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Bad News Hits Bear Stearns

The stock resumes its slide as the CFO says the debt markets are 'as bad as I've seen in 22 years.'

Updated from 12:26 p.m.

Brokerage stocks were dropping sharply again Friday as

Bear Stearns

(BSC)

tried to reassure investors of its "abundant liquidity."

Bear Stearns shares fell as much as 7% early Friday after Standard & Poor's cut the outlook on Bear's credit rating to negative from stable. Bear and other brokerage stocks then bounced back at midday after Bear issued a chest-thumping press release questioning the thinking behind the ratings move.

But all the shares swooned again at midafternoon as Bear finance chief Sam Molinaro told listeners on the call that the credit market is "about as bad as I've seen it in 22 years." He said revenue during July was "under significant pressure" and indicated the firm so far is seeing the same in August.

He and other execs emphasized the firm has been seeing "substantial benefits from hedging" its exposure to subprime loans and leveraged corporate loans. But while Molinaro said the firm was profitable in June and July, he cautioned that given highly stressed market conditions, it is "reasonable to assume that June was a hell of a lot better than July."

Shares bounced off their lows at midday before later giving back some of those gains. After earlier trading down as much as $9 a share at a 52-week low of $106.55, Bear Stearns was off $6.75 at midafternoon to $108.90.

The news comes as big brokerage firms and banks have come under severe pressure with a sharp turn this summer in the capital markets. After Wall Street rose a debt financing boom to record profits in recent years, the credit markets have seized up in the wake of the subprime mortgage mess. As a result, investors worry that the firms will be stuck holding billions of dollars in bad loans.

At midafternoon Friday,

Lehman Brothers

(LEH)

was down 7% and

Merrill Lynch

(MER)

,

Morgan Stanley

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and

Goldman Sachs

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were each down 3%-4%.

Bear Stearns said in a midday press statement that it is "disappointed with S&P's decision" and called the ratings agency's questions about hedge fund problems at Bear Stearns Asset Management "unwarranted, as these were isolated incidences and are by no means an indication of broader issues at Bear Stearns."

The New York firm said its "balance sheet, capital base and liquidity profile have never been stronger." Bear said its "risk exposures to high profile sectors are moderate and well-controlled."

"S&P's action highlights the concerns in the marketplace over the recent instability in the fixed income environment," said CEO James E. Cayne. "Contrary to rumors in the marketplace, our franchise is profitable and healthy and our balance sheet is strong and liquid. Bear Stearns has thrived throughout both tumultuous and fortuitous markets for the past 84 years. We are experiencing another market cycle and we are confident in Bear Stearns' ability to succeed in this environment as it has in so many others."

S&P kept Bear's credit rating at A-plus, but the outlook change means there is a greater chance of a downgrade over the next two years. A downgrade could hit the firm hard, coming on the heels of this summer's blowup of two hedge funds that made big bets on the hard-hit market for securities tied to subprime mortgages. A third fund has stopped permitting investor redemptions.

The ratings agency says Bear's "liquidity is strong," despite challenges tied to the collapse of the subprime lending business. But S&P says its revised outlook "reflects our concerns about recent developments and their potential to hurt Bear Stearns' performance for an extended period."

S&P says Bear's "relatively small capital base, high degree of operating risk, and concentrations in fixed-income products and in the U.S. market partially offset" strengths such as competitive advantages in underwriting mortgage backed securities, commercial mortgage backed securities, asset backed and CDO/CLOs.

The ratings agency says the bank's reputation has suffered from the problems at its hedge funds, and that those problems leave the firm open to costly lawsuits from investors. Bear didn't immediately return a call seeking comment.

But the issues are not just about some wayward funds. S&P says that "Bear Stearns has material exposure to holdings of mortgages and mortgage backed securities, the valuations of which remain under severe pressure."

Bear also could suffer under the weight of committed financing tied to underwriting leveraged buyouts, says S&P.

"We believe these direct balance sheet exposures are not proportionately larger than those of Bear Stearns' peers," write S&P analysts Diane Hinton, Scott Sprinzen and Tanya Azarchs. The analysts even say they expect Bear to be profitable in the current quarter.

S&P says the negative outlook means the ratings may be lowered if "large losses were to be incurred over the next few quarters or if earnings failed to stabilize at a satisfactory level beyond the next few quarters, which we expect will be -- at best -- difficult ones for the company."

The analysts highlight the risk that an "extended downturn" in the U.S. mortgage and leveraged finance sectors would be a particularly harsh blow to Bear, as it relies heavily on those areas for revenues and profitability.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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