A Bear Stearns Smoking Gun – The Cancelled EverQuest IPO

Posted on June 26th, 2008 in Daily Stock Market / Economic News - The Real Story, Mr Mortgage's Personal Opinions/Research

Turning back the clock…

Now that that Bear Stearns has two under indictment and the company will come under even more scrutiny in the near future, I was digging through my past research looking for something that proved Bear Stearns was well aware how dire the situation was long before its Ralph Cioffi led hedge funds collapsed.

When their subprime funds went down mid-2007, I remember being absolutely floored over a story that did not get much press regarding another Bear Stearns owned fund called EverQuest Financial. This fund was buying distressed subprime debt (from Bear of course), and they were hastily planning an IPO when it all unraveled.  Then all of a sudden the IPO was cancelled, press releases disappeared from news sources such as Bloomberg and everyone forgot about EverQuest. Perhaps this could be that smoking gun that proves Bear was saying one thing while doing the other. Remember, its no crime that Cioffi lost money however it is a crime if he misled investors.

On the surface, it looks like Bear’s plan with EverQuest was to pump it full of Bear Stearns failing subprime assets then IPO it and sell this toxic garbage to unsuspecting investors. Then, among all of the chaos when Bear Stearns was at the top of the headlines regarding its failed Cioffi subprime funds, the IPO was instantly pulled. In all the turmoil that followed, very little was written about this and very few even remember. I do. This story is definitely worth a read. -Best Mr Mortgage

The New York Times June 20, 2007

Never underestimate the ability of a Wall Street investment firm to find a new way to pawn off risky assets onto retail investors. The latest example? The initial public offering for Everquest Financial.

Everquest is a fledgling financial-services company that has been buying up equity interests in risky bonds backed by subprime mortgages from hedge funds managed by Bear Stearns (BSC)—one of Wall Street’s biggest underwriters of mortgage-backed securities and other exotic mortgage-related bonds. The deal appears to be an unprecedented attempt by a Wall Street house to dump its mortgage bets.

The sales pitch for the IPO, which Bear Stearns is also underwriting, is that Everquest will “provide attractive risk-adjusted returns” to shareholders by investing in collateralized debt obligations (CDOs)—a sophisticated bond that’s made up of pieces of lots of other asset-backed bonds. The nine-month-old company expects to produce reliable earnings from the quarterly cash flows generated by the underlying “financial assets” in the 19 CDOs it either owns outright or has a majority equity interest in. Everquest’s portfolio of CDOs is valued at about $720 million, of which nearly two-thirds were purchased last fall from hedge funds managed by Bear Stearns Asset Management, a subsidiary of the Wall Street firm.

But Everquest’s portfolio could be a time bomb. A “substantial majority” of the CDOs are backed by mortgages to home buyers with risky credit histories, according to its filing with the Securities & Exchange Commission.

Trouble is, the subprime market has imploded this year with scores of home lenders going out of business and home foreclosures on the rise. There’s fear on Wall Street that pain in the subprime housing market will undermine some of the bonds and CDOs backed by these mortgages—especially as the level of home loan defaults rises.

The Everquest filing notes this possibility, saying: “Subprime mortgages have experienced increased default rates in recent periods. A deterioration in the assets collateralizing the asset-backed securities held by our CDOs could negatively affect the cash flows.”

No Arm’s Length Transaction

The prospectus for every IPO contains a lengthy section entitled “risk factors.” The purpose of this section is to make it difficult for investors to sue a company. It alerts them to all the things that could go wrong with a company’s business model. Often much of what appears in the “risk factors” section is boilerplate stuff about the perils of operating in a competitive market, or a company’s slim operating history.

But the risk factors section of the Everquest IPO—spread out over 21 pages—would give even the most high-stakes gambler reason to pause. That’s especially so in light of the close relationship between Everquest and Bear Stearns.

The filing notes that most of the CDOs were bought from hedge funds managed by Bear Stearns and based on valuations established, in part, by Bear Stearns. The filing concedes that the transaction, in which Bear Stearnshedge funds received 16 million shares in the soon-to-be public company and $149 million in cash, was “not negotiated at arm’s length.”

