Bear Stearns (BSC) and JP Morgan (JPM) filed their S-4 today. These documents, which are required SEC filings in all public mergers, describe the “background” that led to the merger agreement, and this one makes particularly riveting reading. Dealbook’s Steven Davidoff has a breakdown, and we offer the unexpurgated (and annotated) version below.
But here’s one of the most salient and mysterious points:
On the morning of Friday, March 14th, when the Bear Stearns crisis neared its apex, the New York Fed agreed to backstop a loan that JP Morgan agreed to make to Bear to “stabilise” the firm. The Fed’s involvement here was critical: JP Morgan would not have agreed to the loan without the Fed’s help. The news of the emergency JP Morgan loan spooked Bear investors, who were already nervous, and they smashed Bear’s stock into the $30s. At that point, however, the firm was still solvent–the loan from JP Morgan and the NY Fed provided plenty of liquidity.
That evening, however, someone in the government changed their mind:
Bear Stearns and JPMorgan Chase were informed by the New York Fed that the New York Fed-backed secured lending facility that had been entered into earlier that day would not be available on Monday morning.
The Fed’s pull-out killed the JP Morgan loan, which, in turn, forced Bear Stearns into a desperate fire-sale-or-bankrupcty process, which resulted in the emergency sale to JP Morgan. The Fed’s change of heart, therefore, triggered the final death throes of the firm.
So what happened? Who ordered the New York Fed to pull out? Ben Bernanke? Hank Paulson at Treasury? Was Hank Paulson so worried about being accused of a “bail-out” that he ordered the Fed to renege on its deal and force Bear Stearns into a fire-sale? Did Ben Bernanke, after getting the first blast of “bail-out” criticism on Friday, decide he had to let the firm die? Inquiring minds want to know!
In the meantime, here’s the official, sanitised, and largely unexpurgated version of how Bear Stearns died:
THE DEATH OF BEAR STEARNS
On Monday, March 10, 2008, Moody’s Investors Service (referred to as Moody’s) downgraded certain series of mortgage-backed debt issued by the Bear Stearns Alt-A Trust, and rumours began to circulate in the market that there were significant liquidity problems at Bear Stearns itself. Later that day, Moody’s clarified that it had not taken any rating action regarding Bear Stearns’ corporate debt rating and that Bear Stearns’ current ratings outlook was stable. Following the close of the market, Bear Stearns issued a press release denying the market rumours regarding its liquidity position.
On the morning of Tuesday, March 11, 2008, in an effort to alleviate liquidity pressures in funding markets, the New York Fed announced an expansion of its securities lending program under which, beginning on March 27, 2008, it would lend up to $200 billion of Treasury securities to primary dealers, which includes Bear Stearns, for a term of up to 28 days to be secured by a pledge of certain securities, including certain mortgage-related assets. Despite the New York Fed’s announcement, the prior day’s clarifying statement by Moody’s and the press release issued by Bear Stearns, market speculation regarding Bear Stearns’ liquidity position continued.
In light of these developments, late in the afternoon of March 11, 2008, senior management of Bear Stearns decided that Alan D. Schwartz, President and Chief Executive Officer of Bear Stearns, should address the market speculation regarding Bear Stearns’ liquidity position in an interview with CNBC on Wednesday, March 12, 2008.
THE EXODUS BEGINS
On the morning of Wednesday, March 12, 2008, Mr. Schwartz participated in the CNBC interview and addressed Bear Stearns’ liquidity position as relatively unchanged since the beginning of the year as contrasted with the unwarranted market rumours and speculation. [TRANSLATION: ALAN SCHWARTZ DID NOT LIE ON CNBC]. During the course of that day, however, an increased volume of customers expressed a desire to withdraw funds from, and certain counterparties expressed increased concern regarding maintaining their ordinary course exposure to, Bear Stearns, causing senior management of Bear Stearns to become concerned that if these circumstances accelerated Bear Stearns’ liquidity could be negatively affected.
