Things are not looking good for hedge funds betting on risky home loans, reports the Wall Street Journal.
Consider the volatility at Second Curve Capital — a hedge-fund firm run by Thomas Brown, a former Wall Street research analyst — which recently has been hammered betting on the stocks of “subprime” lenders, which cater to high-risk borrowers.
The two main funds at Second Curve were down 8 per cent and 10 per cent in January — and at least as much last month. Hedge-fund databases show the funds’ losses for February at 12.5 per cent and 14 per cent, though Mr Brown contends that the performance was comparable to January. In any case, it is a significant turnabout from 2006, when the Second Curve funds rose nearly 55 per cent.
The recent performance has stemmed from investments in stocks of subprime lenders. But Mr Brown told the WSJ he doesn’t intend to bail out of subprime lenders and indeed might buy more. “Our portfolio ideas worked out well,” he insists in an interview. “We need panic to take full advantage of our beliefs.” Second Curve doesn’t appear to be hit with a spike in withdrawal demands, allowing Mr. Brown the freedom to hang onto his stocks. In a call with investors Friday, he says: “Not one caller asked, ‘What are you doing?’”
He says the subprime shakeout was overdue. “After five years of headlong growth, underwriting standards had become too aggressive,” Mr. Brown says. “The good players will survive and take market share. People are overreacting after last year’s gains.”
Too aggressive? Naked Shorts thinks that with a slowing housing market and accelerating delinquencies in subprime, desperate is another word for it. Online lending site Lendingtree.com, in a tie-up with American Airlines, screams: Earn Miles and Have Banks and Real Estate Brokers Compete! Find a Home Loan - Earn 1,250 American Airlines AAdvantage® miles per $10,000 financed. Find a REALTOR® - Earn 3,000 AAdvantage® miles per $10,000 of your home purchase or sale price.
We’re guessing that an airmiles promo is not designed to lure in the trailer park crowd.
Meanwhile, Donald Tomnitz, chief executive of home builder DR Horton, accurately summed up the mood, when he on Wednesday told a Citigroup conference: “I don’t want to be too sophisticated here, but 2007 is going to suck, all 12 months of the calendar year.”
Much of the recent carnage among subprime-lender investors was concentrated in the more complicated “structured finance” market, adds the WSJ. But the full extent of that damage might not be known for a few more days. Of course, others have thrived. John Paulson, who runs hedge fund Paulson, reported in a letter to investors dated March 2 that one fund the company offers investors — a $1bn portfolio that has bet on a drop in the subprime market — has doubled its money this year.
All those with an interest in tracking the meltdown of subprime lending - and the ensuing shake-out in the sector which will shrink the 100-plus pool of originators in the market last year - have a website just for them. The Mortgage Lender Implode-o-Meter, last updated two days ago, puts the casualty list at 33 since late last year.
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