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Bear Stearns

The investment bank, which is being shredded by the seemingly endless repercussions of the subprime mortgage collapse and subsequent credit crunch, has lost nearly two-thirds of its value over the past year. Bear is the second-largest underwriter of mortgage-backed-securities debt after Lehman Brothers.

New Chief Executive Alan Schwartz appeared on CNBC Wednesday to allay fears that the firm faces a liquidity crisis, a perception heightened by the Federal Reserve's decision on Tuesday to loan up to $200 billion in Treasury bonds to primary dealers, a move that would allow Bear to swap some of its mortgage-backed securities for more secure debt.

"Our balance sheet has not weakened at all," said Schwartz, noting that Bear's $17 billion cash position was the same as it had been in November. On Monday, the company posted a similar message on its web site: "The company stated that there is absolutely no truth to the rumors of liquidity problems that circulated today in the market."

News of the pending implosion of Carlyle Capital, a $21.7 billion bond fund traded in Amsterdam, helped fuel the pile-on effect at Bear, which is one of its lenders. The fund announced Wednesday that a new financing deal had fallen apart and that it "expects that its lenders will promptly take possession of substantially all of the Company's remaining assets" after a week of margin calls in excess of $400 million. It had defaulted on $16.6 billion worth of mortgage-backed debt as of Wednesday.

Other Carlyle lenders include Bank of America, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, J.P. Morgan Chase and UBS.

Punk Ziegel analyst Richard Bove on Tuesday cut his 12-month target price on the stock to $45 from $67 a share. The company is scheduled to report first-quarter earnings March 20.

The Analysis

Bear's swift and savage skinning shows just how open-ended the effects of the subprime collapse have been for the firm, more than a year after rumblings about mortgage troubles started.

Two Bear Stearns mortgage-backed securities hedge funds collapsed last June, and criticism over then CEO James Cayne's handling of that crisis led to his resignation this January.

More recently, its Carlyle troubles have boosted the cost of its credit default swaps, driving a five-year protection on debt default up to 700 basis points by Thursday, from 400 basis points on Friday. Credit default swaps are complex transactions designed to spread the risk of debts turning bad.

"There's just fear over what their capital base is today, and what Schwartz was trying to do when he went on CNBC was get rid of the fear in the marketplace," says Ryan Lentell, an analyst with Morningstar.

Punk Ziegel's Bove wrote Wednesday in a separate note that none of the five bulge-bracket banks Bear, Lehman, Goldman Sachs, Merrill Lynch or Morgan Stanley could expect an end to write-downs in the current quarter. The analyst added "the hoped for recovery for the second fiscal quarter (ends in May) is not likely to appear," and "these companies are likely to experience declines in activity until 2010."

In a March 4 preview note, Wachovia analyst Douglas Sipkin pointed out that Bear's reliance on fixed income gave it less diversity than its competitors.

The collapse of that business, which probably won't show growth for another five years, puts Bear in a tight spot that requires a merger and a new business model, Bove wrote in a Tuesday note.

"Bear Stearns did a superb job in capturing the benefits that accrued from the last cycle," he wrote. "That cycle is gone, however, and the new one will not be driven by the same characteristics as the old. Bear Stearns must adjust and it is probably going to be forced to find a merger partner."

The Bottom Line

There's not much middle ground for Bear. When a CEO is forced to make repeated pronouncements about liquidity to reassure the market, there's an equal chance his words will have the opposite effect.

"It could become a self-fulfilling prophecy," Morningstar's Lentell warns.

Bove gave the firm full credit for a growth spurt that nearly tripled share values between the end of 2002 and the start of 2007, writing that its "key strength in the old cycle was capturing the revenue growth in the mortgage markets. Its genius was to maximize the profits from this growth."

When that cycle collapsed, "unfortunately, Bear did not get out of the way fast enough. Consequently, its balance sheet, its business operations and its reputation were all hurt badly" and its borrowing costs rose sharply, he wrote.

Now, Lentell warns that any investor tangling with Bear could very well be mauled.

"At this point, we believe the outcomes surrounding Bear are bimodal," he wrote Thursday. "Either its rumored liquidity problems will quickly pass, in which case, we believe its stock now trading at approximately 65% of book value is severely undervalued. However, if liquidity concerns have basis or the perception of liquidity problems persist (and counterparties are unwilling to trade with Bear), its intrinsic value would be significantly impaired."

Investors should look to next week's earnings call to see if the wounded firm can come roaring back.