MARCH 18, 2008 Over the weekend, Bush 43 Federal Reserve bailed out JPMorgan Chase.
No, that is not a typo. On Monday, JPMorgan’s stock closed up 10 percent in a down market, increasing the bank’s market capitalization by more than $12 billion. Even assuming that JPMorgan ultimately has to pay more for Bear than its $2-per-share-offer — a big assumption — the market’s initial view is that this takeover of an imploding Wall Street firm was a wealth transfer to JPMorgan’s shareholders of this amount.
Where did this transfer come from? Well, it came from the Federal Reserve and from Bear.
The Federal Reserve has guaranteed Bear’s liabilities to the tune of $30 billion. And some are reporting that the Fed pushed through this deal over the weekend to prevent Bear from completely defaulting on its obligations leaving the government holding the bag, and Bear in bankruptcy.
This is a Goodbody deal — reminiscent of when Merrill Lynch was picked as the biggest banker on Wall Street to pay $15 million to takeover Goodbody & Company to prevent a possible market collapse back in 1970. In the process it demanded, and received, a backstop guarantee of $30 million from the rest of the Wall Street community and made tremendous profits. This time, the Federal Reserve has put together a bailout that appears to significantly benefit the buyer.
I’m not questioning whether market integrity requires this: it appears that it may indeed. I’m not even criticizing JPMorgan for doing what, at least at this point, looks like a good deal.
But it galls me that on Friday, President Bush asserted that we must go slow in helping the millions of struggling American homeowners. He stated that “we got to be careful and mindful that any time the government intervenes in the market, it must do so with clear purpose and great care.” I live in Michigan and drive every day past the many foreclosures and for-sale signs. It breaks my heart that these people are struggling to keep or sell their houses, and the Fed just awarded this boon.
Homeowners may not get any meaningful government help, but at least Bear Stearns shareholders will get $2 (perhaps more) a share. Based on James F. Redda & Associates’ share ownership figures, that’s at least $13.4 million to Bear Chairman James Cayne to fund his bridge and golf hobbies.
It is with this sense of frustration that I read the JPMorgan/Bear Stearns merger agreement. It is a quirky deal, reflective of its circumstance. And it is an agreement that places the Bear on a tight leash. That’s not just because the agreement gives JPMorgan the right to direct the business of Bear in its reasonable discretion, down to having a veto right on Bear’s ability to hire, promote or terminate “employees in the position of vice president or above.” Bear will struggle under the agreement’s terms to escape JPMorgan’s embrace.
JPMorgan’s Out
JPMorgan does not have an out in the agreement for any further deterioration of Bear.
Here, JP Morgan’s comment that the agreement does not have a material adverse change clause is indeed correct. In addition, the agreement requires only the representations and warranties concerning capitalization, the execution of the agreement and the fairness opinion to be true as of the closing. In particular, the representations concerning the financial statements and no material adverse change in Bear’s business do not need to be true as of the closing. Accordingly, unless Bear deliberately breaches the agreement or the guarantee, JPMorgan is bound to complete this deal.
Bear’s Put
Bear’s shareholders will have a vote on the transaction. However, if Bear’s shareholders vote down the agreement, the companies have the obligation under Section 6.10 of the agreement to negotiate a restructuring of the transaction but not a change in the consideration and to resubmit it to Bear’s shareholders for approval. This obligation lasts until the agreement is terminated. The way the agreement works in these circumstances Bear could not terminate the agreement until the drop-dead date of March 16, 2009
The provision appears drafted quickly, and it is unclear what type of restructuring would happen (perhaps an asset purchase?), but it effectively gives Bear shareholders a put right for a year to JPMorgan. During that time Bear’s shareholders could theoretically keep voting while waiting for a better option. Whether this would actually work is uncertain, and commentators were skeptical that one would come along, but a year is a long time. About a year ago, the largest private equity buyout of all time, that of TXU for $43.7 billion, was announced. Remember that?
In any event, I’m not sure that, in normal times, the Delaware courts would uphold this type of arrangement — a repeat force-the-vote provision — but this is not a normal deal.
A Higher Bidder?
The agreement only permits the Bear board to change its recommendation if a higher bid emerges. If JPMorgan chooses, it can force Bear to wait the full year before Bear can terminate the agreement to accept a higher proposal.
Again, this would likely be struck down under Delaware law in normal times. But in any event, it is a big disincentive to any bidder, if such a bidder really wanted to challenge the Fed’s wishes.
All of this means that for a year, at least, Bear is bound to JPMorgan unless JPMorgan frees it. Thereafter, a higher bid can be accepted.
The Building
Ah, the beautiful, new headquarters building. In section 6.11 of the agreement, JPMorgan was granted an option to purchase Bear’s headquarters for $1.1 billion. But the option is exercisable only if the agreement is terminated by: 1) JPMorgan if the board of Bear changes its recommendation with respect to the transaction, 2) JPMorgan if Bear breaches its obligations under the Fed and JPMorgan guarantees in bad faith, and 3) JPMorgan, if there is a breach of the agreement by Bear or by JPMorgan or Bear if the agreement is terminated after the one-year anniversary thereof and another bid is pending at the time.