That’s not to say Everquest got a raw deal in buying up these CDOs from Bear Stearns. But the lack of a give-and-take negotiating process in assembling Everquest’s investment portfolio is an indication of just how beholden the company is to the interests of Bear Stearns.

In fact, Everquest, which is based in New York but incorporated in the Cayman Islands, intends to operate with a minimum of employees. Other than an independently hired chief financial officer, Everquest mainly will rely on employees from Bear Stearns Asset Management to oversee the business.

Some Proceeds Will Pay Down Debt

Also running the show will be employees from Stone Tower Capital, a partner in the venture. Ralph Cioffi, a Bear Stearns senior managing director, will serve as co-chief executive, along with Michael Levitt, chairman of Stone Tower, a New Yorkhedge fund. In fact, Everquest and Stone Tower have the same mailing address on West 57th Street in Manhattan.

Everquest also has a $200 million line of credit from Citigroup (C), from which it borrowed to pay for some of the CDO purchases. Some of the proceeds from the IPO will be used to pay down the line of credit.

The company isn’t saying how many shares will be sold in the offering or who will do the selling. Presumably, some of the 16 million shares obtained by the Bear Stearns hedge fund will be included in the deal. Additionally, Bear Stearns itself purchased 1 million shares. The stock has yet to price.

Janet Tavakoli, a Chicagofinancial consultant who specializes in advising clients on asset-backed investments, isn’t impressed with the Everquest offering. “There is a huge moral hazard with Bear providing the assumptions for valuing the CDO equity,” says Tavakoli. “Bear Stearns Asset Management is very good at surveillance, so if it is trying to get CDO equity off of its balance sheet, incur the costs of securitization, and sell the risk without arm’s length valuation, why would a customer want to buy it on that basis?” Bear Stearns declined to comment for this story.

The Everquest filing could be just the start of things to come for the CDO market, which has grown exponentially in recent years, largely because of the demand for bonds backed by mortgages. Last year about $158 billion in CDOs were sold, up from just $14 billion in 1996. In April, Highland Financial Partners, a CDO manager, filed for an IPO. If Bear Stearns can find buyers for Everquest shares, it’s likely that other Wall Street banks with big exposure to the subprime market may follow its lead.

 

14 Responses to “A Bear Stearns Smoking Gun – The Cancelled EverQuest IPO”

  1. […] Original post here […]

  2. Janet Tavakoli, a Chicagofinancial consultant who specializes in advising clients on asset-backed investments, isn’t impressed with the Everquest offering. “There is a huge moral hazard with Bear providing the assumptions for valuing the CDO equity,” says Tavakoli. “Bear Stearns Asset Management is very good at surveillance, so if it is trying to get CDO equity off of its balance sheet, incur the costs of securitization, and sell the risk without arm’s length valuation, why would a customer want to buy it on that basis?”

    Why? Because some bullish fools will get tricked into buying this crapola…and Bear Stears and Everquest will over-value the fund (lie) the same way banks, underwriters, realtors and 90% of homeowners have overvalued homes for the past 6 years. Its nice to know that Citi is helping them finance this sham, while laying of staff left and right. Here’s a question…how blatantly corrupt must these folks become before the media hypsters (CNBC, et al.)finally have to come out and tell the truth about these Wall Street assholes and their ridiculous scams? It’s like their sense of entitlement is such that they feel they should continue to make mountains of dough, even after they’ve melted down what was left of our economy. I am hoping for a bunch more frog marches in the coming months.

  3. Umm.. would this not be like Fannie and Freddie buying their own loans, repackaging and selling them?

  4. Mr Mortgage is a true American Hero along with Ron Paul and other truth tellers. This American ‘don’t worry, be happy’, crap, will be gone in the aftermath of this preventable financial destruction & its fallout.

  5. The truth is that nothing changed after the internet bubble and ENRON Tyco and Parmalat. They just switched to another piece of worhless crap to criminally inflate. It will never change. Never.

