BizAnalyst Network: Universities scoop up risky subprime debt from Bear Stearns Hedge Fund

Friday, June 22, 2007

Universities scoop up risky subprime debt from Bear Stearns Hedge Fund

Universities scoop up risky subprime debt

University endowments were among the most eager buyers of risky mortgage-backed securities being offloaded by Wall Street this week. "There's an opportunity out there to buy these loans at a discount," said Lou Morrell, vice president for investments and treasurer at Wake Forest University. Meanwhile, Bear Stearns continued to scramble to save two hedge funds hit hard by the subprime fallout, saying Thursday it took on $3.2 billion in loans to stop creditors from seizing assets of one of its money-losing hedge funds.

Bear Stearns Plans $3.2 Billion Hedge Fund Bailout (Update2)
By Jody Shenn and Yalman Onaran
June 22 (Bloomberg) --

Bear Stearns Cos. is proposing a $3.2 billion bailout of a money-losing hedge fund, the biggest rescue since 1998, to forestall creditors from seizing assets, people with knowledge of the proposal said.

The firm told lenders to the High-Grade Structured Credit Strategies Fund yesterday that it would assume their loans, said the people, who declined to be named because the plan is confidential. The New York-based firm made the offer after creditors including Merrill Lynch & Co., JPMorgan Chase & Co. and Lehman Brothers Holdings Inc. put some of their collateral up for sale to investors.

Bear Stearns increased efforts to salvage the fund, one of two that made bad bets on collateralized-debt obligations, as concern about a possible collapse sent stocks and bonds of financial companies lower. An agreement with creditors would prevent a fire sale of the collateral, while increasing the risk to Bear Stearns, the second-biggest underwriter of mortgage bonds.

``Bear needs to put this behind it as soon as possible,'' said Peter Goldman, who helps manage $600 million at Chicago Asset Management, including shares of Bear Stearns. ``The firm might take on some of the risk of the fund they didn't have before, but they're a bond shop and they wouldn't take on risk they shouldn't.''

The Bear Stearns fund lost about 10 percent of its value this year, while the related fund, the 10-month old High-Grade Structured Credit Strategies Enhanced Leverage Fund, lost about 20 percent, according to people familiar with the matter. Both funds are run by Ralph Cioffi, 51, a senior managing director.

Fastest-Growing
The funds speculated in highly-rated CDOs -- securities backed by bonds, loans, derivatives and other CDOs -- that were hurt in March and April as defaults on subprime mortgages to people with poor or limited credit histories increased. The fund also lost on opposite bets against home-loan bonds, which backed many of its CDOs.

Bear Stearns spokeswoman Elizabeth Ventura declined to comment. Lehman spokesman Randy Whitestone also declined to comment. Adam Castellani, a spokesman for JPMorgan couldn't immediately be reached when called after hours.

Investors from hedge funds to pension funds and foreign banks have snapped up CDOs as a new way to invest in debt, making it the fastest-growing market and pushing the amount outstanding to more than $1 trillion.

CDOs trade infrequently and holders rarely have comparable sales to use when valuing the securities on their books. Forced sales may have required investors to write down those values, potentially causing billions of dollars of losses.

Largest Since LTCM
``The problem is not what we see happening, but what we don't see,'' said Joseph Mason, associate professor of finance at Drexel University in Philadelphia and co-author of an 84-page study this year on the CDO market. ``We don't know the price of these assets. We don't know which banks are exposed to this sector. These conditions are the classic conditions for financial crises across history.''

The bailout of the fund would be the largest since Long-Term Capital Management LP, which received $3.5 billion from 14 lenders in 1998. The Greenwich, Connecticut-based fund, run by John Meriwether, lost $4.6 billion.

In the case of Long-Term Capital, lenders agreed to take equity stakes in the fund after New York Federal Reserve President William McDonough called the heads of the firms together. They then sold assets over time to limit the impact of its collapse.

Bear Stearns's proposal doesn't involve taking equity. Instead, the firm would become a lender to the fund, its loan secured by the assets of the fund.

Bundling Securities
Bankers and money managers bundle securities into a CDO, dividing it into pieces with credit ratings as high as AAA. The riskiest parts have no rating because they are first in line for any losses. Investors in this so-called equity portion expect to generate returns of more than 10 percent.

The first CDOs were created at now-defunct Drexel Burnham Lambert Inc. in 1987. Sales reached $503 billion in 2006, a fivefold increase in three years. More than half of those issued last year contained mortgages made to people with poor credit, little loan history, or high debt, according to Moody's Investors Service.

CDOs may have lost as much as $25 billion because of subprime defaults, Lehman Brothers analysts estimated in April.

Bear Stearns shares rose for the first time in four days yesterday after Merrill decided against selling all its collateral. The stock dropped $1.35, or 0.9 percent, to $144.46 at 10:58 a.m. in New York Stock Exchange composite trading.

Risk Perceptions
The perceived risk of owning corporate bonds was little changed today after reaching the highest since September earlier this week. Contracts based on $10 million of debt in the CDX North America Crossover Index was quoted at about $169,000, after rising as high as $179,000 yesterday, according to Deutsche Bank AG.

The Bear Stearns funds had borrowed $9 billion and made bets of more than $11 billion, one of the people familiar with the situation said. The creditors include Merrill, Lehman, JPMorgan, Goldman Sachs Group Inc., Citigroup Inc. and Cantor Fitzgerald LP, all in New York. Bank of America Corp., based in Charlotte, North Carolina, Barclays Plc in London and Frankfurt-based Deutsche Bank AG were the other lenders.

As the funds faltered, Merrill sought to protect itself by seizing the assets that were used as collateral for its loans. The firm was followed by JPMorgan, which offered some securities for sale before withdrawing its plan. Lehman put some securities up for sale, according to a person with knowledge of the situation.

The second fund had less money from investors though was more leveraged, meaning it had borrowed more relative to its assets. Talks with creditors to that fund are also underway, one person said.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net ; Yalman Onaran in New York at yonaran@bloomberg.net .

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