Monday, March 17, 2008

Comments on the Bear Stearns (NYSE:BSC) fall-out

Some interesting comments on the financials from two firms in light of the terrible Bear Stearns (NYSE:BSC) news:

- Deutsche Bank notes one reaction is shock that a company (Bear Stearns) that reaffirmed its book value at around $84 on Wed. can be worth $2 per share four days later on Sunday. Industry confidence erodes given uncertainty in the procedures used to value not only financial assets but entire firms. For this reason, it is not surprising that financial stocks in Asia have opened trading on Monday with declines of 8%-10%.

Yet, the issue is less about solvency and book value than about liquidity. Bear seems to have lost the trust of the markets to make good on its liabilities and did not have adequate liquidity during these abnormal stress times. The initial reaction is to assume that the same could happen to other wholesale funding firms, but this is where game theory takes hold since the Fed and government will likely resort to unusual measures to take actions to protect a system that is man-made and can be tinkered.

This is not to say that the Fed can quickly solve the big problems. Indeed, the demise of Bear reflects three themes, including our firm's expectations for $400B of global subprime related losses , firm's view that industry write-downs of $200B are about 2/3rds done but that the last 1/3rd can hurt the most, and the heightened risk of wholesale funded monoline firms during times of stress (as previously seen with firms such as Household, Countrywide (CFC), and Bankers Trust). The first two factors help to cause Bear's weakness, whereas the last one (liquidity as opposed to solvency) seemed to cause its sudden decline.

The concerns are ongoing. As mentioned by ex-Fed Chairman Alan Greenspan at DB conference on Friday, markets related to subprime and mortgages are likely to bottom only when there is visibility about the stability of collateral - i.e., home prices, meaning that the root cause of the industry's predicament is not likely to end soon (though he stressed that markets can speedily recover once they turn). Also, speakers mentioned that Sovereign funds may not be so quick to offer new funds given their recent investment losses, thereby reducing what has been on saving grace so far in the crises.

Nevertheless, they are leaving open the possibility that Bear's demise is closer to a near-term bottom. Also at firm's conference, speakers mentioned the benefit of failures (rid excess capacity) and that they occur closer to market bottoms. The demise of Bear is the type of watershed event that can help cause at least a temporary turning point. In other words, Bear's demise seems more like another tangible manifestation, albeit huge, of themes that have been discussed. The main reason not to try to "catch the falling knife" is the newer liquidity issue and a complete understanding as to why Bear's funding shut down so quickly in a matter of a few days. In any event, the main beneficiaries longer-term should be those financial firms which have the most capital, are more diverse (conglomerates), and/or have funding which is less dependent on wholesale markets.

- Oppenheimer's Meredith Whitney notes that while they believe BSC's case is unique, what will not be unique, in their view, is a resulting major negative revaluation of financials. For this reason, they provide a detailed examination and explanation of why they believe financial stocks have further downside of as much as 50% based upon 1990/1991 multiples of tangible book values.

- Goldman Sachs believes the group's initial stock reaction will be negative as investors are likely to be surprised by the purchase price. However, this proposed deal, and the Fed cutting the discount rate by 25 bp yesterday, may provide a boost to the credit markets. The current financial situation is a fluid one, so the credit markets' reaction to this deal, broker earnings, and additional Fed action will be crucial for any outperformance this week.

Investors are likely to flock to firms with stronger balance sheets While investor fears of a broker failure have essentially been realized, this transaction highlights the importance of a firm's liquidity position and the diversity of its funding sources. GSCO expects to see a continued flight to quality, particularly with respect to the firm's balance sheet. They believe JPM and MS have the strongest balance sheets at the present time.

Notablecalls: This is the end game, ladies and gentlemen. The Fed sent a pretty strong message to the markets, bailing out one of the worst players. With this they are telling the credit markets they are ready to bail out others as well if needed. Hell, they could have let the bank run on Bear take place. But they didn't.

Bailout is here.

Instead of being a panic seller, one has to step in and buy. Buy Goldman Sachs (NYSE:GS) down 10%. GSCO has proven their worth yet again. They saw the problems coming and hedged. They told the monos to go and screw themselves as they knew their insurance would prove to be worthless. They have played it well & will survive.

I smell a bounce in GS. Same with MS. Would stay away from Lehman (NYSE:LEH), though as these guys could very well end like Bear.

Anyway, GS will report tomorrow. Bet with the jews! Always a winning strategy.

1 comment:

dcxavier said...

Absolutely agree about Goldman. Dimon's problem is convincing Bear's customers that JPM can run a viable investment bank and trading house. It's not a hard call to switch to the people doing it right. Goldman is also in position to cherry pick Bear employees.

From a mid to long term perspective, the bull/bear ratio is at almost unprecedented levels, screaming buy. I'm more of an investor than trader, time to put cash to work.