    Now the problem is much more horrible because they are stuck with 62 trillions of credit default swap, and 1,14 quadrillion of derivatives. These firms are fantastic at promoting crap. Wonder what’s next the next crap they will find ?

    Futures contrats on thrid world country organs ? Hey they should float the idea to China. I am sure the generals would be excited. Iran bomb derivative contrat ?

    Love this expression; “moral hazard”. It’s so funny ! It’s like talking about a prostitute’s virginity.

    The credit default swap on GM are exploding in price. Double trouble ahead. The year of Bear Stearns and the Big Bad Bear. Violence Rated: B.B.B.

  6. Relax, folks! – everything is going according to (Zionism’s) plan (the complete destruction of the West’s economic system and the lives of millions of Americans and others). Ashes, ashes…we all fall down. When the dust settles and the reality sinks in, Americans will smoke out every one of those guilty, nasty Zionists – and hang ’em high! Meanwhile, Annie get your gun! 😉

  7. PS There will be red rivers (of blood) flowing from Here to Eternity!

  8. FED, Facist Economic Development. Here where is the relation. When Lenin took power in Russia, the first thing he did was to destroy the currency. His recognized goal; destroy the bourgeoisie and money savings of owners. When Hitler took power, the same thing had happened before with the fascist industrialist and bankers under the Weimar Republic. Bernanké that twit does not remember history. The source of communism and nazism; extreme currency devaluation and destruction of money and savings. This criminal organization called the FED, is a treat to democracy and to the world. You can see it every day. The middle class is dying in the US.

  9. Wow, Everquest would have been a fun one to short if the IPO had ever gone through.

  10. This Mr. Mortgage is a persistent bugger! As soon as I deposit a pearl of truth, he comes along a little later (Thank God for that ‘little later’) and tramples it with his big Zionist shill cloven hoof! 😉 He wants us to not ask (WHO DID IT) and not tell (that it was Zionists).

    Remember folks – Zionists did it! (and are STILL doing it – or did Bush fire Whirly Ben for treason?)

  11. […] A Bear Stearns Smoking Gun – The Cancelled EverQuest IPOThis fund was buying distressed subprime debt (from Bear of course), and they were hastily planning an IPO when it all unraveled. Then all of a sudden the IPO was cancelled, press releases disappeared from news sources such as Bloomberg … […]

  12. […] A Bear Stearns Smoking Gun – The Cancelled IPO Some of the proceeds from the IPO will be used to pay down the line of credit. The company isn’t saying how many shares will be sold in the offering or who will do the selling. Presumably, some of the 16 million shares obtained by the … […]

  13. […] week I put out a post called A Bear Stearn’s Smoking Gun, the Cancelled EverQuest IPO, . The title speaks for itself… I feel a Bear Stearns fund called Everquest owned by Bear […]

  14. http://www.vanityfair.com/politics/features/2008/08/bear_stearns200808?currentPage=2

    Cioffi, was a Bear lifer, who commuted to oversee two hedge funds at Bear Stearns Asset Management, an affiliate known as B.S.A.M. His main fund, the High-Grade Structured Credit Strategies fund, plowed investor cash into complex derivatives backed by home mortgages. For years he was spectacularly profitable, posting average monthly gains of one percent or more. But as the housing market turned down in late 2006, his returns began to even out. Like many a Wall Street gambler before him, Cioffi decided to double-down, creating a second fund. Whereas the first borrowed, or “leveraged,” as much as 35 times its available money to trade, the new fund would borrow an astounding 100 times its cash.

    It blew up in his face. As the housing market worsened during the winter of 2006–7, Cioffi’s returns for both funds plummeted. He urged investors to stay put, promising an imminent turnaround. (Cioffi and a colleague, Matthew Tannin, were indicted in June for misleading investors.) When the market downturn accelerated last spring, leaving Cioffi with billions of dollars in money-losing mortgage-backed securities no one would take off his hands, he concocted an audacious way to rescue himself, planning an initial offering for a new company called Everquest Financial that would sell its shares to the public. Everquest’s main asset, it turned out, was billions of dollars of Cioffi’s untradable securities, or, as Wall Street termed it, “toxic waste.”

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