J.P. Morgan's Winning Bear Bet

3/17 - "And there you have it. The very figures JP Morgan might have had to work out a price of two bucks a share. It has gotten itself the “deal of the year,” and it's only March. It doesn’t seem quite fair, does it?

That white-shoed JP Morgan is acquiring Bear Stearns at a firesale price after 83 profitable years isn’t about fairness, of course. It’s no more complicated than this: JP Morgan has the heft, resources and $124 billion market cap to make this deal a layup."

3/17 - "BSC’s businesses are an excellent fit as JPM has long wanted a Prime Brokerage capability, ways to expand its Equity franchise, and to grow its Mortgage trading/ securitization capability to be commensurate with its origination capability...We believe that given the speed that was required, JPM was the only bidder that had enough time and information, and it clearly has Fed support based on comments in its presentation re: funding and expedited approval. This allowed for the excellent terms despite what JPM has characterized as a clean and well-managed trading book at BSC."

"Market conditions remain very difficult and despite JPM’s ability to acquire at what we believe is a distressed price, JPM still must deal with weakness in Capital Markets and consumer credit, particularly the $20 BB or so of Home Equity credit (of its $95 B total) which is experiencing sharp deterioration. And we learned some stark lessons last week: innuendo can quickly sink a firm; direct involvement of the Fed in a firm’s funding doesn’t reassure but in fact can scare counterparties away; and, the industry can’t maintain its current levels of leverage. Thus, even at much lower valuations than we have seen in years, we see little near term upside and remain Neutral on the shares of JPM."

3/17 - "...securities tied to mortgages have become all but impossible to trade...The liquidity concerns are weighing heavily on brokerage stocks Monday morning. Lehman Brothers(LEH - Cramer's Take - Stockpickr) shares are down more than 22%, after Moody's Investors Service affirmed its rating on Lehman's debt, but lowered its outlook to stable from positive...Lehman and Goldman are set to report earnings Tuesday morning; Morgan Stanley is slated to report Wednesday...Lehman is expected to record earnings of 72 cents a share, down 63%. Goldman is expected to earn $2.58 a share, down 61%, while Morgan Stanley is expected to make $1.03 a share, down 59% from last year."

"In [fourth quarter 2007] the writedowns were centered on subprime mortgages and asset-backed securities CDOs," David Trone, an analyst at Fox-Pitt, Kelton Cochran Caronia Waller, wrote in an early March note. "In [first quarter 2008] we project writedowns across leveraged loans and commercial mortgage (commercial real estate and [commercial mortgage-backed securities]) as well as more residential mortgages (Alt-A, subprime, non-U.S. mortgage and ABS CDOs.)"

"He estimates the four brokers will take a combined total of $13 billion in gross writedowns (approximately $7 billion in net writedowns) for the quarter ($5 billion related to Alt-A loans, $4 billion related to remaining leveraged loan exposure and another $4 billion for commercial mortgage exposure). The brokers took a combined net total of $12.1 billion in the fourth quarter, according to Trone."

3/17 - "American International Group, Inc. (NYSE: AIG) is down with most of the rest of the market as investors have reacted sharply to the JP Morgan Chase (NYSE: JPM) buyout of Bear Stearns (NYSE: BSC) for only $2/share. Investors seem to be worried that BSC may not be the only bank with overexposure to the troubled credit markets, and fear that the fallout from the credit crunch may spread to other industries. Any stock that has exposure to mortgage backed securities is seeing some fallout from the extremely low valuation of these assets that BSC received."

"For a bearish hedged play on this stock, I would consider an April bear-call credit spread above the $50 range. A bear-call credit spread is an options position that combines the purchase and sale of call options to hedge risk in case the stock doesn't do what you think but still leverage nice returns. For this particular trade, we will make a 4.2% return in one month as long as AIG is below $50 at April expiration. AIG would have to rise by more than 25% before we would start to lose money."