Bear Stearns Removes Spector After Debt Market Losses (Update3)

Date: Tuesday, August 7, 2007
Author: Bradley Keoun and Jody Shenn, Bloomberg

Aug. 6 (Bloomberg) -- Bear Stearns Cos. ousted Co-President Warren Spector after errant trades that led to the collapse of hedge funds tied to the slumping housing market.

The board of the nation's fifth-biggest securities firm named Alan D. Schwartz, 57, as sole president, the company said in a statement yesterday. Spector, 49, was responsible for fixed income, equities, commodities and asset management, and was viewed by analysts as the top candidate to succeed 73-year-old Chief Executive Officer James E. Cayne.

Bear Stearns, founded on Wall Street in 1923, has lost 30 percent of its stock market value this year and analysts are starting to question leadership at the New York-based firm. While Cayne said on an Aug. 3 conference call that the company was ``solidly profitable'' in June and July, Standard & Poor's said Bear Stearns's debt ranking may be cut because of declining earnings from losses in bonds backed by residential mortgages.

``Spector is the person most associated with making decisions in the mortgage and fixed-income business at Bear Stearns, and that's where the problems are,'' said Richard Bove, an analyst at Punk, Ziegel & Co. in Lutz, Florida, who has a ``sell'' rating on the company's stock. By removing Spector, the management is acting as if it ``didn't know what was going on, and that is just totally unsupportable. If there is no oversight system, people should be looking at Jimmy Cayne.''

Leadership Changes

Cayne said in yesterday's statement that ``we have determined to make changes in our leadership structure.'' CNBC reported earlier today that Cayne has no desire to step down, citing an interview with the CEO. Spector declined to comment.

Shares of Bear Stearns rose 5 percent to $113.81 in New York Stock Exchange composite trading, rallying late in the day as financial stocks gained on speculation the government may take steps to limit losses in mortgage lending.

Bear Stearns triggered a decline in the credit markets in June after two of its hedge funds faltered as default rates on home loans to people with poor credit rose. For subprime mortgages turned into securities, defaults hit a 10-year high.

The company pledged $1.3 billion to help stem losses in the funds. They filed for bankruptcy protection on July 31, two weeks after Bear Stearns told investors they would get little, if any, money back. The firm then blocked investors from pulling money from a third fund as losses in the credit markets expanded beyond subprime-mortgage securities.

`Got Away'

``The fact that this thing got away from them raises questions about controls and oversight of the firm,'' Bove said. ``The top management at Bear hasn't really changed for a decade, and these guys have gotten comfortable in their positions.''

Cayne has headed the firm since 1993 when he took over as CEO from Alan ``Ace'' Greenberg, who ran the company for about 15 years. Spector was ``the day-to-day head of the firm, and there were a lot of serious problems that set back the asset-management business significantly,'' said David Hendler, head analyst for financial companies at CreditSights Inc., an independent research firm in New York.

``Cayne is reasserting his authority and laying the blame,'' Hendler said. ``He's trying to reassure debt and equity investors that there's a depth of managerial talent and new bench in place to be in charge of the businesses.''

Surprised Spector

The New York Times reported yesterday on its Web site that Cayne called Spector into his office on Aug. 1 and asked for his resignation. The decision surprised Spector, the Times said, citing people who were briefed on the conversation.

Schwartz joined Bear Stearns in 1976, and became head of the investment-banking division in 1985. He was named co-president with Spector in 2001. In the management shakeup, Chief Financial Officer Samuel Molinaro, 49, was given the additional role of chief operating officer, Bear Stearns said. Jeffrey Mayer, co- head of fixed income, replaces Spector on the executive committee.

Spector becomes the highest-ranking executive at a New York- based securities firm to lose his job since mortgage defaults started increasing more than a year ago.

The son of a Holocaust survivor, Spector joined Bear Stearns in 1983 after graduating from St. John's College in Annapolis, Maryland, and receiving a master's degree in business from the University of Chicago. He started in the bond division and became one of the firm's first mortgage traders.

Spector, who grew up in the Washington suburb of Chevy Chase, Maryland, became friendly with Cayne because of their mutual affection for bridge and helped manage the fixed-income department before being promoted to co-president.

Charity Poker

At a Wall Street charity poker game in 2005, prizes included lunches with Spector and Lloyd Blankfein, the 52-year-old chairman and CEO of Goldman Sachs Group Inc., the biggest U.S. securities firm by market value.

Spector, who was paid $36.9 million in 2006, warned last year that defaults on subprime mortgages were increasing. He said earlier this year that losses would be limited unless they spread through the housing market. Bear Stearns was the eighth-largest underwriter of subprime bonds in the first half, according to industry newsletter Inside MBS & ABS.