Later that evening, senior management of Bear Stearns discussed with representatives of Lazard issues raised by continued market speculation regarding Bear Stearns’ liquidity position and the resulting customer withdrawals and counterparty concerns regarding maintaining ordinary course exposure to Bear Stearns. Lazard had been asked by Bear Stearns in late 2007 to assist Bear Stearns in exploring potential joint ventures and/or strategic business relationships in certain Bear Stearns business units.
On Thursday, March 13, 2008, The Wall Street Journal reported that, in reaction to the increasingly negative market perception regarding Bear Stearns’ liquidity position, trading counterparties were becoming cautious about their dealings with, and exposure to, Bear Stearns. Also during that day, various reported events contributed to increased market concern regarding liquidity in the mortgage-backed securities markets. Over the course of the day, and at an increasing rate in the afternoon, an unusual number of customers withdrew funds from Bear Stearns and a significant number of counterparties and lenders were unwilling to make secured funding available to Bear Stearns on customary terms, which resulted in a sharp deterioration in Bear Stearns’ liquidity position.
During the evening of March 13, 2008, Bear Stearns senior management met with its legal and financial advisors to review the events of the day, the sharp deterioration in its liquidity position, and options potentially available to Bear Stearns. Following this meeting, Mr. Schwartz contacted James Dimon, Chairman and Chief Executive Officer of JPMorgan Chase, to discuss Bear Stearns’ liquidity position and seek funding assistance or a business combination. JPMorgan Chase and Bear Stearns have for many years had a number of commercial relationships, including JPMorgan Chase acting as Bear Stearns’ collateral clearing agent. Bear Stearns’ representatives also advised the New York Fed and the SEC of the situation.
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Later that night, the board of directors of Bear Stearns held a meeting at which senior management reviewed and discussed with the board the developments regarding Bear Stearns’ liquidity position, including the possibility that Bear Stearns would not be able to meet its liquidity needs the next day absent identification of sufficient funding sources. The board of directors agreed to reconvene early the next morning so that management could provide an update on its efforts to secure funding assistance.
THE NEW YORK FED AGREES TO BACKSTOP A JP MORGAN LOAN TO BEAR
Representatives of JPMorgan Chase and officials from the U.S. Treasury Department, the New York Fed and the Board of Governors of the Federal Reserve System engaged in discussions regarding how to resolve the liquidity deterioration at Bear Stearns. These discussions continued throughout the night. JPMorgan Chase made it clear during these discussions that it could not loan funds to Bear Stearns on an unassisted basis. Ultimately, JPMorgan Chase agreed to provide to Bear Stearns a secured lending facility for an initial term of up to 28 days under which JPMorgan Chase would provide funding to Bear Stearns. JPMorgan Chase’s secured lending facility was supported by a non-recourse, back-to-back loan from the New York Fed through its discount window.
Also during the evening of March 13, 2008, at Bear Stearns’ direction, Lazard began contacting other parties to determine their potential interest in providing financing to Bear Stearns or, alternatively, in taking other action intended to stabilise the company, such as purchasing a business unit of Bear Stearns or acquiring Bear Stearns. Later that night, Lazard reported to the senior management of Bear Stearns that there was no significant interest from the parties it had contacted, with the exception of one potential bidder, Bidder A, a private equity firm that had indicated an interest in exploring a potential transaction with Bear Stearns.
During the morning of Friday, March 14, 2008, the board of directors of Bear Stearns met to receive an update from senior management regarding its efforts to identify funding sources and to authorise entry into the proposed secured lending facility from JPMorgan Chase. Later that morning, Bear Stearns issued a press release announcing that it had obtained this secured lending facility and that it was discussing permanent financing and other alternatives with JPMorgan Chase.
Around noon on March 14, 2008, Bear Stearns senior management held a public investor conference call to discuss the secured lending facility that had been announced that morning and the deterioration in Bear Stearns’ liquidity position. Bear Stearns also disclosed that it had retained Lazard to explore strategic alternatives for Bear Stearns in light of Bear Stearns’ current circumstances.
