Bear Stearns is looking for bagholders

http://www.businessweek.com/print/bwdaily/dnflash/content/may2007/db20070511_093244.htm

Bear Stearns' Subprime IPO
Everquest Financial is going public with risky mortgage bets purchased from its underwriter’s hedge funds
by Matthew Goldstein

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."

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