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What, exactly, did J.P. Morgan get for its $236 million purchase of Bear Stearns?
Investors are clearly pleased with the deal—J.P. Morgan shares have soared more than 10 percent today, while shares of other Wall Street banks are plunging.
Analysts almost universally applauded J.P. Morgan and its chief executive, Jamie Dimon. "Even with an estimated $6 billion in transaction costs, the deal economics look very compelling and from a strategic perspective, J.P.M. is getting several business lines from Bear that are very complementary to its investment bank," Citi analyst Keith Horowitz wrote in a report to clients this morning.
More than a few outlets have noted that Bear Stearns' headquarters in Manhattan, which the bank holds through a synthetic lease, is worth much more than the price tag for the entire bank.
J.P. Morgan expects Bear's operations to contribute roughly $1 billion to its earnings once the integration is complete—another figure that makes the $236 million price tag compelling.
Whatever clients that remained with Bear by the end of last week—hedge funds and other institutional clients were the bread and butter of its prime brokerage business—will be a welcome addition to J.P. Morgan's roster should they decide to stay (something J.P. Morgan should go to great lengths to encourage). More than two decades ago, Bear became one of the first banks to offer prime brokerage services, which includes everything from financing to trading and reporting for hedge fund clients. It remains one of the biggest providers of the lucrative services today.
In a clear effort to stave off further defections from Bear, J.P. Morgan's chief financial officer told investors that any parties in current transactions with Bear should now proceed with the "full faith and credit" of J.P. Morgan.
But the real price that J.P. Morgan is paying has less to do with Bear's assets and everything to do with its liabilities.
The analysts at Credit Sights broke it down in a report published this morning: Bear comes with about $33 billion worth of risky mortgage positions. But the deal included a $30 billion lending facility from the Federal Reserve, which discounts that exposure considerably. It also gives J.P. Morgan time to unwind its positions, instead of forcing them out in a fire sale.
J.P. Morgan is getting a sizable mortgage business with Bear Stearns, something it had previously said it wanted.
Citi's Horowitz noted that J.P. Morgan bankers are known for their strength in due diligence, which gives extra weight to its risk assessment of Bear's balance sheet. On the conference call, J.P. Morgan's William Winters said the bank had a team of 200 bankers dissecting Bear's books for three full days.
Credit Sights also noted that J.P. Morgan, by backing all of Bear's operating activities, has actually done itself a favor. As of September 30, 2007, J.P. Morgan had the most credit derivative exposure of any bank—nearly twice that of Citigroup, who had the next-biggest stake. J.P. Morgan, like other banks, "likely faced some risks from a major counterparty (Bear Stearns) potentially having to seek bankruptcy protection," the analysts wrote.
So what's next for J.P. Morgan, which had been expected to have a shopping spree this year in the banking sector? "In our view, the low price paid for Bear Stearns could leave J.P. Morgan with sufficient financial resources to make a bid for WaMu," the analysts wrote.
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