Opening Bell: Notice of Default

Carlyle on the ropes; housing is just unbelievable; problems in 'Bama; roaches in the economy, etc.

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.

Teetering banks

Banking regulators are putting the heat on banks to beef up their capital in a preventive move against bank failures, the WSJ says on C1. Regulators also want healthier banks to get more capital so they can lend more, helping the economy through the downturn.

By making the case publicly to even safe banks, regulators are trying to remove some of the “stigma” attached to raising capital, since such a move typically is taken only by banks that are in deep trouble. Banks also have been trying to preserve their capital ratios by scaling back or halting dividend payments and stock buybacks.

But losses keep piling up. In the first quarter, banks are likely to suffer tens of billions of dollars in new write-downs and losses, as well as hefty charges to cover future defaults. In addition to losses on mortgages, the latest worry is that many banks—especially some regional lenders—are overexposed to commercial real-estate loans.

Alabama credit problems

An Alabama county is in trouble after losing big time on a derivatives bet it says was meant to hedge its risk of higher interest rates, Bloomberg reports. The county may be forced into bankruptcy. Maybe the municipal-debt markets aren’t so unhinged from reality after all. If there’s more stuff like this out there, and we’re sure there is, the markets are smartly imputing that the credit debacle has infected even the most safe lenders—those with the power to tax.
Here’s the WSJ on C1:

Jefferson County’s troubles began to crop up after it borrowed more than $3 billion to make its sewage system compliant with federal regulations. But the stench is spreading through the rest of the county as its other debt faces additional scrutiny. Rating firms yesterday also downgraded the county’s general debt, its school warrants and various other municipal issues.

Subprimates probed

The WSJ reports on A3 that the Illinois attorney general is investigating whether Countrywide and Wells Fargo—the country’s two biggest home lenders— unfairly gave minorities subprime mortgages when they were eligible for less-expensive loans.

Yesterday’s subpoenas were prompted in part by a study by the Chicago Reporter indicating that Chicago led the country in high-cost loans and that African-American and Latino borrowers were more likely than white borrowers to get a high-cost loan. That study, which looked at data reported under the Home Mortgage Disclosure Act, identified Countrywide and Wells Fargo as having large disparities in loans provided to white and minority borrowers, Ms. Madigan said.

The Chicago Tribune says the AG’s moves are just the latest subpoenas in the office’s investigation of the home lenders.

The Wal-Mart economy

In economic news, same-store sales were up 1.9 percent in February compared to just a 0.5 percent increase the month before. Still, retailers are not optimistic about their outlook, and the numbers were boosted by higher sales at low-ball Wal-Mart.
The Associated Press reports that jobless claims dropped solidly last week, though a Bloomberg survey says a report today will show an increase in the unemployment rate to 5 percent on extremely weak hiring, or just 23,000 new jobs.

American household wealth fell in the fourth quarter for the first time in five years, dropping 3.6 percent to $57.7 billion on falling home and stock prices.

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.