Subprime Woes Pinch Bear's Mortgage Star
Risky Fund's Big Loss Forces a Bond Auction; Goldman Profit Diverges
By KATE KELLY and SERENA NG
June 15, 2007; Page C1
At a financial conference in late February, Ralph Cioffi, a senior hedge-fund manager for Wall Street firm Bear Stearns Cos., said that a meltdown in the subprime-mortgage market was "unlikely to occur."
He spoke too soon.
Five days after the conference, an index tracking subprime mortgages, the riskiest piece of the mortgage market, fell to its lowest point ever. And in recent months, the riskier of the two funds he runs for Bear Stearns, the $600 million High-Grade Structured Credit Strategies Enhanced Leverage Fund, tumbled in value amid a surge in home-mortgage defaults.
Mr. Cioffi, 51 years old, has been at Bear for 22 years and is a mortgage-market veteran. But his riskier fund lost nearly one-fourth of its value in the first four months of this year. In recent days, lenders led by Goldman Sachs and Bank of America began making margin calls on the fund, requesting additional cash or collateral.
Yesterday, seeking to raise the cash, Mr. Cioffi's funds auctioned off nearly $4 billion in some of their highest-quality mortgage bonds. The auction went smoothly, but now Cioffi's funds are left holding riskier investments that could be harder to sell. Wall Street was watching the sale closely yesterday, fearing the market could soon be flooded with low-quality mortgage securities in the weeks to come.
Whether the Bear sale raised enough money to meet redemption requests and margin calls -- requests from lenders for additional cash or collateral -- remains to be seen. Late yesterday, a number of creditors for the two funds met with its managers, but the outcome of the meeting wasn't known.
The downturn in the subprime market spilled over into Bear's fiscal second-quarter earnings yesterday. The firm posted lower-than-expected earnings of $362 million, or $2.52 a share, for its second fiscal quarter, which ended May 31. After adjusting for a $227 million write-down on Bear's exchange-floor trading business, the firm earned $3.40 a share, 9% lower than the same period last year and 10 cents lower than analyst expectations.
Contrasting with Bear's woes, Goldman, which has less exposure to the mortgage market, beat analyst expectations by a significant margin. Buoyed by robust investment-banking activity and growth overseas, Goldman reported a profit of $2.33 billion, or $4.93 a share, a 1% rise from the same period last year and 14 cents a share above analyst estimates of $4.79 a share.
Yet, both Goldman and Bear yesterday sounded one common chord: that continued troubles in the mortgage market remain a big worry.
With the sort of weakness investors are seeing in the subprime market, "there's no hedging strategy you're going to be able to employ that's going to completely immunize you," said Sam Molinaro, Bear's chief financial officer, in an interview. Investors have made big profits on subprime loans in recent years, and losses on risky mortgage loans "are to be expected," he added. "While you don't like to have them, it's a fact of life in the business."
In a call with reporters, Goldman finance chief David Viniar was even blunter. "I don't think we've seen the bottom" of the subprime problems, he said.
Bear, which is known for its tough risk controls, has so far been unable to navigate its way out of the turmoil. This raises the specter that other Wall Street funds are sitting on big losses that could crop up in the days and weeks ahead. Bear itself and a handful of top firm executives have only $40 million invested in Mr. Cioffi's funds, with the rest of the money belonging to clients.
Bear's $4 billion auction was well-received by the market, according to mortgage traders, with a number of parties bidding for the portfolio of high-grade assets at prices fairly close to the loans' estimated values. The bidders included brokers, managers of collateralized debt obligations and some hedge funds.
In a sign of the market's stability, Merrill Lynch & Co. launched an offering of roughly $1.6 billion of new securities backed by subprime loans. It generated significant investor interest, according to one market participant.
Bear is selling 150 different bonds from the two of Mr. Cioffi's funds. One of the funds had around $600 million in equity and $6 billion in loans to finance its bets. The other fund had more than $1 billion in investments, and the amount of leverage it has is unclear.
The assets on the block yesterday were the most stable and liquid ones, with very strong credit ratings of double-A and triple-A -- meaning they have a very low risk of default. These assets, which are essentially bonds backed by thousands of home loans, have largely maintained their market value over the past few months and weren't the cause of the losses in the Bear funds.