In the afternoon of March 14, 2008, Standard and Poor’s, Moody’s and Fitch Ratings issued press releases stating that as a result of the deterioration in Bear Stearns’ liquidity position, each had downgraded the long-term and short-term credit ratings of Bear Stearns to BBB/A-3, Baa1/P-2, and BBB/F3, respectively, and that each agency was continuing to review Bear Stearns’ ratings with consideration to further potential downgrades. These new ratings represented two to four notch downgrades from Bear Stearns’ ratings as of the prior day.
Throughout the day of Friday, March 14, 2008, Lazard also spoke with other parties regarding their potential interest in a strategic transaction with Bear Stearns. Lazard met with senior management of Bear Stearns to discuss the results of its contacts with other parties and reported that, aside from Bidder A and JPMorgan Chase, none of the parties expressed meaningful interest, although two other parties had indicated an interest in conducting due diligence. Bear Stearns prepared an electronic dataroom to permit potential bidders to conduct due diligence. Later in the afternoon and evening of March 14, 2008, Bidder A conducted due diligence at Bear Stearns’ headquarters.
Despite the Bear Stearns announcement on Friday morning regarding the New York Fed-backed secured lending facility from JPMorgan Chase and that Bear Stearns was discussing permanent financing and other alternatives with JPMorgan Chase, throughout the day, customers continued to withdraw funds at an increasing rate, counterparties continued to seek to reduce their exposure to Bear Stearns also at an increasing rate, and Bear Stearns’ common stock closed down 47% from the previous day’s closing price.
THE FED WELCHES
On Friday evening, Bear Stearns and JPMorgan Chase were informed by the New York Fed that the New York Fed-backed secured lending facility that had been entered into earlier that day would not be available on Monday morning. Also on Friday night, a government official advised Mr. Schwartz that a stabilizing transaction needed to be accomplished by the end of the weekend. In light of this information and the actions of customers, counterparties, lenders and other market participants, Bear Stearns’ senior management concluded that it would not be possible to open for business on Monday, March 17, 2008, without obtaining substantial alternative sources of funding and that Bear Stearns’ only options were to consummate a transaction over the weekend or file for bankruptcy by Monday morning.
During the morning of Saturday, March 15, 2008, the senior management of each of Bear Stearns and JPMorgan Chase, as well as their respective financial advisors, Lazard and JPMorgan Securities Inc., met at the Bear Stearns headquarters to discuss various aspects of a potential transaction between the two companies, and JPMorgan Chase conducted due diligence regarding Bear Stearns. Throughout the day, representatives of Lazard and Bear Stearns continued to have discussions with JPMorgan Chase and other parties regarding their interest in a potential transaction with Bear Stearns. Bidder A, JPMorgan Chase and two other parties that were potentially interested in acquiring certain Bear Stearns assets had been invited to the Bear Stearns headquarters to conduct due diligence. Representatives of JPMorgan Chase and Bidder A met separately with Bear Stearns’ management in the morning and continued to conduct due diligence throughout the day. During the course of the day, the two other parties indicated that they were not interested in pursuing a transaction with Bear Stearns and consequently did not perform due diligence. Bear Stearns’ management and legal and financial advisors continued discussions with representatives of JPMorgan Chase and Bidder A and assisted in providing those parties with information necessary for them to prepare their respective proposals for a transaction with Bear Stearns. Lazard noted that certain other parties with possible interest in a transaction with Bear Stearns indicated that they were not in a position to submit a proposal within the required timeframe.
During the course of the day on Saturday, March 15, 2008, a separate team of Bear Stearns representatives and Bear Stearns bankruptcy advisors met to analyse potential bankruptcy and/or liquidation scenarios, taking into account, among other things, the significant limitations on bankruptcy relief and automatic stay protections available to stockbroker businesses under the United States Bankruptcy Code, as well as the liquidation provisions of the Securities Investor Protection Act of 1970 applicable to insolvent or bankrupt broker-dealers, and the risks associated with such scenarios. Bear Stearns’ bankruptcy advisors continued to prepare for the possibility that a bankruptcy filing might be necessary late Sunday if a transaction could not be agreed upon.
