Sideways: Private market problems are going public

lock-unlock-open-key-340.jpgReal estate investment trusts (REITs) that invest in mortgages have become an early source of market instability in the coronavirus crisis. Forced sales of mortgage-backed securities by REITs that are facing collateral calls from dealers seem to have been a factor in the Federal Reserve’s dramatic extension of support for bond markets.

Some lending vehicles are fully independent, but many firms that are under pressure are part of bigger private investing groups. A mortgage lender sponsored by private equity firm TPG said on March 23 that it is suspending a dividend payment and may run out of money, for example.

A mortgage investment trust run by investment group Angelo Gordon said on the same day that an unusually high number of margin calls meant that it missed a deadline and did not expect to be able to meet future demands. And an Invesco mortgage unit made the same statement the following day.

The failure of a structured vehicle does not necessarily entail a substantial financial cost for a bigger private lending parent. But it should involve a reputational hit, even in a sweeping downturn. And defaults by obscure trusts may affect confidence in the broader shadow-banking sector that has partly displaced traditional bank exposure with private lending since the 2008 financial crisis.

Information battle

A market dislocation on the scale of the one that is happening at the moment creates opportunities as well as the inevitable losses. This is leading to a shadowy information battle by asset managers normally keen to keep their activity as private as the name of the sector would suggest.

A flurry of basis trading between Treasuries and futures by Citadel’s fixed income business led many dealers to conclude that it must have been forced to close leveraged positions at a loss, for example. Estimates of the total ranged into the hundreds of millions of dollars. But on March 24 a news report said that not only had the fixed income fund recovered unrealized losses but that both it and Citadel’s flagship fund Wellington were up for the year to date.

The current downturn is likely to expose complex and opaque lending policies and structuring tactics of certain asset managers to scrutiny 

Joy must have been unconfined among the high-end real estate brokers who rely on Citadel founder Ken Griffin for eye-watering purchases. Although even Griffin may wait a while before he takes a tilt at the US price record he set when he bought a New York penthouse on central park south for $238 million early last year.

Citadel is a big hedge fund, but it is dwarfed in scale by private equity firms such as TPG, which had $119 billion of assets under management when it last reported, and Blackstone, which had $571 billion.

The size of the bigger private equity firms provides some comfort that they will be able to weather problems in pockets of their lending activity, such as the move in recent years to buy European bank non-performing loans that do not look like good bets at the moment.

Sharp contrast

The current downturn is nevertheless likely to lead to disputes over asset valuation, leverage policies and fee structures in some of the vehicles that private equity firms have established. US regulators made a collective decision after the 2008 crisis to focus on increased oversight of the banking sector, leaving the asset management industry virtually undisturbed.

That has resulted in a confidence in the core banking system during the coronavirus crisis to date that is in sharp contrast to the panic of 2008. It is also a logical approach to regulating asset managers that stick to investing, whether they are old-fashioned stock pickers or quant funds.

However, the current downturn is likely to expose complex and opaque lending policies and structuring tactics of certain asset managers to scrutiny that may be unwelcome for some of the biggest names in private investing.

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