Effectively, this means that Bear keeps the building unless it breaches the agreement or another bid appears that Bear recommends or otherwise is pending when the agreement is terminated. And for those who think this type of arrangement looks familiar, a stronger type of asset lock-up was used in Dynegy’s failed bid for a failing Enron.
The Fairness Opinion
Apparently Lazard gave Bear a fairness opinion on this deal. Well, that is likely to be one caveated opinion. In any event, once again the current uselessness of these opinions is highlighted. What a waste of a few million dollars.
The Bankruptcy Option
Is bankruptcy a better option? Well, Bear would have to sell off its brokerage operations and any other operations that did not qualify for a Chapter 11 reorganization. Brokerages can file to liquidate only under Chapter 7.
The big question is whether Bear’s shareholders would make out better in a bankruptcy. Here, there is a good example: Drexel Burnham. Drexel filed for Chapter 11 and went into a runoff mode with everything put into a liquidating trust run by the distressed credit managers. Highly illiquid securities and equity trades were separately placed into a new vehicle called New Street run by four bankers from Drexel. Separately, the officers of Drexel settled with the Resolution Trust by giving up their partnership interests in Drexel’s private equity funds and some severance and other vested benefits. The Drexel Brokerage unit was sold to permit a Chapter 11 filing. It took a number of years, but the unsecured creditors were made whole.
Is this a viable process to follow here? Who knows. The fees alone would be in the hundreds of millions, and the assets of Bear uncertain. But I suspect someone is crunching these numbers now. In any event, this is not an outcome the Fed appears to want, and so Bear’s options were limited.
Alliance Data Systems
On Monday, I surmised that it would be a great day for Alliance Data Services to announce the termination of its deal. I was half wrong. ADS instead issued a press release again accusing Blackstone of breaching their agreement. If ADS wanted to shame Blackstone into closing, this was pretty much the worst day to try and do so. An unsolicited suggestion: Next time, do it on a slow news day and give David Faber a few hours’ notice. Nevertheless, given the poor case ADS has, I suspect the company is simply posturing to try and collect part of the Blackstone’s $170 million reverse-termination fee.
Billionaire media mogul and longtime Democrat Barry Diller condemned the Obama administration for targeting JPMorgan Chase on Tuesday.
Diller angrily wondered why the government would fleece a record $13 billion from a bank
he believes handled itself “quite well.”
he believes handled itself “quite well.”
“Where is it actually going?” Diller asked at the DealBook Conference, referencing the rumored $13 billion in settlement money sought by the Department of Justice for JPMorgan’s trading in toxic bonds. “A relatively small portion of it goes to people who were actually harmed, but the vast majority of it goes to the government.”
. “A relatively small portion of it goes to people who were actually harmed, but the vast majority of it goes to the government.”
What is the point of taking money from shareholders and shipping it to the government for — what purpose?” he asked incredulously.
Diller is chairman and senior executive of InterActiveCorp, a massive media and Internet conglomerate worth nearly $4 billion. He is also a strong supporter of President Barack Obama and the Democratic Party, shelling out $72,500 to support them last year.
But he had little love for Obama on Tuesday, arguing that his administration likely went after the bank “because of [JPMorgan's] own vulnerability — because [JPMorgan] probably can’t stand to fight it.”
At issue are the vast supply of bad mortgage-backed securities sold to investors by Washington Mutual and Bear Stearns in the years leading up to the 2008 financial crisis. JPMorgan acquired these banks after they went bankrupt, but only did so at the strong urging of the federal government.
by Washington Mutual and Bear Stearns in the years leading up to the 2008 financial crisis. JPMorgan acquired these banks after they went bankrupt, but only did so at the strong urging of the federal government.
“You certainly can’t be responsible for being induced to buy two banks in the “Great Problem Years,’” Diller said, “and be responsible for their practices during that period as if it was the fault of your governance.”
in the “Great Problem Years,’” Diller said, “and be responsible for their practices during that period as if it was the fault of your governance.”
Once JPMorgan took over the new banks, Diller says it played by the rules. “What did they know, when did they know it, and what did they do about it?” he asked. “In every one of those cases — every one that is public — they did the correct thing.”
He also rejected the notion that Jamie Dimon, JPMorgan’s CEO, should have sought explicit legal protection from the federal government before purchasing the two banks. Diller says Dimon tried to get a guarantee against prosecution but “couldn’t get it.”
, should have sought explicit legal protection from the federal government before purchasing the two banks. Diller says Dimon tried to get a guarantee against prosecution but “couldn’t get it.”
“They pressed him anyway,” he continued, “and he did the thing that, essentially, various people were ordered to do.”
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