Another Subprime Mortgage Hedge Fund Halts Redemptions

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Bloomberg reports that a Key Biscayne based brokerage firm, United Capital Markets, barred redemptions on its hedge funds that invested in subprime mortgages.

This isn’t Bear Stearns redux. The firm presented the problem as simply investor jitters. Bloomberg reports that the fund suffered modest losses (5%, if you believe the valuations, which given press about CDO pricing, is becoming more of an article of faith) after a year of strong gains in 2006 (40%).

“We did that as a defensive move because we had an unusually high number of redemption requests and we didn’t want to be a forced seller in this market,” [firm spokesman Michael] Gregory said in a telephone interview. One of the redemption requests was from an investor who had put up about 25 percent of the funds’ money.

It’s not clear how large these funds are. The firm’s website indicates that it is an institutional broker specializing in all sorts of hairy paper (e.g., subordinated bonds in subprime autos, equipment leases, manufactured housing, subprime auto) and stresses its expertise in asset backed securities (the firm bought over $2 billion of ABS as a principal in the preceding twelve months). However, having 25% of the assets in a hedge fund is not a position most institutions want to be in (the vast majority of institutiional investors have policies that restrict their holdings in any one hedge fund to 10% of the fund’s assets. That’s yet another reason that hedge fund redemptions can cascade. If a withdrawal by one investor results in an institutional investor now holding more than 10% of the fund, that institution will redeem to reduce its stake to the permitted level even if it is happy with the fund’s performance).

So in light of the Key Biscayne location, the exotic mix of paper, and the factoid about the big daddy investor, my guess is that UCM;s typical clients are small money managers and independent/small firm retail brokers and the hedge funds aren’t big enough for a liquidation to have much impact on the overall market (assuming things were to get that far). I will restrain myself from saying what I think of money managers who put clients’ savings into this sort of thing.

The Bloomberg piece also cites analysts who argue that many hedge funds delayed marking down CDO prices in their portfolios until the Bear debacle broke. Indeed, quite a few stories had reported that the prevailing practice was not to revalue CDOs unless there was a rating agency downgrade.

From Bloomberg:

United Capital Markets Holdings Inc., a brokerage run by John Devaney, halted redemptions on some of its hedge funds that invest in subprime-mortgage bonds.

The funds are within the company’s Horizon Strategy group, including the Horizon ABS Fund LP, said Michael Gregory, a spokesman for the Key Biscayne, Florida-based firm.

“We did that as a defensive move because we had an unusually high number of redemption requests and we didn’t want to be a forced seller in this market,” Gregory said in a telephone interview. One of the redemption requests was from an investor who had put up about 25 percent of the funds’ money.

The decision by Devaney, 37, follows the collapse of two hedge funds run by Bear Stearns Cos., which also lost money amid a plunge in bonds backed by subprime mortgages. As the Bear Stearns funds faltered, prices of the securities tumbled on concern the bonds would be dumped on the market at fire sale prices. Owners of similar securities may face $90 billion in losses, Deutsche Bank AG analysts predicted June 29.

“People are very nervous about how deep the revaluations of these securities will have to go,” said Virginia Parker, who helps advise about $1.8 billion in client money at Parker Global Strategies LLC in Stamford, Connecticut. “These positions didn’t get marked down until June. Nobody’s hand was forced in the market until then.”

Caliber, Queen’s Walk

Caliber Global Investment Ltd., a $908 million London-listed fund managed by Cambridge Place Investment Management LLP, said June 28 that it would shut down within a year following subprime losses. Queen’s Walk Investments Ltd., a fund investing in the riskiest portions bonds backed by mortgages, reported a $91 million loss from its investments in the year ended March 31.

UBS AG, the world’s biggest asset manager, shut down its New York-based Dillon Read Capital Management LLC hedge fund unit in May in part because of losses attributed to U.S. mortgage investments.

The firm, which Devaney founded in 1999, had $619 million in assets under management as of March, according to a filing with the U.S. Securities and Exchange Commission. United Capital began as a broker-dealer specializing in low-rated and distressed asset-backed securities, collateralized debt obligations and collateralized mortgage obligations, according to its Web site.

It has since branched out into real estate and money managing, with a similar focus.

`Arbitrage Players’

Devaney prides himself on finding a bargain.

After the 9/11 terrorist attacks, United Capital “stood there waiting to make a bid” on bonds created by bundling together aircraft leases, as insurers and other investors dumped them, Devaney said in an interview in November 2006.

In times of market stress, “we figure out a bond is worth 80, and we go in and buy it for, say, 60,” he said at the time. “We’re arbitrage players.”

Fixed-income arbitrage managers try to exploit price differences between fixed-income securities.

The Horizon ABS Fund’s offshore version gained 0.27 percent this year through May 31, according to Bloomberg data. That compared with a 6.8 percent average gain by hedge funds globally and 3.2 percent by fixed-income arbitrage managers, according to Chicago-based Hedge Fund Research Inc.

The Horizon ABS offshore fund lost 5 percent from March 31 through the end of May. The fund gained almost 40 percent last year.

Delinquencies Rise

Assets managed by hedge funds globally have more than doubled over the past five years to almost $1.6 trillion as of the first quarter of 2007, according to Chicago-based Hedge Fund Research Inc. Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets and participate substantially in profits from money invested.

While prices of mortgage-backed securities were declining earlier this year, many funds probably weren’t recording those drops until the Bear Stearns funds collapsed, Parker said.

“Based on what we were hearing about the lack of liquidity and absence of bidders in the market, it’s hard to fathom that these securities weren’t worth less back in March, April and May,” Parker said. “These positions didn’t get marked down until June. Nobody’s hand was forced in the market until then.”

About 12 percent of subprime mortgages packaged into bonds were delinquent by at least 90 days, in foreclosure or already turned into seized property, according to a report today by Friedman Billings Ramsey Co. in Arlington, Virginia. That’s up from 5.37 in May 2005, and the highest since August 1997. Subprime home loans are given to borrowers with poor or limited credit histories or high debt burdens.

`News Likely’

“There is likely to be news around quarter end of more hedge funds that need to recognize large losses, possibly forcing liquidation of the funds,” Deutsche Bank analysts led by Mustafa Chowdhury wrote in the June 29 report. Chowdhury said total losses probably will range from $70 billion to $90 billion.

Bear Stearns agreed to a $1.6 billion bailout of one of its money-losing hedge fund and is liquidating a second fund after they made bad bets on securities including collateralized debt obligations, many of which were backed by subprime bonds.

After the funds reported losses, investors demanded their money back, forcing the funds to halt redemptions. Bear Stearns stepped in when lenders began seizing assets.

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