From January to the end of April, the fund with $600 million in equity has lost 23% of its value. The other fund, which is less leveraged, is down about 5%.
The funds still own a number of collateralized-debt obligations, pools of hundreds of mortgage-backed bonds. CDO securities, unlike the assets they hold, are less liquid and hard to trade or price in the secondary market.
Goldman, meanwhile, reported its slowest profit growth in three quarters, as net revenue, revenue minus interest expense, from its important fixed-income business fell 24% to $3.37 billion in the second quarter. Investment-banking net revenue rose 13% to $1.72 billion. Overall, the firm reported net revenue of $10.18 billion, down 1% from the year-earlier level.
Bear's Fund Is Facing Mortgage Losses
Bond Sale Set for Today in Attempt to Raise Cash;
Woes Could Be Another Sobering Sign for Market
By KATE KELLY and SERENA NG
June 14, 2007; Page C1
A hedge fund managed by Bear Stearns Cos. is scrambling to sell large amounts of mortgage securities, a setback for a Wall Street firm known for its savvy debt-market trading.
The fund makes bets on bonds backed by mortgages, many of which are subprime, meaning they go to especially risky borrowers.
Faced with losses on its investments, the fund, called High-Grade Structured Credit Strategies Enhanced Leverage Fund, together with a sister fund, is trying to sell about $4 billion in mortgage-backed bonds to raise cash, according to people close to the fund and traders who have been solicited to buy the bonds.
The sales represent a sliver of the $7 trillion residential-mortgage-backed bond market, but it is still a large amount to be sold at one time and a potentially troubling sign for the broader mortgage-backed bond market.
In a separate matter, Bear, a feisty company run with a hands-on approach by Chairman and Chief Executive James Cayne, has also been arguing with other hedge funds over its trading desk's dealings in the mortgage-backed securities market. In part because it is exposed to the mortgage-bond business, Bear is expected by analysts to report a 6% drop in fiscal second-quarter earnings today, compared with a year earlier. (More on Bear and mortgages in Breakingviews.)
Bids for the sale of bonds are due at 10 a.m. EDT today -- shortly after Bear announces its results.
Late Tuesday, Wall Street traders began circulating a list of mortgage assets that Bear had put on the block, according to email exchanges reviewed by The Wall Street Journal. On the list were roughly 150 of the funds' most easily traded, investment-grade bonds, which are backed by subprime mortgages. The estimated value of the bonds ranges from $1 million to nearly $110 million apiece.
Yesterday, Bear directors convened for a regularly scheduled board meeting, during which they were briefed on the fund's performance and outlook. Two people familiar with the situation said if the sale isn't a success, the Enhanced Leverage Fund could ultimately be shut down.
Bear's Limited Exposure
The Bear fund, which was down 23% in value in the year through April, has more than $6 billion in assets. Bear's own exposure to it is limited. The firm and some of its executives have invested just $40 million in the fund, meaning Bear isn't likely to be hit deeply by losses if the fund's problems mount.
Other investors include wealthy individuals and other hedge funds. It is run by Ralph Cioffi, a Bear mortgage-bond veteran.
The mortgage-bond market has been a key source of profit for Wall Street, which has gone beyond simply packaging and trading these bonds to owning subprime lenders themselves and starting up hedge funds that focus on the sector.
After several years of playing heavily in the market for subprime mortgages, players like Bear now contend with falling home prices and a rise in late or missed payments on some of the shakiest mortgages. Investor concerns about these developments have led them to sell some mortgage-backed bonds, putting downward pressure on portfolios like the one run by Bear.
Bear isn't alone. Early last month, the Swiss bank UBS AG shut down Dillon Read Capital Management, an internal hedge fund, after bad trades in mortgages led to a $124 million loss.
Lots of Leverage
The Bear fund, only 10 months old, is highly levered, meaning that in addition to raising money from investors, it borrows heavily to fund its investments.
Launched last year, the fund quickly raised more than $600 million in investments, much of which was put toward the purchase of mortgage-backed securities.
