Bear Stearns' Fund on the Brink

[HenryTo]

Merrill's choice not to wait may cause some dislocation in various part of the mortage market next week. Following article is courtesy of the WSJ:
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A 'Subprime' Fund Is on the Brink
By KATE KELLY
June 16, 2007; Page B1

Concerned that an internal hedge fund at Bear Stearns Cos. wouldn't be able to meet a margin call, Merrill Lynch & Co., one of the fund's biggest lenders, seized $400 million of its assets and is preparing to auction them off.

The auction, in the coming week, could trigger the fund's dissolution -- the second blowup in recent months of a hedge fund that made dicey bets on the market for risky home loans, known as subprime mortgages.

The surprise move involving the two Wall Street firms came as the Bear fund's managers, led by bond-sales veteran Ralph Cioffi, scrambled Thursday and Friday to sell hundreds of millions of dollars in bonds to satisfy demands for cash and assets from creditors and stave off liquidation. Mr. Cioffi's group had successfully auctioned off almost $4 billion in high-quality mortgage bonds Thursday morning. Later that afternoon at Bear's New York offices, the fund managers presented lenders with a 30-day plan for selling more assets, a blueprint for meeting new margin calls that appeared to have been well-received.

Merrill opted not to wait. Friday afternoon, the firm's bond traders began circulating a list of securities that had served as collateral, or security, for the credit it had extended to the Bear fund, High-Grade Structured Credit Strategies Enhanced Leverage Fund.

Bids for the securities are scheduled to be negotiated starting at noon on Monday.

The seizure by Merrill -- which could spur other lenders to seize fund assets -- may well mean the end of Mr. Cioffi's two funds.

The Bear fund has different bets on the health of subprime mortgages, both positive and negative, but has been hurt particularly by a negative bet after a rebound on a key index that tracks the sector.

In the earlier blowup, in May, UBS AG shut down Dillon Read Capital Management after bad trades in subprime-mortgage loans led to a $124 million loss.

The latest auctions have been watched closely by Wall Street. Especially concerned are other hedge funds that may be forced to lower the value of their own assets if the Bear sale fetches bids that are well below what the fund says they are worth. Unlike the high-quality and liquid mortgage-backed bonds that Bear sold this past week, the assets up for sale this time comprise securities that are considerably less liquid.

Mr. Cioffi's 30-day plan was a last-ditch effort to salvage his fund, which he has run since August and is geared to sophisticated investors. Built on about $600 million in investor capital, $40 million of which came from Bear and a group of firm executives, the fund had borrowed at least $6 billion in additional capital from a dozen Wall Street lenders, say people familiar with the matter, including Merrill, Goldman Sachs Group Inc., Bank of America Corp. and Deutsche Bank AG. It was run by Bear executives alongside a larger sister fund with relatively little borrowed capital.

The fund bet a popular index that tracks subprime mortgages, the ABX, would fall. Late last year and early this year, those moves bore good returns, says a person familiar with the matter. Then the tide began to turn. After reaching a low of 62 late in February, amid rising numbers of defaults and delinquencies in the subprime market, the ABX unexpectedly recovered in the months that followed, reaching 72 in mid-May. It has since gone back down to 61. This led to losses for Mr. Cioffi.

Mr. Cioffi's team also bet collateralized debt obligations, or pools of mortgage-backed bonds, would keep their value. But some of them fell in value, leading to further losses.

During April, the leveraged fund began falling sharply. Its bearish bets on subprime securities had created paper losses, and some investors were getting antsy and asking to redeem their cash, says a person familiar with the matter. After getting wind of the redemption requests, some of the firms that had sold subprime securities to the fund asked to revalue them at a lower level, says this person. By the end of the month, the leveraged fund had fallen 23% for the year.

Mr. Cioffi's team froze the redemption requests, hoping to stabilize the fund, and began selling off billions of dollars in its most valuable assets from both the leveraged and the less-risky funds. From the beginning of May through Thursday, the Bear funds had sold roughly $7 billion in assets, says a person familiar with the matter. Friday, the fund began auctioning hundreds of millions more. As this was under way, Merrill moved in and seized assets in an attempt to protect its investment.

--Serena Ng contributed to this article.

Write to Kate Kelly at kate.kelly@wsj.com

[HenryTo]

A further update as the whole CDO industry is now on the brink:

http://www.bloomberg.com/apps/news?pid=20601087&sid=ahWfhEJ7dra4&refer=home

[nodoodahs]

The problem with hedge funds "trading" in illiquid instruments is that they get to decide what price to book the investment at ... at least, until they need to sell. LOL!
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He was wearing my Harvard tie. Can you believe it? My Harvard tie. Like oh, sure, HE went to Harvard.

