Credit Meltdown gaining momentum--Subprime Uncertainty Fans Out Bear's Hedge Funds Are Basically Worthless;More Bond Fire Sales
By KATE KELLY , SERENA NG and MICHAEL HUDSON
July 18, 2007; Page C1
Investors in two troubled Bear Stearns Cos. hedge funds that made big bets on subprime mortgages have been practically wiped out, the Wall Street firm said yesterday, in more evidence of the turmoil in this corner of the bond market.
Bear said one of its funds was worth nothing and another worth less than a 10th of its value from a few months ago after its subprime trades went bad, according to a letter Bear circulated and to people briefed by the firm. The Wall Street investment bank -- known for its bond-trading savvy -- has had to put up $1.6 billion in rescue financing.
The revelations marked another anxious day for subprime investors. As a market index that tracks the performance of subprime bonds hit new lows, signs emerged that the pain experienced by Bear's hedge-fund investors is being felt by investors around the world.
Wall Street firms yesterday circulated at least a dozen lists of subprime-related bonds they planned to hastily sell to investors. Some of the assets were from a fund managed by Basis Capital, a large hedge-fund manager based in Australia, and were put on the block by Citigroup Inc. and J.P. Morgan Chase & Co., according to people familiar with the matter.
Basis Yield Alpha Fund last week informed its investors it had lost around 14% in June. Another fund, called Basis Pac-Rim Fund, was down 9.2% that month. Basis said the declines came after bond dealers abruptly marked down the value of the securities, which it said were "otherwise fundamentally sound."
Investors are struggling to place values on assets tied to subprime home loans. Because some of these instruments aren't actively traded, investors worry that they are holding securities on their books at values that are no longer accurate.
• What's Next: How low will the key ABX index, which tracks subprime bonds, go? It hit a new low yesterday."The Funds' reported performance, in part, reflects the unprecedented declines in the valuations of a number of highly rated" securities, Bear brokers wrote in a letter disseminated to clients yesterday.
Last week, Moody's Investors Service and Standard and Poor's, the two big credit-rating services, knocked down their assessments on hundreds of mostly lower-rated subprime-backed bonds.
Delinquencies and defaults have been rising on subprime mortgages -- which are taken out by borrowers with shaky credit backgrounds. Some of these mortgages were subject to fraudulent loan documentation when they were written.
The problems haven't filtered into the stock market, which hit new records yesterday. But the mortgage-bond market is filled with uncertainty, and investors show signs of aversion to risky corporate bonds, too.
"Right now things are starting to come unglued," said Charles Gradante, co-founder of hedge-fund consultant Hennessee Group.
The net value of assets in Bear's highly indebted fund, High-Grade Structured Credit Strategies Enhanced Leverage Fund, is wiped out, according to people familiar with the matter, who were briefed on the contents of a late-afternoon call with brokers. The net value of assets in its other, larger, less-leveraged fund is roughly 9% of the value at the end of March, these people said. The net-asset value represents the value of an investor's holdings after debts have been paid.
The funds invested in mortgage-backed securities and collateralized-debt obligations, which are bundles of bonds. The funds also made other bets in the debt markets through various derivative investments.
In March, before their sharp losses, the enhanced-leverage fund had $638 million in investor money, while the other fund had $925 million.
The funds' net values, which took more than two weeks to calculate because of the fluctuating values in the market for risky, or subprime, mortgage securities, came amid another tumultuous day for the broader mortgage market.
The ABX index, which tracks the performance of various classes of subprime-related bonds, hit new lows yesterday. In the past few months, the portions of the index that tracked especially risky mortgage bonds with junk-grade ratings had been falling. But now, the portions of the index that track safer mortgage bonds, with ratings of triple-A or double-A, are also falling sharply.
The portion of the index that tracks triple-A subprime debt issued last year has fallen about 5% in the past week. The portion of the index that tracks low-rated triple-B bonds is down more than 50% this year.
Investors have been buzzing for days, trying to explain the latest losses in the ABX index, which signaled a deepening panic in the mortgage market. Several factors have been at play, including the ratings downgrades.
It also could have been related to mortgage-backed-securities holders' hedging of positions by making bets against the index. Or it could have been because speculators are betting the subprime woes will worsen.
The index isn't a perfect indicator of the health of these securities, because it represents only a narrow slice of the subprime-bond market, and it isn't widely traded. Nevertheless, investors are watching it closely.
"The decline in the ABX indexes has been significant, and certainly some people are panicking and shorting it further because many assets they own are going down in value," says Alan Fournier of hedge fund Pennant Capital, which has been betting against the subprime market.
Several traders said Calyon, the investment-bank division of French bank Credit Agricole SA, was active in the market. In a May conference call, bank officials said some of its dealings in collateralized debt obligations -- which are bundles of bonds sometimes holding subprime mortgages -- had "suffered from the crisis" in subprime. It could have been forced to hedge against exposure by taking positions that pushed the index lower.
A Calyon spokeswoman said in a statement that the firm doesn't have any "direct exposure" to subprime home-equity loans, though it is involved in warehousing asset-backed securities that are used for CDO transactions that Calyon arranges.
In the statement, spokeswoman Virginie Ourceyre said the asset-backed securities market "has been volatile since the middle of the first quarter. Since then, Calyon has not originated any new ABS CDO deals." She added that Calyon has been "actively managing its credit-trading books."
Treasurys End Down as Bernanke Is Awaited
The U.S. Treasury bond market had a jumpy day as subprime worries lingered. Prices ended lower as investors remained cautious ahead of Federal Reserve Chairman Ben Bernanke's testimony before Congress today and tomorrow.
At 3 p.m., the benchmark 10-year note was down 9/32 point, or $2.8125 per $1,000 face value, at 95 18/32. Its yield rose to 5.078% from 5.043% Monday, as yields move inversely to prices. The 30-year bond shed 16/32 point to yield 5.161%.
"There's the fear that Bernanke is going to be once again hawkish over the next few days," said Tom di Galoma, managing director and head of Treasurys at Jefferies & Co., referring to concerns that the Fed chief could continue to stress the risks to the economy from inflation.
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