBO debt. The other Wall Street banks are faced with these problems with too, but the problem with Bear is that their franchise is built largely on fixed-income instruments such as these. So Bear is feeling and will feel a disproportionate amount of pain. The other problems for Bear flow from this reliance on bond instruments. These securities are not marketable right now which leads to liquidity issues which impact Bear's ability to conduct other businesses such as proprietary trading. It also impacts the company's ability to attract investment banking clients because of its reduced capability to lend funds to M&A transactions.
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That is why we are hearing comments from analysts implying that Bear's business model is 'broken.' The foundation is in fixed income not equities and that is not the place to be right now. But this doesn't mean that Bear's business model will remain broken forever. After all, if you have been around since basically World War 1, you have to have shown an ability to adapt to tough times along the way. However, the way the stock is trading right now, you would think Bear is filing for Chapter 11 protection tomorrow. There is nothing substantive to back up the liquidity rumors, as of right now at least. Bear hasn't defaulted on any debt yet and unlike, Carlyle Capital Corp, hasn't been besieged by margin calls. Bear's CEO Alan Schwartz went on CNBC this morning to drive home that point and in the process indicated that the company still has around $17 billion in excess cash on its balance sheet and expects to meet analysts' projections when it reports Q1 numbers next week. The stock rallied a fair bit on those comments. So while Bear has a long and uncertain road ahead, things might not be as bad as the stock price suggests. After all, there is always a chance that somebody will buy them and the street doesn't even seem to be pricing that possibility in as a floor.
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