07.04.10

Hedge Fund Lending

Posted in Economics, Financial Markets, Politics and Policy at 10:12 am

The WSJ has an interesting article on hedge fund lending to non-financial firms, and the impact it has (detrimental) on the borrowers’ stock prices:

http://online.wsj.com/article/SB10001424052748704699604575343273915683134.html?mod=googlenews_wsj

Companies that borrow money from hedge funds often see a sharp rise in bets against their shares before the loans or loan amendments are announced, new research shows, suggesting that fund managers or others privy to these deals may be illegally trading ahead of the announcements.

The sharp spike contrasts with little change in the short selling of companies that borrow money from banks, according to the research.

The academics found that the average company receiving a new loan from hedge funds saw a 74.8% spike in the volume of short sales during the five days preceding announcement of the new loan, as compared with the volume of short selling 60 days before the deal.

By contrast, 255 similar companies turning to banks for loans saw little change in the volume of short selling during the five days prior to the announcement of new loans.

This raises the obvious question of why hedge funds would trade against the stock of firms to whom they have loaned funds.

Why might a hedge fund bet against shares of a company while also lending it money? Traders say a fund might seek short-term gains from a potential tumble when word emerges that a company has turned to hedge funds for a high-rate loan, even if the fund is comfortable extending a loan because the company is likely to survive over the long haul. It also could be that some hedge funds are offered the chance to lend to a company, turn down the opportunity and then short the company’s shares.

The second explanation seems far more plausible to me.

Also, some data on the size of the Asset Based Lending Hedge Fund (ABL) market:

http://www.compasscayman.com/cfr/2010/04/14/Asset-based-lending-hedge-funds–The-alternative%E2%80%99s-alternative/

In 2007 and 2008 in particular, total asset-based loan volume outstanding was $545 and $590 billion, respectively, according to the Commercial Finance Association.

According to the HedgeFund.net database, ABL funds managed approximately US$15.6 billion in assets as of February 2009 compared to less than $1 billion in 2004.

Rapid growth and leverage out the wazoo, combined with near zero regulation.

It’s getting hard to argue that the financial crisis was not about the rise of the shadow banking system.

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