When the consensus was that JP Morgan got a screaming deal in its acquisition of Bear Stearns, I thought it was way too early to make that call. Yes, it certainly looked like the New York bank pulled a master stroke in getting the Fed to eat $29 billion of exposures, guaranteed to be the worst stuff that Morgan could hoover up.
But Bear also had a very large derivatives book, and as we well know, was a large credit default swaps protection writer. Those contracts are traded bi-laterally; JPM would not have particularly strong insights (its role as Bear’s clearing bank wouldn’t be of much help) and a mere weekend was clearly not enough time to do more than have a few key questions answered in the heat of putting a deal together. Similarly, Bear had two valuable assets: its headquarters building and its prime brokerage operation. The building, though still a good investment, will be worth less as Wall Street fires more people and Class A vacancies rise. Moreover, Bear was losing market share in prime brokerage, and in a period of deleveraging, it’s the riskiest exposures that get cut deepest (and don’t kid yourself, the real money in prime brokerage is in the lending).
So just as Bank of America’s once touted deal with Countrywide looks like it will turn out to be a slow-motion train wreck, the Bear deal has the potential to be a millstone rather than an asset to JP Morgan.
A further sign that all is not well in former Bear-land is the sudden exodus of two former executives who were given very senior roles at Morgan. I came across this story by happenstance; it was broken by the Financial Times on a holiday weekend at 11:11 PM EDT (no coverage on any other outlets covered by Google News, nor on a search of the big financial blogs). So the pair was evidently forced out Friday to minimize press notice. And the article makes clear that mortgage valuations played a role in their removal.
These departures could be the result of bigger-than-expected Bear-related writedowns; in other words, this may merely be another aspect of a problem that has already been disclosed. But the way this was handled is highly sus, as the Australians would say. Don’t be surprised if more shoes drop at JP Morgan.
From the Financial Times:
Two senior Bear Stearns executives who moved to senior positions at JPMorgan Chase just weeks ago are leaving the bank.
The departure of Jeff Mayer and Craig Overlander comes amid questions about the value of the Bear Stearns mortgage book. The two men had been in charge of the fixed income department at Bear Stearns and were named vice-chairmen of JPMorgan’s investment bank soon after it agreed to buy Bear Stearns in mid-March. The promotion of the pair was seen as a sign of JPMorgan’s commitment to integrating Bear Stearns staff.
But they are leaving, partly because of problems with Bear’s mortgage portfolio. Their departure “is not exclusively because of marks on the mortgage book,” according to a person familiar with the matter, who added “there were plenty of other people involved with that.”
A JPMorgan internal announcement from Steve Black and Bill Winters, who run the investment bank, said: “Jeff Mayer and Craig Overlander have let us know that they plan to leave the company.”
Jamie Dimon, JPMorgan’s chairman and chief executive, said last week that it would take a one-off charge of $9bn to cover the losses at Bear, as well as potential litigation costs, and severance and retention payments. That number is about 50 per cent more than its original estimate of the cost of the take-over. Mr Dimon said the higher costs were driven by losses and a bigger than expected amount of bad assets on Bear’s balance sheet.
Update 3:45 AM: Alert reader Steve wrote to tell me another shoe has already dropped, and has been curiously gone largely unnoticed. JP Morgan’s option to buy the headquarters is being contested by the ground lease holder. This is a huge oversight. I can’t imagine someone at Bear didn’t know that this is the sort of thing that its acquirer would want to know, but hey, you pay a knocked-down price in haste, it’s your obligation to know what exactly you are getting. At a minimum, this is pretty embarrassing. I assume that the bank will have to pay the plaintiff to go away. Wonder if they’ll be able to avoid disclosing the amount.
This story ran in Reuters on Thursday:
In the lawsuit, filed in New York state court, 383 Madison LLC claimed that under a ground lease Bear used for the property, 383 Madison was supposed to be given an opportunity to buy the building if Bear ever considered selling it.
In March, when JPMorgan offered to buy Bear Stearns, it was given an option to purchase the Bear Stearns building for $1.1 billion, even if the deal were to fall apart….
383 Madison claimed Bear committed itself to scenarios under which it would sell the building to JPMorgan without even attempting to give the land owner notice of the agreement or engage in negotiations with it. It also claimed JPMorgan ignored the company’s rights under the ground lease.
“JPMorgan wrongfully and intentionally induced Bear Stearns to breach the Ground Lease and the Right of first offer for its own personal gain,” the suit claims. The land owner is seeking the right to acquire Bear Stearns’ interest in the building or because it believes the building is worth more than $1.1 billion it is asking for the fair market value of the building above that price, according to the lawsuit.
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HOOCOODANODE there were problems at BS? or that it might take more than a weekend to perform due diligence? I’m SHOCKED!
Bank failures don’t cause recessions, they lengthen them,” Mason, the Drexel professor, explained. “We could get a mild recession that could linger for a while longer because of the inability to recharge capital in the banking and financial system.”
Why doesn’t JPM just offer them the building at the “fair market price” that the plaintiff’s are arguing that it is worth? That might shut them up – especially if they have to raise cash.
Am I missing something here?
Well, Bear and JPM signed a merger agreement and are well on the way to executing it. JPM has already assumed operational control. Recall that Bear sold 39.5% of its shares in the form of newly issued stock already. The arguably artificially cheap price of the building was part of that deal; you can’t easily retrade it now. If the building should have been sold to either JPM or 383 Madison at a higher price, how do you now convey that extra value to the Bear shareholders as of the announcement of the merger (March 18) who were cheated? There is no mechanism for doing that.
And the board members may be liable, particularly Bear’s (yes, they have insurance, but they may still have to defend a suit. Time consuming and draining).
So I expect the 383 Madison types will be able to extract a large payment for this huge oversight (where the hell were Bear’s lawyers on this one?). The 383 Madison people effectively have a right of first refusal. That is a VERY valuable right that was ignored. Believe me, the simplest (only) answer is to pay them to go away. And they ought to be able to extract something pretty handsome (although it may be hidden from the public via renegotiating the ground lease to give 383 Madison greatly higher payments).
Other quick thoughts (and anyone with expertise is encouraged to speak up):
1. 383 Madison no doubt tried to settle this and isn’t happy with what they were offered (of JPM may be trying to delay to push this out beyond the closing of the Bear acquisition). You don’t file lawsuits as your first move. You send nice letters, then nastygrams, then sue.
2. The comments about ignoring other rights under the ground lease may indicate that JPM is acting as if it can assume the ground lease (ie, by keeping the Bear legal entity around). You’d have to read the ground lease and the merger agreement to see how much a stretch that was.
3. I imagine the normal outcome 383 would want/expect upon an offer to buy the building is they’d waive their right to exercise the option in return for a considerable increase in the ground lease payments to the new owner.
4. Dunno if 383 Madison has enough access to dough to buy the building (they presumably could get an equity partner) but JPM does not want that building in someone else’s hands. The Bear HQ has trading infrastructure that JPM badly needs and any new owner could extract an above market rent (there was a case many years ago, in 277 Park, when Chemical spent $100 million, which was an enormous sum at the time, putting in a state-of-the-art trading room. The landlord then hit Chase for a massive increase in rent when the lease came up for renewal. I have no doubt there have been less public versions of the same behavior). That’s why the fact that this has wound up in court is odd.