Hedge fund industry hit by worst crisis in a decade
By Tom Cahill and Katherine Burton Bloomberg NewsPublished: March 10, 2008
LONDON: The hedge fund industry is reeling from its worst crisis in a decade as banks demand more money pledged to support outstanding loans even when the investment is backed by the full faith and credit of the United States.
Since Feb. 15, at least six hedge funds, totaling more than $5.4 billion, have been forced to liquidate or sell holdings because their lenders - staggered by almost $190 billion of asset write-downs and credit losses caused by the collapse of the subprime-mortgage market - raised borrowing rates by as much as 10-fold while making new claims for extra collateral.
While lenders are most unsettled by credit consisting of real estate and consumer debt, bankers are now attempting to raise the rates they charge on Treasury securities, considered the world's safest investments, because of the price fluctuations in the bond market.
"If you have leverage, you're stuffed," said Alex Allen, chief investment officer of Eddington Capital Management in Britain, which has $195 million invested in hedge funds for clients. He likened the crisis to a bank panic turned upside down - with bankers, rather than depositors, concerned they will not get their money back.
The lending crackdown is the worst to hit the $1.9 trillion hedge fund industry since Russia's debt default in 1998 roiled global credit markets and required the U.S. Federal Reserve to push the securities industry to arrange a $3.6 billion bailout of the hedge fund Long-Term Capital Management. Today, hedge funds are being forced to sell assets to meet banks' margin calls, resulting in the dissolution of the funds.
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"There has to be more in the next weeks," Allen said. "There are people who have been hanging on by their fingernails who can't hold on much, much longer."
Ivan Ross, founder of the hedge fund Tequesta Capital Advisors in Connecticut, received a call from his bankers on Feb. 22 demanding that he put up more money or risk losing his loans. Ross was unable to meet the margin call as the market for mortgage-backed debt seized up, preventing him from selling securities to raise the cash. Four days later, lenders liquidated his $150 million fund.
"Because it's impossible in this environment to move among dealers, you're at the mercy of counterparties," said Ross, who has managed hedge funds for 13 years, including a stint handling mortgage-backed debt for the billionaire George Soros. "To the extent they want to shut you down, they can."
The demise of Tequesta revealed the deathtrap for hedge funds caught in the credit maelstrom of banks selling mortgage-backed bonds as fast as they can while demanding more collateral from clients who use the securities to back loans.
On Feb. 24, Peloton Partners gave up a "night and day" effort to stave off demands from lenders, including Goldman Sachs Group and UBS, for as much as 25 percent collateral for securities that once required 10 percent, according to investors in the fund. Peloton, based in Britain and run by the former Goldman partners Ron Beller and Geoff Grant, liquidated the $1.8 billion ABS Fund, its largest.
The same day, about 5,000 miles, or 8,000 kilometers, away in Santa Fe, New Mexico, JPMorgan Chase told Thornburg Mortgage that it had defaulted on a $320 million loan because it could not meet a $28 million margin call, according to U.S. regulatory filings.
Thornburg, the home lender that lost 93 percent of its market value in the past year, was near collapse late last week after it failed to meet $610 million in margin calls.
Larry Goldstone, its chief executive, said the company had fallen victim to a "panic that has gripped the mortgage financing industry."
In Europe, Carlyle Capital, the debt-investment fund started by the private equity firm Carlyle Group of Washington, was suspended from trading Friday in Amsterdam after it did not meet margin calls and its banks seized and sold assets.
"Banks are reducing exposure anywhere they can and the shortest way to do that is to cut leverage," said John Godden, chief executive of the fund consultant IGS AIS in London.
Hedge funds are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether the price of assets will rise or fall.
The managers who trade fixed-income securities generally borrow money through repurchase agreements, or repos. In a repo, the security itself is used as collateral, just as a homeowner puts up the house as collateral for a mortgage.
Banks usually limit their risk on repos by lending less than the value of the securities used as collateral. Tequesta was able to borrow $95 on every $100 worth of AAA rated jumbo prime mortgages in early 2007, meaning the bank took a so-called haircut of $5, or 5 percent.
By last month, the amount required had risen to as much as 30 percent, Ross said. Jumbo mortgages are loans of more than $417,000, typically used to finance more expensive homes.
Carlyle said Thursday that margin prices requested for securities were not "representative of the underlying recoverable value" of its securities. Lenders started to liquidate its portfolio of $22 billion of AAA-rated, or highest-level, mortgage debt issued by Fannie Mae and Freddie Mac, the U.S. government-chartered finance companies.
"It's not a question of prime brokers deciding which firms live and which don't," said Odi Lahav, head of the European Alternate Investment Group at Moody's Investors Service in London. "They're trying to manage their own risk. There's a Darwinian aspect to survivorship in this industry."
Some managers set themselves up for a stumble by taking on too much leverage and not anticipating that terms could change, said Christopher Cruden, chief executive of Insch Capital Management in Lugano, Switzerland. "If you're going to dance with the devil, there comes a time when your toes are going to be stepped on," Cruden said. "Prime brokers are there to do business, not be your friend." |
