Merrill Lynch analyst Guy Moszkowski confirms our views of the last few days, that Bear Stearns will probably have to orchestrate some sort of orderly wind-up for its second hedge fund, the High-Grade Structured Credit Enhanced Leveraged Fund.
For those who have not been following this story closely, Bear had two funds, both managed by Ralph Cioffi, with similar names. Bear devised a plan for the smaller fund with better quality assets that was widely reported to involve a $3.2 billion bail-out (which implies Bear was putting its own capital at risk). However, a report from Fitch (cited by Tanta at Calculated Risk) stated that Bear was using a credit facility, a collateralized repo , “a product offered in Bear Stearn’s usual commercial activity,” meaning no meaningful increase in exposure to the hedge fund.
However, that does not mean that Bear is yet out of the woods (no pun intended). Moszkowski, quoted in a Bloomberg story, explains why Bear will probably have to rescue the second fund:
Bear Stearns Cos. may have to salvage the second of its two teetering hedge funds after offering $3.2 billion last week to bail out the first one, Merrill Lynch & Co. analyst Guy Moszkowski said.
Investors “can’t rule out” the chance that Bear Stearns will “stump up even more for a similar, more-leveraged, fund,” Moszkowski, who rates the firm a “buy,” wrote in a note to clients today. He estimated that the second fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund, owes about $7 billion to its financiers.
Bear Stearns, the biggest broker to hedge funds, is struggling to keep the funds from collapsing after losses on securities backed by home loans led lenders including Merrill Lynch to demand more collateral. By assuming the loans, New York- based Bear Stearns is protecting the funds’ investors while increasing the risk to the firm itself, according to Moszkowski.
“In its two decades as a public company, we do not believe Bear Stearns has faced a situation of this magnitude,” Moszkowski wrote.
Russell Sherman, a spokesman for Bear Stearns in New York, declined to comment.
Bear Stearns raised almost $2 billion from investors for the two funds and borrowed more than $10 billion against that equity to make bigger bets and earn higher returns. The Bear Stearns High-Grade Structured Credit Fund, which was bailed out last week, had had “something like 40 consecutive quarters of profitable performance” before the losses, Chief Financial Officer Samuel Molinaro said on a June 22 conference call.
Bear Stearns had little choice but to come to its rescue, Moszkowski wrote.
“Investor and lender expectations are different for a fund managed by a large securities firm rather than a stand-alone hedge fund manager,” he said in the note. “Whether legally remote from the parent company or not, a fund managed by a large securities firm would generally not be expected to be allowed to go belly-up.”
Lenders to the second fund haven’t been repaid.
“It’s not yet clear that the firm won’t ultimately feel the need to provide support here as well,” Moszkowski wrote.
Bear Stearns, the fifth-biggest U.S. securities firm by market value, may become more vulnerable to a takeover because of the funds’ losses and the bailout, he said.
“If the firm is not able to resolve its position without a meaningful loss, we think likelihood of a sale rises materially,” Moszkowski wrote in a separate note on Friday. He estimated that a buyer probably would pay at least $185 per share, or twice the firm’s book value.
Bear Stearns stock fell $2.58, or 2 percent, to $140.90 in 1:47 p.m. composite trading on the New York Stock Exchange, and earlier touched $139.55, the lowest since September.
Moszkowski appears unaware that the $3.2 billion of support for the first fund is in the form of a repo facility rather than an equity infusion or commitment (although in fairness, the distinction could prove to be academic. If Bear is unable to realize the value of the assets subject to the repo, it will wind up being the bagholder and would suffer losses).