Combined with around $6 billion in borrowing from a dozen major Wall Street players, including Goldman Sachs Group Inc. and Bank of America Corp., it has assets in excess of $6 billion. Goldman and Bank of America declined to comment. The sister fund, which uses less leverage, was launched four years ago and goes by a similar name, High-Grade Structured Credit Strategies Fund.
A person familiar with the situation said the fund is liquidating positions to free up cash for redemptions and to prepare for likely margin calls. A margin call is when a bank asks for repayment of its loans or more collateral as its borrowers' investments fall in value.
Last month, Bear blocked some investors from taking money out of the fund.
The fund is part of Bear's internal asset-management unit.
A Rocky Quarter
Analysts are bracing for a rocky quarter and have been edging down their forecasts for the big brokerage over the past month or so, according to data provider Thomson Financial. So far this year, Bear's stock has fallen 8% compared with a rise of about 2% for the broader Dow Jones Wilshire U.S. Financial Services Index.
As for some of its peers, Goldman is up 16% so far this year and Lehman, which also has a big exposure to the mortgage market, is down 1.1%.
Bear is a bit of an anomaly on Wall Street. As financial firms like Citigroup Inc. have built their firms through acquisitions or by significantly pushing into new business lines, from insurance to retail banking, Bear remains a singular Wall Street bond house. It is known for tight cost and risk controls and has managed to avoid a major trading blowup over the years.
The latest mortgage woes seem to be hitting the broader market.
ABX's Decline
An index tied to risky subprime bonds has in recent days plunged to lows last seen in late February. Traders say the dive in the index, called the ABX, was triggered by reports of rising delinquencies and foreclosures and a steep rise in long-term bond yields.
Rising interest rates could make it more difficult for homeowners to refinance their mortgages and could send more borrowers into default. The ABX index yesterday traded at around 62.5, down from 73 a month ago and a high of 97 early in the year, according to Markit, a data firm.
"There are concerns about investment vehicles that are seeing negative returns because of their subprime exposure," said Alex Pritchartt, a mortgage-derivatives trader at UBS Securities. "If some funds try to liquidate their portfolios and sell large blocks of securities, it could cause a backup in prices and spreads."
Bear Stearns Fund Hurt by Subprime Loans
By KATE KELLY and SERENA NG
June 12, 2007; Page C5
Hard hit by turmoil in the market for risky mortgages, a big Bear Stearns Cos. hedge fund has fallen 23% from the start of the year through late April, according to people familiar with the matter.
The performance was disclosed late last week in a letter to investors from executives at the Wall Street firm's asset-management division, these people say. The fund, called the High-Grade Structured Credit Strategies Enhanced Leverage Fund, is widely exposed to subprime mortgages, or home loans to borrowers with weak credit histories, these people add. It has $600 million under management, but as the fund's name suggests, it borrows heavily to make bigger bets. A spokeswoman for Bear Stearns wouldn't comment on the fund's performance.
While the fund is down significantly, it is hard to tell what the actual losses will be because a few good trades could bring it back into the clear. Still, given the fund's heavy exposure to this deteriorating corner of the mortgage market, in which many people are struggling to pay down their home loans, the news isn't good. Recently, the fund prevented some investors from pulling their cash.
Limited Impact on Bear
While the year-to-date performance of the leveraged fund is a blow for its managers, Ralph Cioffi and Matthew Tannin, the paper losses will have a limited impact on Bear, two people close to the situation say.
The brokerage and a group of individual executives have invested about $40 million in the fund, according to someone familiar with the matter.
The majority of the $600 million under management comes from outside investors such as hedge funds and wealthy individuals.
Trouble for Everquest IPO
Some market participants predict the fund's downturn could have a chilling effect on Bear's planned initial public offering of Everquest Financial Ltd., a holding company that contains risky assets from some Bear Stearns hedge funds, including the one with recent losses. Everquest is run, in part, by Mr. Cioffi.
Everquest was formed last fall when two credit hedge funds transferred some of their riskiest assets into the new entity.
In return, the funds received a majority stake in Everquest, which was valued at $400 million, plus nearly $149 million in cash, according to regulatory filings submitted to the Securities and Exchange Commission last month. |
