Credit funds: Behind the rhetoric

As fund after fund succumbs to emergency measures to halt redemptions, shore up funding or sell off structured credit assets, the terms used to describe them are too often blurred and confused.

After Bear Stearns announced an initial $3.2 billion rescue of Bear Stearns Asset Management’s (BSAM's) High-Grade Structured Credit Fund on June 22, funds with exposure to structured credit and subprime mortgage securities seemed to topple like dominoes. It is tempting to label them all ‘subprime meltdown’, but the frozen redemptions and emergency funding have been initiated for a wide variety of reasons.

By June 26, the Bear Stearns fund had used $1.6 billion of the $3.2 billion available from the bank in the form of a secured financing facility. Meanwhile, BSAM’s High-Grade Structured Credit Enhanced Leverage Fund, although not receiving any support funding, was having trouble with its $1.2 billion of repurchase agreements.

Three weeks later, on July 18, Bear Stearns warned investors in the funds that they could expect to see little of their investment back. The High-Grade Structured Credit Strategy Fund could only return 9% to investors, and nothing could be expected on the other fund. The reason for this loss was clear: BSAM had been trying to de-leverage the funds, but the market price for subprime loans and collateralised debt obligations of asset-backed securities (CDOs of ABSs) had tanked. Mark-to-market losses had caused the funds’ dealers, including Merrill Lynch (on June 21), to seize and auction collateral (see Bear Stearns bails out hedge fund with $1.6 billion injection).

Jump forward to the most recent funds to run into trouble, and it seems like a similar story, with redemption requests and collateral seizure leading to the sale of assets at fire-sale prices and a consequent marking down of portfolios. But look beneath the surface and the story is different.

When BNP Paribas was forced to suspend redemptions for three of its funds on August 9, some observers marked this down as yet another imminent collapse. Unusually, the bank also suspended its net asset value (NAV) calculation for the funds in question: Parvest Dynamic ABS, BNP Paribas ABS Euribor and BNP Paribas ABS Eonia. The bank blamed evaporation of liquidity in some US securitisation markets, saying that “it is no longer possible to value fairly the underlying US ABS assets” in the funds.

Such a statement was bound to cause a furore, and the French regulator requested a meeting with the bank to discuss its management of the situation. However, on August 23, two weeks after the suspension was announced, the bank said it intended to resume trading on two of the funds on August 28 and on Parvest on August 30. This was partly due to the availability of a new pricing mechanism that uses market indexes to extract pricing information and the application of illiquidity factors to issuers.

There is a clear distinction between those funds that have direct and attributable subprime losses, in terms of both default and mark-to-market losses, and those that have suffered from contagion and negative investor sentiment.

Of those in the second category, two funds with little or no exposure to subprime assets were forced to suspend investor redemption requests as the turn in sentiment and pricing made it difficult to manage the funds effectively. Frankfurt-Trust Asset Management, a Frankfurt-based collateralised loan obligation investor, suspended redemptions on its FT-ABS-plus fund on August 6. At the same time, Union Investment Management suspended redemptions on its ABS-Invest fund for the same reasons, despite the manager's claim that the fund had less than 6% exposure to US subprime ABS. Florida-based United Capital Asset Management also suspended four of its funds on July 3 after redemption requests, including one from a single investor who accounted for 25% of the firm’s invested capital.

In contrast, Sydney-based hedge fund Basis Capital suffered as a result of mark-to-market hits on its portfolios, and was unable to meet margin calls. As a result, banks seized collateral on its Basis Yield Alpha and Basis Pac-Rim Opportunity funds. On August 30, the Basis Yield Alpha fund filed for bankruptcy protection in the US, citing a more than 80% loss in the portfolio. The manager had suspended NAV calculations on its funds on July 24.

A version of this article appears in the September issue of Risk.

See also: Bear Stearns bails out hedge fund with $1.6 billion injection
Bear Stearns funds have "lost almost all value"
Sovereigns step in as ABS funds reel
German contagion looms as funds buckle
Re-evaluating valuation