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Bear Stearns: 2 funds wiped out

Mortgage-backed bonds in the portfolios have been sunk by sub-prime turmoil.

July 18, 2007|Tom Petruno | Times Staff Writer

Brokerage Bear Stearns Cos. said Tuesday that investors in two of its hedge funds that owned mortgage-backed bonds had lost virtually all of their money -- an announcement likely to jolt the already shaky market for those bonds.

Particularly troubling was the company's warning that bonds that had high credit ratings were experiencing "unprecedented declines" in value.

The Bear Stearns funds last month became symbols of the turmoil in the mortgage-backed securities market, as rising defaults on sub-prime loans made to people with dicey credit have slashed the value of bonds backed by those loans.

As investors sought to pull out of the brokerage's funds, the firm was unable to sell the funds' bonds for enough to repay investors. The problems were compounded by the funds' heavy use of borrowed money to buy bonds -- a strategy that can quickly cause huge losses if the securities fall in value.

In a letter to clients Tuesday, Bear Stearns said "preliminary estimates show there is effectively no value left for the investors in the Enhanced Leverage Fund and very little value left for the investors in the High-Grade Fund." The letter was posted by the Wall Street Journal on its website.

The Enhanced fund held investor capital of $638 million and the High-Grade fund had $925 million, both as of the end of March, according to Bloomberg News. The funds then borrowed nearly $11 billion and nearly $9 billion, respectively, to boost their bond bets.

Bear Stearns' stock was slammed after news of the funds' losses. The shares fell to $134.60 after hours, down from $139.91 at the close of regular trading.

The troubles of sub-prime mortgage borrowers have become well known on Wall Street this year as delinquencies have risen. But in recent weeks, concerns have increased about the potential for losses on mortgage-backed bonds that had been considered high quality.

Bear Stearns reinforced those fears in its letter to clients, saying that its funds' woes reflect "in part ... the unprecedented declines in valuations of a number of highly rated (AA and AAA) securities."

Although market data indicate that the drop in the value of the highest-rated mortgage-backed bonds in recent weeks has been 5% or less, many investors had expected no decline at all. Now, investors are doubting that the credit ratings accurately reflect the quality of the loans, said Janet Tavakoli, president of Tavakoli Structured Finance Inc. in Chicago and an expert on mortgage securities.

In another sign that credit problems are spreading in the mortgage market, bond rating firm Moody's Investors Service said Tuesday that it might downgrade $318 million worth of bonds backed by so-called Alt-A mortgages -- loans made to borrowers considered above sub-prime but below prime.

Moody's said it made the decision partly based on "higher-than-anticipated delinquency rates" on the mortgages.

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