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I am keeping an eye on Bear Stearns (BSC). I think it is too early to buy, but I want to prepared in case a buying opportunity arises. Or, it may not.

These are among the numbers in which I am interested, according to the most recent 10-Q:

  • $12.3 billion in securities owned and pledged as collateral - which are "financial instruments ... pledged to counterparties where the counterparty has the right ... to re-hypothecate those securities."
  • $52.2 billion in mortgages and mortgage-backed securities.
  • $10.4 billion in derivatives.
  • $18.0 billion in securities valued as Level 3 securities as defined by SFAS No. 157 where Level 3 valuations are based on unobservable inputs that are not corroborated by market data. As the filing states,

    Level 3 is comprised of financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are generally less readily observable from objective sources. Included in this category are distressed debt, non-performing mortgage-related securities assets, certain mortgage-backed securities and residual interests, Chapter 13 and other credit card receivables from individuals, and complex and exotic derivative structures including long-dated equity derivatives.

    In other words, valuations based on what Bear Stearns states is the valuation. (Though, as I understand it, Bear Stearns is conservative in their valuation methodologies.)

  • $7.2 billion in retained securitization, of which $5.7 billion are investment-grade and $3.8 billion are AAA rated. Thus, $1.5 billion of retained securitizations are non-investment grade.
  • $19.6 billion, net, of contingent commitments, which are, as the 10-Q describes "provided in connection with leveraged acquisitions" though the company notes that "These commitments are not indicative of the Company's actual risk."
  • $9.5 billion in junk bonds and non-investment grade company debt.
  • A daily aggregate VAR (value at risk) of $28.7 million, ranging from a high estimate of $33.3 million to a low estimate of $22. 7 million.
  • $11.2 billion in cash.
  • Net cash capital of $2.9 billion.
  • $4.0 billion credit facility.
  • $13.1 billion in equity.
  • In the most recent quarter, 74% of revenues came from the Capital Markets division, which is comprised of Fixed Income, Institutional Equities and Investment Banking. Fixed Income accounted for the largest percentage of Capital Markets revenue at 52%, or 38% of firm-wide revenue. Fixed income is where mortgage-related securities and derivatives reside. Equities accounted for 22% of firm-wide revenue while Investment Banking was 14% of total revenues. Bear has two other divisions, Clearing and Wealth Management. Clearing was 13% of total revenues and Wealth Management 14%. Capital Markets accounted for 64% of pre-tax income, Clearing 26%, and Wealth Management 10%.

    At $108, Bear is trading 1.18x book value, below its bottom of 1.25x in 2000. However, the environment is more serious for Bear compared to the popping of the Tech Bubble because of its large holdings of mortgages, and mortgage-related derivatives. Friday's call by its CFO when Bear announced it was suspending its share buyback and S&P placing Bear on watch for a downgrade does not bode well in the near-term.

    Financials are black-boxes. Since I am not privy to the operations of Bear Stearns, I will watch for signals from the company that it is time to buy. Such signals include insider purchases, a resumption of Bear's share repurchase plan, lower than expected write-downs, etc. I will also pay attention to technical signals.

    Ultimately, the answer lies in Bear's capital preservation. If you believe the value of Bear Stearns' book will not fall, and you are a long-term investor, you buy now and you buy in size. But the risk of a write-down is high.

    Source: Bear Stearns: Watching and Waiting for a Buy Signal