Bear Stearns told clients in its two battered hedge funds late yesterday that their investments, worth an estimated $1.5 billion at the end of 2006, are almost entirely gone. In phone calls to anxious investors, Bear Stearns brokers reported yesterday that May and June had been devastating months for the portfolios.
The more conservative fund, the High-Grade Structured Credit Strategies Fund, was down 91 percent by the end of June, investors were told. The High-Grade Structured Credit Strategies Enhanced Leverage Fund, which used extensive borrowings and assumed more risk, has no investor capital left, the firm said.
“In light of these returns, we will seek an orderly wind-down of the funds over time,” a letter to Bear Stearns clients said.
Overseen by Bear Stearns Asset Management, the hedge funds had been stellar performers until this spring when the mortgage securities market began to falter. Delinquencies on loans made to risky borrowers, known as subprime mortgages, started climbing in February; since then the value of the securities have spiraled downward.
Bear Stearns executives declined to comment last night.
The drama surrounding the two funds began in May when investors in the more leveraged hedge fund were told losses through the end of April totaled 23 percent, not 10 percent as they had been told earlier. As securities markets declined, even the more conservative fund registered losses starting in March.
Investors tried to get out of the funds, but in May, Bear Stearns halted redemptions. Shortly after that, several banks and brokerage firms that had provided loans began demanding more cash as collateral. On June 26, Bear Stearns said it would offer a $1.6 billion loan to shore up the more conservative fund and unwind its positions.
In yesterday’s letter to clients, Bear Stearns said that some $1.4 billion of the loan remains untapped.
While risky mortgages are thought to have been central to the funds’ misfortunes, Bear’s letter said that “unprecedented declines in the valuations of a number of highly rated (AA and AAA) securities” contributed to June’s woeful performance.
The more conservative of the two Bear Stearns funds was the older; established three years ago, it generated monthly gains of roughly 1 percent to 1.5 percent until March. Bear Stearns started the more leveraged fund last summer, just as the mania for mortgage securities was topping out. At their peak, the funds were valued at $16 billion, including the leverage that they used.
The announcement that the funds are now almost worthless came as a surprise to many on Wall Street. “How did you go from reporting very high returns to suddenly now saying the collateral is worth nothing?” asked Janet Tavakoli, president of Tavakoli Structured Finance, a research firm in Chicago.
The Bear Stearns funds, like so many others, bought collateralized debt obligations, investment pools consisting of hundred of loans and other financial instruments. Wall Street divides the pools up in slices based on their credit quality and sells them to investors.
Mark H. Adelson, head of structured finance research at Nomura Securities, said that the Bear Stearns funds steep decline had broad implications for investors in these bonds. “It’s going to provide an additional item that argues for lower valuations on these positions,” he said.
Ms. Tavakoli said other hedge funds would face a tougher time justifying to both investors and regulators the value they have assigned to mortgage-backed securities they hold. “Depending on how aggressive the S.E.C. wants to be, this could get ugly,” she said.
In after-market trading, Bear Stearns shares fell 3.6 percent, to $134.90. The stock is down about 14 percent for the year.
Even before Bear Stearns made its disturbing disclosures, the ABX index, which tracks the price of insuring losses in subprime bonds, hit fresh lows. The part of the index that tracks A-rated segments of mortgage securities issued in late 2006 and early 2007 fell to 68.5 cents on the dollar, down from 72.36 cents Friday.
“There are a bunch of unanswered questions here,” said Joshua Rosner, a managing director at Graham & Fisher, an investment firm. “For me, one of the big unanswered questions is, do the prime brokers and others who have extended lines of credit to the hedge funds really have a good handle” on how those borrowings have been invested.
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