Bear Acquisition Brings JPMorgan a Prime Broker for Hedge Funds

Date: Tuesday, March 18, 2008
Author: Katherine Burton and Edgar Ortega, Bloomberg.com

Michael Corcelli, manager of Miami- based Alexander Alternative Capital LP, was preparing last week to switch his hedge fund's brokerage account from floundering Bear Stearns Cos.

With the announcement over the weekend that New York-based JPMorgan Chase & Co. will buy Bear for $240 million -- and the promise from Chairman Jamie Dimon that the third-largest U.S. bank by assets will guarantee Bear Stearns's obligations -- Corcelli says there's no reason to leave.

``It's all about the people and the relationships,'' he said.

Other clients, including Paulson & Co., a $30 billion hedge- fund firm run by John Paulson, plan to keep Bear Stearns as their prime broker. Yesterday, the prospect that JPMorgan had picked up a profitable broker and clearing division for a bargain sent its shares up $3.77, or 10 percent, to $40.31 in New York Stock Exchange composite trading.

``As bad as things are at Bear Stearns, this is still a franchise with a lot of value,'' said William Fitzpatrick, who helps overseee $1.6 billion at Optique Capital Management in Racine, Wisconsin.

Clients, including hedge funds, withdrew $17 billion from New York-based Bear Stearns accounts in two days last week amid concerns the fifth-biggest U.S. securities firm would run out of cash. That, and the reluctance of investors to trade with Bear Stearns, forced it to agree to a JPMorgan buyout for $2 a share, 90 percent less than its market value on the previous trading day.

For JPMorgan, which last month said it was considering purchasing a prime brokerage, Bear Stearns brings it the third- largest in the business behind Goldman Sachs Group Inc. and Morgan Stanley. Prime brokers provide an array of services to hedge funds from record-keeping to lending stocks and cash.

Record Revenue

The Bear Stearns Global Equities division, which includes both clearing and prime brokerage, generated record revenue of $3.36 billion last year, even as clients moved their accounts to other companies. The shift first started in July after two Bear Stearns hedge funds that invested in securities tied to mortgages collapsed.

``When Bear passed around a circular in July saying everything was safe and secure and funding was not a problem, we recommended to all our clients to pull,'' said Bob Sloan, managing partner of S3 Partners, a New York-based company that provides financing for hedge funds. In the end, his clients withdrew $25 billion from Bear Stearns.

Margin Calls

While the future of Bear Stearns's 14,153 employees has yet to be determined, Michael Cavanagh, JPMorgan's chief financial officer, said Bear Stearns's prime brokerage is ``fully additive'' to JPMorgan's investment bank.

``They're getting a very capable staff and a lot of expertise about running a risk-based equity prime brokerage,'' said Josh Galper, a managing principal at Vodia Group LLC, a Concord, Massachusetts-based consulting firm for the financial- services industry. ``Backed by JPMorgan's liquidity and Bear Stearns's custody and clearing business, they are all of a sudden in a very strong position.''

The challenge for JPMorgan will be to ascertain whether the clients who've remained at Bear Stearns have the cash on hand to meet margin calls if their positions deteriorate, said Larry Tabb, president of Tabb Group LLC, a Westborough, Massachusetts-based financial-services consulting firm.

``They would really have to take a close look at customer defections and the assets that Bear has on hand,'' Tabb said. ``What is the collateral and what do the margin levels look like?''

Corcelli, who runs a fund that trades stocks, bonds and currencies as a way of betting on macroeconomic trends, said he received a call from Bear Stearns yesterday morning saying business was continuing as usual.

His fund doesn't use leverage, but he says funds that do probably won't be able to borrow as much with JPMorgan as their counterparty.

``I will be shocked if they lend with the same aggressiveness after such a scary event,'' Corcelli said.

To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net; Edgar Ortega in New York at ebarrales@bloomberg.net