A successful investing strategy often flies in the face of conventional wisdom and puts the investor opposite the expectations of the general public. Such is the case with my recent purchase of Bear Stearns (BSC).
Bear has been in the news spotlight the last few weeks as two hedge funds it is affiliated with have come under intense pressure. The funds invest in Collateralized Debt Obligations (CDO) and are fairly leveraged vehicles. The more risky of the two reportedly raised $600 Million and then went out and used that to borrow an additional $6 Billion to invest. The company used the investments as collateral to secure the loans and now that the collateral is valued lower, lenders such as Merrill Lynch have threatened to pull the collateral, sell it in the market at drastically lower prices in order to get out of their predicament.
In steps BSC to save the day. The company has graciously offered to put up $1.6b (and possibly as much as $3.2b) as collateral to bail out the funds. The stock has been hit hard on the news and speculation is abundant that this could be a very damaging move for BSC. Some have even suggested that this could put Bear out of business and others speculate the stock will be pushed so low as to make Bear a sure take out by another brokerage.
If you look back at the history of Bear, you see a few key differences between the company and their counterparts across the street. Bear may not be as talented at attracting the individual assets like Merrill Lynch, they play a smaller role at incubating new funds than Goldman Sachs, and their investment banking doesn't do nearly the volume of Credit Suisse. However, the company does an Excellent job of managing and investing its own capital. The corporate culture still reverberates around making positive returns on assets and traders are meticulously trained to manage risk, and build the company's asset base by seizing opportunity.
This bailout is just that... An opportunity for the company to issue a loan (they are being compensated for the risk they are taking) and make a good return on their money. I picked up a position in BSC calls and expect this wave of selling to be just about over. I would not suggest putting too much capital at risk, but the chances of a rebound are good, and the size of the move is potentially very exciting.
FD: Author has long position in BSC
3 comments:
I really don't understand much about the Bear Stearns scenario -- I admit that right off -- so to my uneducated eye, the whole thing looks crazy. You have a hedge fund that's highly leveraged in these CDOs, so you have a lot of risk to begin with. The lending market gets rocky, so the leveraged strategy doesn't work: the fund is at risk of suffering gambler's ruin. In steps Bear Stearns to loan them a bunch of money so that they can continue to pay on existing debt? Really, how will taking on more debt help the fund? If I were one of the funds investors, I'd be doing all that I could to cut my losses and get out, yet Bear Stearns thinks that the funds can hold on long enough to repay the loan. That seems to be a quite risky move. Perhaps this post reveals total ignorance of the circumstances, but that's the best of my understanding.
well you're right in that the fund needs to be shut down. The problem was that investors couldn't get out because in order to meet withdrawals the fund had to sell securities that were illiquid and once the market knows there is a motivated seller, the bids dry up and it is impossible to sell to meet redemptions. Lenders like MER then get spooked and take posession of collateral in place of the loans, continuing a vicious cycle.
To my understanding, Bear's capital will allow the fund to meet redemptions, and dissolve in an orderly fashion. The fund (funds) will be shut down but hopefully in a manner that at least gets investors some return of their capital and lenders some return of their loans.
Much of these dealings are not completely transparent so there is definitely a lot of uncertainty surrounding the situation. Bear is not an investor in the funds and so this has more to do with the company's reputation than a financial loss suffered by BSC (aside of course from the most recent capital infusion)
That helps me to understand the situation better, but I don't understand what Bear Stearns has to gain from loaning money to a dying fund. If the fund is selling off its CDOs, is their price really likely to hold steady? As their price declines, what if the creditors get spooked and start calling the loans? It seems to me that the fund is near bankruptcy already and that Bear Stearns is probably taking a lot of risk with a few billion dollars. If they loose $2,000,000,000 dollars in the deal (I just had to type that number out in all its glory), then they loose more than 1% of their entire market cap in one transaction and probably loose a lot more of their liquidity.
All that having been said, I wish you and them the best in pulling this off. (And, again, I don't understand these things very well to begin with!)
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