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Bear Stearns stands firm in face of trouble

By Ben White and David Wighton

Published: June 27 2007 03:00 | Last updated: June 27 2007 03:00

When Federal regulators implored James Cayne, Bear Stearns chief executive,
to participate in a bail-out of Long Term Capital Management in 1998, he
declined, even though Bear served as the collapsing hedge fund's prime
broker.

Given that history, analysts say the anger now coursing through Wall Street
about how Bear has handled the near-collapse of two of its proprietary hedge
funds may be somewhat misplaced.

Dire warnings about the long-term impact on Bear's reputation - and its
prospect as a takeover candidate - may also be wide of the mark.

According to this theory, Bear has long made it clear that it is not in the
business of exposing itself to large amounts of risk and has little appetite for
participating in big bail-outs.So why should things be different now? And how
could Bear's already stingy reputation for not bailing out big banks and
sophisticated investors when they get in trouble really get much worse?

With equity capital of just $13bn, Bear is hardly in position to offer the
kind of full-scale rescue that a larger bank might consider.

Thus far, Bear has only agreed to make a $3.2bn secured loan to the less
levered of the funds, which the bank says is more than collateralised by assets
held by the funds. People close to the situation say Bear may wind up having to
put up just $1.6bn.

"They can't afford abail-out and there is no legal reason that they have to
offer one," said Richard Bove, analyst at Punk, Ziegel. "They don't own the
funds and they don't have obligations to people who loaned money to the
funds."

However, Mr Bove and other analysts noted that Bear's asset management
business, one of its main growth engines, will take a reputational hit.

Bear did not return calls seeking comment.

Senior executives at other leading Wall Street banks that run hedge funds,
including Goldman and JPMorgan Chase, say that one of the attractions of their
funds is the implied commitment by the banks to stand by them in a crisis.
"Investors know that they are backed by the financial muscle of a large
institution that has a big interest in safeguarding its reputation," said one.
That said, a bail-out of this kind has no precedent.

A top executive at another leading Wall Street bank said: "Our reputation is
very valuable to us. We would have acted rather differently to protect it."

But some senior Wall Street figures say Bear is right not to step in to
protect the leveraged fund.

"They have handled it badly but I don't think it creates too much of an issue
for Bear Stearns Asset Management if they don't stand by the funds," said one.
"It's still a great firm, which is well-managed."

He added that it would have been much more serious had Bear gone ahead with
the initial public offering of Everquest, the vehicle Bear had planned to use to
offload some of the riskier elements of the funds' holdings. "Bear is lucky it
all blew up before the IPO."

In terms of Bear's reputation, executives at some other Wall Street banks say
the real damage stems from Bear's role as prime broker for the funds.

"What really incenses the creditors is seeing Bear as prime broker standing
at the front of the queue making sure it is OK," said one senior banker. Bear
has a relatively small asset management business but it is growing fast. In the
second quarter, revenues soared eightfold to $184m, about 7 per cent of the
group total, thanks largely to a jump in performance fees.

Assets under management were $60bn, up 25 per cent on last year, with hedge
funds and other alternative assets accounting for $10.2bn, up 50 per cent.

The slide in Bear's shares at least partly reflects investor concern over the
future of the asset management business.

However, even the share price decline must be taken in context, analysts
say.

The shares have fallen by about 19 per cent since January but are still up
174 per cent over the past five years. While some analysts have suggested that
Bear is now more vulnerable to a take-over, others say the chances of a sale
have not increased.

The bank's earnings are not likely to suffer munch, according to Roger
Freeman, analyst at Lehman Brothers.

If Bear really gets into trouble, and its shares slump, regulators might not
be willing to let another bank magnify its own risk by taking on Bear's.

In the end, says Michael Mayo, an analyst atDeutsche Bank, Bear'slikelihood
as a takeovercandidate remains essentially the same as it was before the recent
troubles began.

Background

Bear Stearns' troubles began in April when it told investors in its HighGrade
Structured Credit Strategies Enhanced Leverage Fund of underperformance on bad
subprime mortgage bets.

News that the fund was down 23 per cent for the year scared investors in that
fund and a less leveraged sister fund, who began demanding money back -
troublesome, given the illiquid nature of the funds' holdings. The squeeze led
to talks with creditors and Bear's decision to make a $3.2bn loan to prop up the
less leveraged fund. The other fund is expected to be wound down.

Copyright The
Financial Times Limited 2007

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