Hedge Funds Hit As Banks Impose Tougher Margin Requirements

Not only does leverage cut both ways, amplifying returns and losses, but bankers have a nasty habit of imposing tougher borrowing terms at the worst possible time.

The hedge fund industry is learning this lesson the hard way, as cash strapped and newly risk averse prime brokers are raising margin requirements across the board, even on Treasuries, pushing some hedge funds over the edge.

From Bloomberg:

The hedge-fund industry is reeling from its worst crisis in a decade as banks are now demanding more money pledged to support outstanding loans even when the investment is backed by the full faith and credit of the United States.

Since Feb. 15, at least six hedge funds, totaling more than $5.4 billion, have been forced to liquidate or sell holdings because their lenders — staggered by almost $190 billion of asset writedowns and credit losses caused by the collapse of the subprime-mortgage market — raised borrowing rates by as much as 10-fold with new claims for extra collateral.

While lenders are most unsettled by credit consisting of real estate and consumer debt, bankers are now attempting to raise the rates they charge on Treasuries, considered the world’s safest securities, because of the price fluctuations in the bond market.

“If you have leverage, you’re stuffed,” said Alex Allen, chief investment officer of London-based Eddington Capital Management Ltd., which has $195 million invested in hedge funds for clients. He likens the crisis to a bank panic turned upside down with bankers, not depositors, concerned they won’t get their money back…

“There has to be more in the next weeks,” Allen said. “There are people who have been hanging on by their fingernails who can’t hold on much, much longer.”….

“Banks are reducing exposure anywhere they can and the shortest way to do that is to cut leverage,” said John Godden, chief executive officer of London-based hedge-fund consultant IGS AIS LLP….

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….

Some managers set themselves up for a stumble by taking on too much leverage and not anticipating that terms could change, said Christopher Cruden, CEO of Lugano, Switzerland-based Insch Capital Management, which oversees $150 million for clients.

“If you’re going to dance with the devil, there comes a time when your toes are going to be stepped on,” Cruden said. “Prime brokers are there to do business, not be your friend.”