No Fallout From Bear Stearns On ETN So Far

By Matthew Hougan

News that Bear Stearns (BSC) is facing a liquidity crisis has had no major impact on the BearLinx Alerian MLP Select Index ETN so far.

JPMorgan Chase (JPM) said earlier Friday that it would supply emergency funding to Bear Stearns for up to 28 days to help the company weather a fast-developing liquidity crisis. The JPMorgan loans are being backed by the Federal Reserve Bank of New York, in yet another sign of the government's intensive efforts to forestall a lock-up in global financial markets. Bear Stearns is also looking at "permanent" financing options.

When I heard the news, my attention immediately turned to the BearLinx Alerian MLP Select Index Exchange-Traded Note (BSR). One key difference between ETNs and exchange-traded funds is that ETNs come with credit risk; if Bear Stearns becomes insolvent, holders of the BearLinx ETN will join other creditors looking for pennies on the dollar.

The JPMorgan bailout underscored the severity of Bear Stearns' liquidity crisis and I wondered if BSR would be impacted by the news.

The answer appears to be "no," although we won't know for sure until next week.

If there were to be an impact, it would show up one of two ways: 1) The note would trade at a discount to its index; 2) There would be mass redemptions.

Through the close of trading yesterday, BSR was trading almost perfectly in line with its index: The note closed at $31.90/share, while the index closed at $32.07. The note continued to trade in line with its index on Friday after the JPMorgan deal was announced.

As for redemptions, the timing of recent developments makes it a bit difficult to tell. BSR can be redeemed in large blocks from Bear Stearns at net asset value on a weekly basis. To redeem notes, investors must contact Bear Stearns on Thursday ... and the redemptions are paid out on Friday.

There were rumors about Bear Stearns' liquidity position last week, but news of the JPMorgan financing didn't occur until Friday morning ... after the redemption window had closed. So large investors reacting to the news won't be able to redeem notes until next week.

Bear Stearns said there was negligible redemption activity in BSR on Thursday. There was a lot of trading activity, though, and that activity continued on Friday: as of 12:45 p.m., more than 300,000 shares had traded hands, or 6X the average daily volume.

The big question is what will happen next week in terms of redemptions. It still seems that the likelihood of a Bear Stearns default is vanishingly small, but some investors may worry. Credit default swaps on Bear Stearns widened today to 730 basis points, meaning it costs $730,000 per year to insure $10 million of Bear Stearns debt.