Not everyone's afraid of the credit market meltdown. For some firms subprime slaughter has a whiff of opportunity to it. Now they're coming out to hunt.
They're working in scary territory. Tuesday analysts following insurance giant AIG calculated that the company might have lost as much as $2.3 billion from its holdings of securities backed by subprime mortgages. Macquarie Bank of Australia disclosed that two of its investment funds could lose up to 25%, or $300 million, of their value because of exposure to the market.
A third Bear Stearns fund had been closed to redemptions, a month after the bank, which happens to be among the biggest packagers of mortgage securities, shut down two of its other mortgage-laden hedge funds in June amid margin calls and redemptions.
Bear Stearns, whose shares were down more than 2% Wednesday and are at a 19-month low, also faces an arbitration suit by a 73-year-old investor who claims the firm misled investors about its exposure to subprime mortgages.
Still, it wasn't a complete bloodbath. Several firms came out to deny rumors of their imminent demise--Beazer Homes being one. The mortgage company denied it is approaching the bankruptcy abyss, refuting rumors that started after American Home Mortgage shares plunged 90% Tuesday when the company said it was having trouble getting funding.
Caxton Associates, an $11 billion New York hedge fund firm, said Wednesday that contrary to rumors on the Internet, its flagship fund is up 3.2% for the year after fees. Caxton did say the fund was down 3% in July and that it had moved to reduce its value-at-risk (how much it could lose at any one time under certain market conditions) to 0.5% of capital.
Caxton president Peter D'Angelo wrote in a letter to investors Wednesday that circulated on the Internet, "We believe that this market change will continue to provide renewed opportunities in the macro trading environment."
He's not the only one to think this subprime meltdown may lead to profits. Several funds specializing in buying up distressed debt are swooping in, hoping the paper was written down to artificially low levels and will rebound once investors regain their sea legs.
Citadel Investments, the Chicago hedge fund, bought the credit portfolio of Sowood Capital earlier this week after the troubled fund ran into problems with the repricing of assets in the subprime sector. Marathon Asset Management, a $9 billion New York fund firm, is said to be setting up a distressed subprime fund, seeing "significant" opportunity in the sector. Another fund that specializes in distressed assets, Harbinger Capital, is thought to have logged double-digit gains in July.
Official performance figures for hedge funds will be released next week by Hedge Fund Research, the Chicago firm that keeps track of the industry.
Fund managers who had sold short the shares of mortgage lenders and other financial firms over the last few months have also made money.
Charles Gradante, research director at the Hennessee Group, which advises clients on hedge fund investments, said many long/short hedge funds had earmarked 5% to 10% of fund assets to be short the lenders and the subprime index since last year. The group is up 9% year to date, one-third of that gain attributable to making the right bet on subprime.
But most funds aren't crazy enough to risk buying up the distressed debt and riding out the market, Gradante says.
Many hedge fund managers have been moving to cash until the panic subsides. "The fundamentals are still good, but the big unknown is how much the panic is building up," he says. "It's like a kettle with steam. You just don't know when it's going to blow."
On Wednesday, Fitch Ratings affirmed $20 billion worth of residential mortgage backed securities and downgraded $2.4 billion. It has been reviewing 170 deals, about $7 billion worth, and will be announcing its ratings action over the next two weeks. This first $2.4 billion batch was what was considered the worst performing of the 170 deals.
Credit markets have seized up in the last few weeks after a record first half of the year, when $452 billion worth of leveraged loans and $98 billion of high-yield bonds hit the market, according to Standard & Poor's. The average quality of those new issues was lower than in the same period last year--about 48% of it was rated B-minus or below, compared with 32% of new issues in the first half of 2006.
But some point out that the credit markets are not so much in severe distress as they are coming down off remarkably good times. Spreads between Treasurys and speculative grade credit are 417 points. But the longer-term average is more like 450 points, according to S&P, meaning spreads have a way to go to meet the average.
The widest spreads came after the dot-com bubble burst, when speculative grade credit traded at 1,000 basis points or more over Treasurys. "The market needed to be prepriced," says Diane Vazza, managing director of fixed income research at S&P. "But you can argue that the market has gone too far the other way, and we would say that is the case."Source: Forbes.com