[HenryTo]

DealBreaker on the whole Bear Stearns fiasco:

http://www.dealbreaker.com/2007/06/bear_stearns_lenders_score_hig.php

[Breezin]

I am curious as to others views in terms of understanding Merrill's behavior of approaching an auction process of CDOs squared, selling a piece of the $800 million face, and then backing away. Strikes me that if they could get pricing within a reasonable range of the face, they would have finished the auction. The failure to complete makes me very uneasy as I am left feeling that there is no price, and therefore the market for new is dead, and the market for old will teeter for a bit, before a rash of calls force liquidation and multiple bankruptcies. What do you think?

[HenryTo]

Breezin,

I think you're pretty much on the money. Even if Bear Stearns is able to "paper over" the crisis for now, everyone now knows the game is pretty much up, especially given the continued rise in mortgage rates in recent weeks:

http://www.bloomberg.com/apps/news?pid=20601087&sid=amZ.IeL2pJHo&refer=home

[HenryTo]

The paper co-authored by Joseph Mason of Drexel University that has no doubt been circulated around Wall Street over the last few months:

http://www.hudson.org/files/publications/Mason_RosnerFeb15Event.pdf

[HenryTo]

A behind-the-scenes look at the person behind the Bear Stearns' funds, Ralph Cioffi. Also a demonstration of what could happen when bets are, for the most part, one-sided and illiquid:

http://www.bloomberg.com/apps/news?pid=20601109&sid=azWrpTVCph08&refer=home

[HenryTo]

The two Bear Stearns funds are now almost worthless. Following is courtesy of WSJ:
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Two Bear Funds
Nearly Worthless,
Investors Told
By KATE KELLY and SERENA NG
July 17, 2007 5:30 p.m.

Weeks after the meltdown of two prominent Bear Stearns Cos. hedge funds that bet heavily on the market for risky home loans, the brokerage has told the funds' investors that the portfolios' assets are almost worthless, according to people familiar with the matter.

The assets in Bear's more-levered fund, the High-Grade Structured Credit Strategies Enhanced Leverage Fund, are worth virtually nothing, according to people familiar with the matter. The assets in the larger, less-levered fund are worth roughly 9% of the value since the end of April, these people said. The April valuations were not immediately available, but in March, before their sharp losses, the enhanced leverage fund had $638 million in investor money, while the other fund had $925 million.

The two funds have been in the spotlight for weeks after suffering heavy losses in the subprime market. Late last month, Bear helped stabilize the less-levered fund with a $1.6 billion secured loan; the enhanced fund began trying to unwind its remaining $1.1 billion in debt.

Bear disclosed this information to investors earlier today and is expected to make a statement this evening, these people said. A spokeswoman for Bear did not return calls for comment.

These losses, which took more than two weeks to calculate because of the fluctuating values in the market for risky, or subprime, mortgage securities, came amid another tumultuous day for the broader mortgage market. One particularly wobbly slice of the market tracked by a closely watched index called the ABX fell to an all-time low of 44.

[TRS]

Traders are going to have to be fleet of foot now. This could all unwind really quick. If you happen to be long you may want to tighten up the stops. The contagion is just beginning.

[nodoodahs]

"Contagion?" Could it be any more clear that "subprime" is this year's "bird flu?"
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He was wearing my Harvard tie. Can you believe it? My Harvard tie. Like oh, sure, HE went to Harvard.

[rffrydr]

[nodoodahs]

Amaranth was a spread deal, too.

I'm convinced that whatever "higher math" has been used to convince all of these funds that spread plays are "low risk" should be dumped in favor of high school (well, mid- to early-20th-century high school) algebra.
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He was wearing my Harvard tie. Can you believe it? My Harvard tie. Like oh, sure, HE went to Harvard.

[rffrydr]

I've been burned more than once--and it is the leverage. And will again, but will try to limit it again. Can't trade grains in Summer without offseting some drought risk. Can't trade oil into hurricane season without some hedge. Buy the OFTM option. Speading on an "abstract" BTU equivilant AKA NatGas for instance doesn't cut it.

Trying to "play it safe" in an ineherently dangerous game should be looked at long and hard. And this goes far beyound the markets, into our social even family models. Thinking you HAVE played it safe and leveraging up, that's a mug's game.

Turns out BS's "high-grade" really was: all AAA and Alt-A:

http://www.bloomberg.com/apps/news?pid=20601087&sid=ao3.vbiiZJZM&refer=home

Once again, metaphor is the mechanism: the broad brush tarring the media (we) wanted tell became the reality.
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Today is the Tomorrow you worried about Yesterday!

[nodoodahs]

Speaking of Bear Sterns (BSC), they seem to be holding above last week's low ...
_________________
He was wearing my Harvard tie. Can you believe it? My Harvard tie. Like oh, sure, HE went to Harvard.