Around noon on March 15, 2008, the board of directors of Bear Stearns met to review with senior management the events of the previous day and to discuss Bear Stearns’ liquidity position and the status of due diligence meetings and discussions with each of Bidder A and JPMorgan Chase.
In the afternoon of March 15, 2008, Bidder A presented a preliminary proposal to Lazard for a transaction with Bear Stearns. Bidder A’s proposal involved a cash infusion of $3 billion into Bear Stearns in return for a 90% equity interest in Bear Stearns, with the existing Bear Stearns stockholders diluted to 10% ownership on a pro forma basis. The proposal also required a $20 billion credit facility from a consortium of banks that had not yet been formed and assurance that the New York Fed would make loans available to Bear Stearns through its discount window for a period of one year. At the time, the New York Fed’s discount window was not available to primary dealers such as Bear Stearns. Lazard discussed this preliminary proposal with Bear Stearns’ senior management, who gave permission to Bidder A to contact financial institutions to ascertain if they would be interested in participating in the credit facility.
In the evening of March 15, 2008, representatives of JPMorgan Chase met with representatives of Lazard and Bear Stearns. At this meeting, after noting that JPMorgan Chase still had significant diligence and analysis yet to be completed, representatives of JPMorgan Chase informed Lazard that their current thinking was a business combination with Bear Stearns in which Bear Stearns common stock would be exchanged for JPMorgan Chase common stock having an implied value range of $8 to $12 per share of Bear Stearns common stock.
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JPMorgan Chase also contemplated an option to purchase Bear Stearns common stock in an amount representing 19.9% of the then outstanding shares and options to purchase the prime brokerage business unit of Bear Stearns and the Bear Stearns headquarters building. The JPMorgan Chase representatives noted that their thinking at this stage was still preliminary, that JPMorgan Chase was still awaiting additional input from its due diligence teams, and that the value of the transaction could be lower than $8 per share (but in any event would not be higher than the indicated implied value range) depending upon the outcome of due diligence.
During the evening of March 15, 2008, the board of directors of Bear Stearns met to review the preliminary indications of interest from each of Bidder A and JPMorgan Chase regarding a potential strategic transaction with Bear Stearns. Senior management recommended that it would be advisable at this stage to pursue both indications of interest.
Later that evening, representatives of JPMorgan Chase and Bear Stearns met again. At this meeting, Bear Stearns indicated that it was willing to continue discussions with JPMorgan Chase, but that any merger transaction with JPMorgan Chase could not, under the circumstances, be subject to any material conditions. Specifically, Bear Stearns noted that customary closing conditions relating to the accuracy of representations and warranties and the absence of a material adverse change in the business of Bear Stearns could not be conditions precedent to completion of a transaction between JPMorgan Chase and Bear Stearns. Bear Stearns requested that JPMorgan Chase produce draft documents for such a proposed merger transaction as soon as possible. JPMorgan Chase acknowledged that it understood Bear Stearns’ desire for certainty that JPMorgan Chase would close a merger transaction with Bear Stearns. JPMorgan Chase also stated that any transaction that did not deliver a high degree of certainty of closing to JPMorgan Chase would be highly problematic.
Late in the evening of March 15, 2008, Bidder A informed Lazard that it would have to revise its preliminary proposal because it was having difficulty identifying financial institutions willing to provide the debt financing necessary to implement its proposal.
Representatives of both JPMorgan Chase and Bidder A remained at the Bear Stearns headquarters until early in the morning of Sunday, March 16, 2008, during which time each party continued to conduct due diligence and hold discussions with Bear Stearns’ representatives and its legal and financial advisors regarding a potential transaction.
In the early morning of Sunday, March 16, 2008, representatives of the legal advisor of JPMorgan Chase delivered to Bear Stearns and its representatives a draft agreement and plan of merger and a draft stock option agreement. In addition, representatives of the legal advisors of Bear Stearns and its board of directors and representatives of the legal advisor of JPMorgan Chase discussed various issues regarding the draft transaction documents.
