Carlyle Capital, a publicly traded hedge fund-like company, failed to meet margin calls from its banks on some of its $22 billion portfolio of AAA-rated mortgage bonds, sending markets tumbling and causing trading in its shares to be suspended after falling nearly 60 percent.
The Wall Street Journal enfolds the news in a broader story on A1 about banks demanding some of their money back from hedge funds and others—notably Thornburg Mortgage this week—to cover big losses on the funds’ investments in recent weeks. The WSJ says the trend raises the specter of spiraling margin calls and losses that could leave banks in possession of even more wobbly investments.
The Financial Times puts the story on the cover of its Companies & Markets section, and says the situation is similar to what caused the implosion of the Peloton Partners hedge fund last week and what’s giving private-equity competitor KKR fits right now:
Carlyle on Thursday said it had received one notice of default in recent days after its banks made $37m of margin calls. On Friday, it said in a statement it had been informed by its lenders that “additional margin calls and increased collateral requirements would be significant and well in excess of the margin calls it received Wednesday. The company believes these additional margin calls and increased collateral requirements could quickly deplete its liquidity and impair its capital.”
It said it was closely monitoring the situation and “considering all available options”.
What’s extra worrisome is that the margin calls are on some of the top-flight investments, like mortgage bonds backed up by Fannie Mae and Freddie Mac, who most investors see as essentially insured by the federal government. Forced selling would further erode, quickly, the value of those investments. For instance, the WSJ says the implosion of Peloton Partners last week after similar margin calls on falls in its holdings’ value, could saddle the fund’s fourteen big lenders with $17 billion in mortgage securities that are hard to sell and whose value is in doubt.
The WSJ says in so many words that Carlyle could face liquidation:
When hedge funds can’t come up with cash to meet a margin call, they are at risk of losing all access to credit and shutting down immediately. In that case, banks and brokers are forced to seize the collateral, leaving them holding the troubled securities at the root of the hedge funds’ problems. Analysts say banks may have to take billions of dollars in further write-downs.
Carlyle, which was launched by private-equity heavyweight Carlyle Group last year, is leveraged to the gills with debt. The FT and WSJ say it has $28 to $32 in debt for every $1 of equity.
Floyd Norris, writing in his New York Times column, provides some good context:
As the economy grew through most of this decade, much of the growth was fueled by borrowing, both by individuals taking out mortgages and by investors who sought high returns through highly leveraged investments. Some of those investments are now unraveling because lenders will not lend enough money to enable investors to hold on to them. That reluctance forces the sale of investments, which lowers prices and makes lenders even less willing to risk their capital.
Bloomberg has our Apocalypse Now (or at least Impending) Quote of the Day:
“The credit crisis is spilling over to the next asset class, agency (Freddie and Fannie-backed) bonds,” said Philip Gisdakis, senior credit strategist at UniCredit SpA in Munich. “There’s never just one cockroach. If you see one highly leveraged hedge fund going bust, then there’s another on the way.”
Incredibly bad housing news
Yes, there’s more bad news today. The WSJ goes big on page one with news that home foreclosures hit a record in the fourth quarter, with 2 percent of all loans in the foreclosure process and 0.83 percent entering foreclosure in the last three months of the year. Both numbers are the highest on record. Meanwhile, nearly 6 percent of homebuyers are late on their payments, a twenty-three-year high. The NYT combines the numbers to report that essentially one in 12.5 home loans is late or in foreclosure—by far a record.
The Journal twins that with news that homeowners’ equity hit the lowest level since record-keeping began after World War II, falling to 47.9 percent in the fourth quarter, down a full point from the previous quarter. The FT says that will make government efforts to ameliorate the housing crisis more difficult.