Haricuts - new fashion amongst banks Tuesday, March 11, 2008
Continuing my recent theme on banks demanding extra margin, these news clips from Bloomberg illustrate the double whammy being felt by hedge funds
Margin Calls/Haircuts
- On Feb. 24, London-based Peloton Partners LLP gave up a ``night and day'' effort to stave off demands from banks, including Goldman Sachs Group Inc. and UBS AG, for as much as 25 percent collateral for securities that once required 10 percent, according to investors in the fund. Peloton, run by former Goldman partners Ron Beller and Geoff Grant, liquidated the $1.8 billion ABS Fund, its largest.
- Banks usually limit their risk on repos by lending less than the value of the securities used as collateral. Tequesta was able to borrow $95 on $100 worth of AAA rated jumbo prime mortgages in early 2007, meaning the bank took a $5, or 5 percent so-called haircut. By last month, the amount required had risen to as much as 30 percent
- For AAA rated residential mortgage backed securities, banks have raised haircuts 10-fold in the past year to 20 percent, according to estimates from Citigroup credit analyst Hans Peter Lorenzen in London.
- On AAA asset-backed securities, banks are demanding a 15 percent haircut, up from 3 percent last summer. Corporate bond haircuts have gone to 10 percent from 5 percent, bankers said.
- At least one bank has raised Treasury haircuts, which range from 0.25 percent to 3 percent, depending on the length of the loan and the creditworthiness of the borrower, said bankers, who declined to be identified. They said they wouldn't be surprised if the practice becomes more widespread, not because they expect the U.S. government to default, but rather because there have been bigger price swings in the Treasury market, which affects value.
- Christopher Cruden, CEO of Insch Capital Management said. "Prime brokers are there to do business, not be your friend."
As Gordon Gekko said in the film Wall Street "If you want a friend, get a dog".
As shown above, collateral haircuts vary by asset type which is reflective of several factors including price volatility, asset liquidity and potential of asset default. So to illustrate the double whammy, if you have borrowed $95 dollars to buy a bond for $100, [extra being $5 of fund money] the deemed collateral haircut is 5%. If the bond falls in value to $95, you would either have to repay part of the loan or add/substitute collateral.
However, because of the sharp falls in value of the bond which have also hit the fund valuation, the banks now increases the collateral haircut on such bonds to 15%. If similar bonds were used, it would now require bonds valued at $112 to cover a $95 loan. Alternatively the fund could reduce it's borrowings to $81 by repaying part of the loan. In either case, it has to fund the difference from its' own resources but such funds rarely have idle balances on which to draw. So the banks sell the collateral and thus prompt the fund's demise.
Layman explanation
You buy a house for $100k, with a 95% mortgage. When the house falls in value the bank asks you to either repay some of the mortgage or provide it with more security e.g. parental guarantee. When you can do neither, despite you being up to date with interest, they decide to avoid possible future losses and demand immediate repayment. With the deterioration in the housing market you find yourself unable to remortgage on the same terms and so are forced to sell your home.
Labels: credit crunch, Hedge Funds
posted by John Wilson @ 11:46 AM Permanent Link
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