Also during the morning of March 16, 2008, Bidder A continued to seek to identify one or more financial institutions to purchase either or both of Bear Stearns’ prime brokerage and derivatives businesses in order to enable Bidder A to present a formal proposal to Bear Stearns, and two large financial institutions with which Bidder A had been speaking arrived at Bear Stearns’ headquarters to conduct due diligence. One of these parties was reviewing the prime brokerage and derivatives businesses, and the other party was working with Bidder A on evaluating financing options related to the Bear Stearns headquarters.
Later that morning, representatives of JPMorgan Chase informed Lazard that JPMorgan Chase had concluded that it was not in a position to effect an acquisition of all of Bear Stearns because of the risks such a transaction would impose on JPMorgan Chase. JPMorgan Chase reported to Lazard that it had not abandoned its efforts to undertake a transaction, but that in order to proceed it would need some level of financial support from the New York Fed. In that same time frame, representatives of JPMorgan Chase similarly informed the U.S. Treasury and the New York Fed of its conclusions. The representatives of the U.S. Treasury and the New York Fed encouraged JPMorgan Chase to continue to work towards a transaction.
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A team of Bear Stearns’ legal and financial advisors continued to analyse potential bankruptcy and/or liquidation scenarios throughout the day on March 16, 2008.
Throughout the late morning and afternoon, JPMorgan Chase held discussions with the New York Fed regarding the possibility of government support. The New York Fed indicated that it would be willing to consider the possibility of an arrangement that would result in the New York Fed assuming some of the risk associated with the Bear Stearns balance sheet and the consequences of combining the Bear Stearns balance sheet with the JPMorgan Chase balance sheet. As a result of these discussions, it was agreed that as part of a transaction, the New York Fed would provide $30 billion of non-recourse funding secured by a pool of collateral consisting primarily of mortgage-related securities and other mortgage-related assets and related hedges.
Throughout the remainder of the afternoon and into the early evening of March 16, 2008, representatives of Bear Stearns and Lazard continued their discussions with representatives of both JPMorgan Chase and Bidder A regarding the terms and conditions of their respective proposals, and the respective legal advisors of Bear Stearns and JPMorgan Chase discussed and negotiated the terms of the draft transaction documents for the proposed transaction between Bear Stearns and JPMorgan Chase. These discussions also addressed the need for JPMorgan Chase to guaranty certain obligations of Bear Stearns effective immediately upon the signing of definitive transaction documents to restore the confidence of Bear Stearns’ customers, counterparties and lenders.
During this time, the board of directors of Bear Stearns met continuously at the Bear Stearns headquarters to review and consider the proposals from JPMorgan Chase and Bidder A and the terms of draft transaction documents for the proposed transaction with JPMorgan Chase and to receive periodic updates regarding the progress and status of discussions between the parties and their respective advisors. The board of directors also reviewed with senior management and its legal and financial advisors, among other things, the substantial deterioration in Bear Stearns’ liquidity position during the previous days, management’s view that Bear Stearns would not be able to open for business on Monday without a transaction that restored market confidence in Bear Stearns, and the necessity of a bankruptcy filing in the event that Bear Stearns was unable to reach an agreement with either of the bidders and the risks associated with such a filing. Among other things, the board was advised by management and its financial and legal advisors that if a bankruptcy filing was to be made, Bear Stearns would not be able to commence trading operations in Asia and would have to make disclosure of that fact not later than the open of business in Asia in the early evening New York time. The board was updated on the efforts of Bear Stearns’ bankruptcy advisors who had been working through the weekend to prepare for a filing before the open of the financial markets on Monday.
By mid-afternoon on March 16, 2008, Bidder A indicated that it had not been able to obtain support from the New York Fed for its proposal, and it had not been successful in acquiring commitments from third party financial institutions to fund the secured credit facility required for its offer. Representatives of Lazard and Bear Stearns continued to work with Bidder A on its proposal, but Bidder A was unable to provide a viable proposal for a strategic transaction with Bear Stearns within the required timeframe.
