Bear Stearns: Behind S&P's Negative Call

The ratings agency cut its outlook on the company, citing continued mortgage exposure and litigation risk. Still, S&P thinks Bear has strong liquidity

On Aug. 3, Standard & Poor's Ratings Services said it revised its outlook on Bear Stearns (BSC) to negative from stable. Standard & Poor's also said that it affirmed its A+/A-1 issuer credit rating on Bear Stearns as well as its ratings on various Bear Stearns affiliates.

Notwithstanding the challenges Bear Stearns currently faces, S&P believes the company's liquidity is strong. "Still, the negative outlook reflects our concerns about recent developments and their potential to hurt Bear Stearns' performance for an extended period," notes S&P credit analyst Diane Hinton. "We believe Bear Stearns' 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."

Bear Stearns has material exposure to holdings of mortgages and mortgage-backed securities (MBS), the valuations of which remain under severe pressure. It also has exposure to debt it has taken up as a result of unsuccessful leveraged finance underwritings, and it has significant further underwriting commitments.

Overcoming Current Challenges

Broadly, we believe these direct balance-sheet exposures are not proportionately larger than those of Bear Stearns' peers. Also, despite these challenges, we expect Bear Stearns to be profitable in the current quarter. However, Bear Stearns has a relatively high degree of reliance on the U.S. mortgage and leveraged finance sectors, and its revenues and profitability would be especially affected if there were an extended downturn in those markets.

The ratings could 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. On the other hand, if Bear Stearns can overcome current challenges and effect a more rapid recovery than we currently anticipate, the rating outlook could be revised back to stable.