``The biggest question is whether or not it has a broader impact on the housing market,'' Spector said at a meeting with analysts in March. ``Unless that happens, and there's not enough evidence for us to think that's happening, I don't see it as a big event.''

Overly Dependent

Spector hadn't done enough to build up the rest of Bear Stearns's trading businesses, leaving the firm too dependent on mortgage bonds, Hendler said.

``He should have been more well-rounded,'' Hendler said. ``He continued to be very much a mortgage-type of guy. When you're being groomed for CEO, you've got to branch out your strategic vision and not rely on your previous successes and previous career track.''

Since the two hedge funds collapsed in June, Bear Stearns has replaced the head of asset management, Richard Marin. Bear Stearns hired Lehman Brothers Holdings Inc. Vice Chairman Jeffrey Lane, 65, a Wall Street veteran with four decades of experience, to take Marin's job.

S&P cut its outlook on Bear Stearns's A+ credit rating on Aug. 3 to ``negative,'' citing concern about the mortgage market's effect on earnings. A reduction would leave Bear Stearns with the lowest rating of the five biggest U.S. securities firms. Only New York-based Lehman underwrites more mortgage bonds than Bear Stearns.

Swap Index

An index of credit-default swaps tied to 20 subprime mortgage bonds rated AAA and created in the second half of 2006 fell 1.8 percent to a new low of 88 on Aug. 3, according to index administrator Markit Group Ltd. The ABX-HE-AAA 07-1 index dropped more than 11 percent since June, suggesting a similar decline in the value of the bonds. All other ABX indexes are at record lows, with some losing more than 60 percent of their value.

Bear Stearns executives, including Cayne, tried to ease shareholder concerns after S&P's announcement. The firm faces ``an extremely challenging market environment'' and is ``taking this situation seriously,'' Cayne said on the conference call.

``I've been involved in the securities industry for more than four decades, and I have seen a broad spectrum of market dislocations,'' he said. ``In the stock market crash in the late '80s, fixed-income troubles in the mid '90s, and the bursting of the Internet bubble in 2001, this is not the first time and certainly will not be the last time that Wall Street and the financial community will work through difficult conditions.''

Bank Credit

Treasurer Robert Upton said on the call that the company has unused committed secured bank lines of more than ``$11.2 billion, $4 billion of which is available to be drawn on an unsecured basis.''

The comments didn't help Bear Stearns shares as they fell 6 percent, leading a slide in Wall Street stocks. The 12-member Amex Securities Broker/Dealer Index closed Aug. 3 at 214.35, the lowest in almost 11 months. The perceived risk of owning Bear Stearns bonds rose to the highest in at least six years.

Credit-default swaps based on $10 million of Bear Stearns bonds surged $35,000 to $155,000, according to broker Phoenix Partners Group in New York. An increase signals deterioration in investor confidence. Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt.

S&P said in its Aug. 3 report that Bear Stearns has enough cash and other assets to meet short-term funding requirements.

Return on Equity

Return on equity for the current quarter may be near the historical lows for the firm, Bear Stearns's Molinaro said on the call. It has ranged from 12 percent to 20 percent, according to Merrill Lynch & Co. analyst Guy Moszkowski. Bear Stearns's return was 15.6 percent in the quarter ended in May.

Molinaro, who has been in the securities industry for 22 years, said the fixed-income market was ``as bad as I've seen it.''

The company has a ``relatively high degree'' of reliance on the U.S. mortgage and leveraged-finance markets, and its revenue and profit would be hurt if there is a prolonged decline, according to S&P.

At the current share price, Bear Stearns trades at about 1.2 times book value, or assets minus liabilities. The average Wall Street stock trades at about two times book value.

Merrill's Moszkowski wrote in a June 22 report to clients, two days after Bear Stearns disclosed the hedge fund losses, that the company might fetch two times book value in a takeover. The stock traded at $144 at the time. Bear Stearns would be attractive to ``large global banks looking to improve their U.S. capital markets position,'' Moszkowski wrote.

The company's market value has since tumbled to about $15 billion from $22 billion. That's almost half of Lehman and less than a fifth of Goldman Sachs.

Bear Stearns's ``reputation has suffered from the widely publicized problems of its managed hedge funds, leaving the company a potential target of litigation from investors who have suffered substantial losses,'' S&P said on Aug. 3.

To contact the reporters on this story: Bradley Keoun in New York at bkeoun@bloomberg.net ; Jody Shenn in New York at jshenn@bloomberg.net .