The Wall Street Journal, in “Barclays Spars Over Its Losses at Bear Stearns,” discusses how Barclays is wrangling with Bear over what may be as much as $400 million in losses related to the failure of its two hedge funds run by Ralph Cioffi.
The article is remarkably unclear as to what exactly the disputes it about. What the Journal missed saying explicitly, and the Financial Times has said, almost from the very beginning of this sorry tale, was that Barclays was more exposed than other players by virtue of providing a separate facility that allowed risk-seeking investors to achieve even more leverage. An update in the June 29 FT article provided some details:
The new [Enhanced Leverage] fund was created after Barclays Bank in London agreed to provide a financing facility of up to three times investor capital through an over-the-counter derivative, according to people familiar with the structure.
Bear trumpeted the borrowing facility when it was agreed last year, telling investors that it gave the fund more flexibility and was “better quality leverage” than previous funding.
Enhanced Leverage had attracted $638m from investors by the end of March, which it geared up more than 10 times using a mixture of repo financing and the Barclays facility, documents sent to investors show
While the Journal did not appear to have gotten to the bottom of the Bear-Barclays relationship (it suggests Barclays may also have invested in the fund), Towards the very end of the story, the writers endeavor to describe how the facility worked, but it’s an inept description that makes it sound as if Bear on a routine basis would step up as an equity investor for a fee (ie, while that may be the economic result from the investor’s viewpoint, there in no mention of a derivative). However, they did learn that Barclays imposed restrictions on Bear pursuant to providing this vehicle, including limits on non-investment grade securities and CDOs, and the fund apparently violated some of these requirements.
The incomplete reporting may reflect the Journal’s desire to break this story. At this hour, I don’t see a similar item on Bloomberg, the FT, or the New York Times.
From the Wall Street Journal:
Signaling the frustration among investors who were hurt by bad bets on the risky subprime-mortgage market, Barclays PLC is sparring with Bear Stearns Cos. over a loss that could be as high as $400 million, according to people familiar with the matter.
Barclays is a onetime supporter of a hedge fund at Bear, the Wall Street firm, that put billions of dollars into subprime securities.
It’s a bitter turn to what had been a strong relationship. London-based Barclays, one of the world’s biggest banks, wore several hats in its dealings with Bear Stearns Asset Management’s High-Grade Structured Credit Strategies Enhanced Leverage Fund, say people with knowledge of the fund’s inner workings. Barclays lent the fund about $200 million, these people say, and later offered an additional $250 million. The bank or investors — and possibly a combination of both — who bought a Barclays’ product also invested hundreds of millions of dollars in the fund.
In a recent statement, Barclays said that it had “some” exposure to the Bear fund but that it doesn’t believe the amount to be material.
Firms like Barclays and Bear not only compete for some of the same business, but behind the scenes they also extend one another credit, team up for private-equity investments, and, in the case of Barclays, put its own money — or that of investors using Barclays’ products — into a Bear hedge fund.
Barclays’ $200 million loan has been paid off, say people familiar with the matter, and the subsequent $250 million infusion it offered ultimately wasn’t extended. But with Bear’s announcement Tuesday that the assets in the enhanced fund are at this point essentially worthless, Barclays is reviewing its options for recovering $400 million that it invested in the fund separately from the loan, the people familiar with the matter say. The possibilities: arbitration, or a negotiated settlement, or litigation.
“I would be astounded if there weren’t lawsuits, given the magnitude and speed of the collapse,” says Scott A. Meyers, who focuses on the securities and hedge-fund industries at Levenfeld Pearlstein LLC in Chicago and represents clients who invested in the Bear Stearns hedge funds. “The fundamental issue will be what caused the collapse, a general market event, something specific to the way these funds were managed, or some combination of the two.”
Attorney Ross Intelisano, who represented a group of investors who lost $20 million when the Connecticut hedge fund Bayou Management LLC failed in 2005, says he has been hired by a wealthy Southern family and a New York-based fund of funds to investigate how and why they lost money in the Bear funds.
“They feel that the information they received was either untrue or inaccurate,” says Mr. Intelisano, who wouldn’t divulge the clients’ names.
A Bear Stearns spokeswoman declined to comment on the investor backlash.
Since investors’ redemption requests and declining conditions in the subprime market forced the funds to hit the rocks last month, Bear Stearns has been working to mitigate the damage. Several weeks ago, the firm extended a less-leveraged sister fund a secured credit line of $1.6 billion to help stabilize it. That money was used to repay lenders, and according to a letter that Bear sent to clients this past week, the fund has managed to reduce what it owes to Bear to $1.4 billion.
At the same time, Bear’s effort to wind down the enhanced fund, which a few weeks ago still owed creditors about $1.1 billion, is moving apace, according to a July 10 regulatory filing, with the current debt standing at about $600 million.
Bear’s funds got burned for betting too heavily on the market for subprime mortgages, which cater to borrowers with weak credit, and relying too much on credit to survive a downturn. But Bear’s hedge funds weren’t the only ones looking for outsize returns. Outside investors in the more-leveraged fund were also trying to juice returns, in some cases by adding leverage to their Bear fund investments.
For instance, an investor might have liked Bear’s pitch but wanted even higher returns than the ones that were promised. To increase the potential upside, that investor could pair his or her $50 million with $50 million from a bank. The investor would pay the bank a fee, and the bank, in turn, would invest the $100 million in the fund, allowing the investor to benefit as if he or she had initially put in $100 million.
To protect investors who used such a strategy, Barclays imposed certain investment restrictions on Bear. The restrictions ranged from limiting the number of noninvestment grade holdings that the fund could buy, to curbing the fund’s exposure to collateralized debt obligations, securities backed by pools of mortgage loans, and asset-backed securities. But according to people familiar with the situation, some of those restrictions were breached by the Bear fund.