Later that afternoon, Lazard reported that, based on the New York Fed’s willingness to provide the $30 billion special funding facility, JPMorgan Chase thought that it would be able to work towards negotiating a stock-for-stock merger with Bear Stearns with an implied value of $4 per share of Bear Stearns common stock, subject to its ability to finalise the terms of the non-recourse funding facility with the New York Fed. Shortly thereafter, representatives of JPMorgan Chase contacted Lazard and informed Lazard that JPMorgan Chase was prepared to pay merger consideration consisting of JPMorgan Chase common stock having an implied value of $2 per share. Bear Stearns registered its objections to the proposed merger consideration and suggested that JPMorgan Chase consider whether it would increase the merger consideration by adding consideration of a contingent nature. JPMorgan Chase informed representatives of Bear Stearns that, following JPMorgan Chase’s discussions with government officials, it was unwilling to increase the $2 per share merger consideration.
The board of directors of Bear Stearns subsequently convened again. Senior management of Bear Stearns and its legal and financial advisors reviewed with the board of directors of Bear Stearns the terms of JPMorgan Chase’s merger proposal and the terms and conditions of the related transaction documents. The transaction was
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structured as a stock-for-stock merger at a fixed exchange ratio of 0.05473 shares of JPMorgan Chase common stock for each share of Bear Stearns common stock, which reflected an implied value of $2 per share of Bear Stearns common stock based on the closing price of JPMorgan Chase’s common stock on March 14, 2008. Additionally, JPMorgan Chase would guaranty Bear Stearns’ trading and certain other obligations, and the New York Fed would provide supplemental funding of up to $30 billion secured by a pool of collateral consisting primarily of mortgage-related securities and other mortgage-related assets and related hedges. Further, JPMorgan Chase would also obtain an option to purchase Bear Stearns common stock in an amount representing 19.9% of the then outstanding shares and an option to purchase the Bear Stearns headquarters building, each upon the occurrence of certain events.
Representatives of Bear Stearns’ legal advisors reviewed the fiduciary duties of the board of directors, including the duties of directors if a company is insolvent or approaching insolvency. Based on information provided by Bear Stearns’ management, its legal advisors and Lazard regarding Bear Stearns’ financial position, the expected treatment of its businesses, assets and financing arrangements in a bankruptcy proceeding and the expected actions of its customers, counterparties, creditors, employees and regulators in the context of a bankruptcy, the board of directors was advised by Lazard, Bear Stearns’ legal advisors and management that it was their collective view that, in the event of a bankruptcy of Bear Stearns, the holders of Bear Stearns common stock likely would receive no value and there likely would be losses incurred by certain creditors of Bear Stearns.
Representatives of Lazard reviewed with the board of directors their efforts to identify potential buyers for all or part of Bear Stearns and their contacts with other parties in this regard. Lazard indicated that none of these other parties submitted a viable proposal for acquiring or investing in Bear Stearns. Lazard advised, and indicated that it was prepared to render its written opinion to the Bear Stearns board of directors to the same effect, that as of such date and based on and subject to various assumptions, procedures, factors, limitations and qualifications in its opinion (some of which would be non-customary due to the unique circumstances in which the merger was negotiated), the exchange ratio of 0.05473 was fair, from a financial point of view, to holders of Bear Stearns common stock.
Following Lazard’s oral presentation to the board, representatives of Bear Stearns’ legal advisors summarized the material terms of the proposed agreement and plan of merger and the related transactions. Following consideration of the proposed terms of the agreement and plan of merger and the related transactions, and after extensive discussions, including discussions with its financial and legal advisors, the Bear Stearns board of directors unanimously approved the agreement and plan of merger and the related transactions and recommended that the Bear Stearns stockholders vote in favour of the approval and adoption of the agreement and plan of merger. The Bear Stearns board of directors then directed management to execute the agreement and plan of merger and the related transaction agreements. In the early evening on Sunday, March 16, 2008, JPMorgan Chase and Bear Stearns entered into the agreement and plan of merger and the stock option agreement and JPMorgan Chase issued the guaranty of Bear Stearns’ trading and certain other obligations. Later that evening, JPMorgan Chase and Bear Stearns issued a joint press release announcing the transaction.
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