Last Updated: May 2, 2008: 4:15 PM EDT
Bear Stearns second
brush with bankruptcy
The firm wasn't out
of the woods even after its initial agreement to merge with JPMorgan, a
JPMorgan chief Jamie Dimon's
$10-a-share offer for Bear Stearns headed off a bankruptcy
(Fortune) -- Bear Stearns
nearly collapsed not once but twice before the cash-strapped brokerage firm
was rescued, a regulatory filing shows.
By now it's well known that
JPMorgan Chase (JPM,
agreed on March 16 to buy Bear for $2 a share in a Fed-brokered agreement to
fend off a possible bankruptcy filing at the cash-strapped brokerage firm. A
week later the sides agreed to boost the value of the all-stock deal to $10
a share. That move, announced the morning of March 24, was widely portrayed
as JPMorgan chief Jamie Dimon having thrown a bone to the restive Bear
investors who were threatening to veto the agreement when it came up for
But Bear Stearns' (BSC,
latest proxy statement, filed Monday with the Securities and Exchange
Commission, shows that the stakes were much higher. Bear believed that if it
failed to get a new agreement that reaffirmed JPMorgan's guarantee of Bear
Stearns' obligations, Bear could have been cut off from JPMorgan's
Fed-backed funding and forced into bankruptcy - an outcome that many
investors assumed had been forestalled by the March 16 merger agreement.
The dispute that nearly
brought Bear down a second time turned on whether JPMorgan would stand
behind Bear Stearns' massive credit default swap book and other liabilities.
The firm's lack of access to other funding had Bear lawyers preparing for a
possible bankruptcy the weekend before the revised merger agreement was
The filing says that Bear
execs noted continued reluctance by market players other than JPMorgan and
the Fed to lend to Bear even in the wake of March 16's $2-a-share buyout
pact. The execs feared they could be left without funding as they sought to
clarify the pivotal guarantee issue. In the initial merger agreement,
JPMorgan appeared to guarantee Bear's obligations. Later in the week,
however, JPMorgan attempted to float the story that this guarantee had
slipped into the agreement in error.
Without the JPMorgan
backing, the filing says, "Bear Stearns would not be able to open for
business on Monday, March 24, 2008, and would have no choice but to file for
bankruptcy by that morning. Bear Stearns' bankruptcy advisors were
instructed to be prepared for this contingency by the end of the weekend."
The knowledge that other
market players doubted the JPMorgan guarantee put both sides in a tricky
spot. Without any other financial institution providing liquidity to it,
Bear had drawn heavily on JPMorgan's credit, borrowing a total of $9.7
billion - $3.6 billion of which was unsecured. The bank also had $3.7
billion in repurchase agreements with Bear. JPMorgan had, as they say, skin
in the game.
Meanwhile, Bear's customers
and competitors, with nearly $13.4 trillion worth of derivative exposure to
the firm, were refusing to do business with Bear. The loss of customers was
highly concentrated in Bear's once-vaunted prime brokerage unit.
Specializing in clearing trades and providing margin for the world's largest
hedge funds, this group regularly provided a double digit percentage of
Bear's net income. Without Bear's prime brokerage unit, and with Bear's
mortgage unit at the crossroads of the securitized market collapse, JPMorgan
was at risk of buying a business with little profit potential. For their
part, Bear managers knew that a bankruptcy filing might mean liquidation of
the firm, which would wipe out shareholders and could have left many
creditors holding worthless claims.
The filing shows that as
the week of March 17-21 came to a close, the sides began discussing a
renegotiation of the terms of the deal. "Representatives of JPMorgan Chase
informed Bear Stearns that during the week the New York Fed had repeatedly
requested that JPMorgan Chase guaranty Bear Stearns' borrowings from the New
York Fed, and that JPMorgan Chase was at this time unwilling to do so," the
filing states. "Both parties perceived that the absence of JPMorgan Chase's
guaranty could place continued funding from the New York Fed in jeopardy."
In response, JPMorgan
proposed a deal that would allow it to purchase more than two-thirds of
Bear's stock, to fend off the shareholder uprising, and that the deal be
sweetened via the issuance of a security whose value would be contingent on
the performance of some Bear Stearns mortgage securities. Bear's board
rejected that deal, saying it wanted more money for shareholders.
Working through the weekend
of March 23, Bear and JPMorgan boards managed to cobble together an
agreement that increased the bid to $10 per share, which took the likelihood
of a shareholder blocking action off the table. In return, JPMorgan bought
enough stock to guarantee the deal's completion - thus safeguarding its
loans to Bear. Bear's customers got an operating guarantee from JPMorgan
that clearly spelled out the bank's assumption of Bear's obligations.
But while the deal is now
securely in place, it's not certain that a happy ending is in sight. After
the merger, JPMorgan - with around $91.7 trillion in total derivative
exposure - will solidify its position atop the derivative league tables.
is a distant second at $34 trillion, according to the Office of the
Comptroller of the Currency.
First Published: May 2, 2008: 2:17 PM EDT
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