Toomre Capital Markets LLC

Real-Time Capital Markets -- Analytics, Visualization, Event Processing, and Intelligence

Hedge Funds: The Next Stage of Credit Crisis?

Toomre Capital Markets LLC ("TCM") has watched the deleveraging of the financial system progress through one after another area of the Capital Markets. First it was the sub-prime mortgage sector and the intense focus on where the ABX was trading down to. Then, there was an awe-like focus on Collateralized Debt Obligations ("CDOs"), Asset-Backed Commercial Paper ("ABCP") and Structured Investment Vehicles ("SIV"). Next focus shifted to whether the monoline credit insurers likeAmbac and MBIA might survive. More recently, leveraged loans, Alt-A mortgages and commercial mortgage-backed securities ("CMBS") have been sinking in value. Finally, in the last ten days, there was intense speculation about whether the investment banks and primary dealers might survive, culminating the virtual bankruptcy of Bear Stearns last weekend.

This week the earnings reports from Goldman Sachs, Lehman Brothers and Morgan Stanley all exceeded the much diminished analyst expectations for their first quarter earnings reports. What was relatively impressive is that diversified trading operations produced sufficient revenues to offset asset write-downs of between $1.5 and $2.5 billion. As a result, the pressure on the investment banks (for the moment at least) seems to have eased. The question now is in what sector of the capital markets will the next stage of the credit crisis appear? Will it be with the three wounded ducks (Citigroup, Merrill Lynch and UBS), the European banks or the many hedge funds seemingly just barely hanging on?

Toomre Capital Markets LLC suspects that next focus will be on the hedge fund community. By way of example, consider what has happened with Endeavour Capital LLP and JWM Partners LLC this year. From the website comes the news that:

Endeavour Capital LLP, the London-based hedge-fund firm founded by former Salomon Smith Barney Inc. traders, has reportedly fallen about 28 percent this month because of "extreme volatility and vast moves'' in Japanese bonds. The $2.88 billion Endeavour Fund sold ``substantially all'' of its Japanese government debt this week, it's CEO stated in an interview.

The JMM Partners LLC fund manager is John Meriwether's successor hedge fund to Long Term Capital Management LP, which famously blew up in 1998 and needed to be rescued by the Wall Street dealer community. According to the Bloomberg article entitled John Meriwether's Bond Fund Loses 24% on Credit-Market Plunge,

JWM Partners LLC, the investment firm run by ex-Long-Term Capital Management LP chief John Meriwether, lost 24 percent in its $1 billion fixed-income hedge fund this year through March 14, according to two people with knowledge of the matter.

Meriwether's Relative Value Opportunity fund was hurt as bond managers such as Peloton Partners LLP and Carlyle Capital Corp. were forced to sell securities to meet margin calls, said the investors, who asked not to be identified because JWM doesn't publicly disclose returns. The Greenwich, Connecticut- based firm, which is selling holdings to reduce borrowings and lower risk, didn't have any loans called, they said.

"There's been a lot of forced de-leveraging," said Benjamin Sarly, head of marketing at Sanno Point Capital Management in New York, a relative-value credit fund.

Toomre Capital Markets LLC suspects that the public will soon be hearing about more hedge funds like these two that have suffered near catastrophic losses or even are shutting down. Certainly the investor reports that hedge funds distribute for the first quarter are going to be mighty interesting.