Institutional Investor's Alpha Magazine - July/August 2008 - (Page 33)

Strategies Lending F or years E*Trade Financial Corp. invested a good chunk of its capital in collateralized debt obligations. It seemed like a great way for the online brokerage firm to generate balance-sheet gains: Interest rates were falling and real estate prices were rising, driving up CDO values. But when the real estate market began to tank last summer, so did the value of E*Trade’s CDOs, and by November 2007 mortgage-related losses had slammed the company. Its stock price fell 58.7 percent virtually overnight — or, to be precise, over a weekend — from $8.59 per share on Friday, November 9, when the company announced after the market closed that it would have to take “signiﬁcant write-downs” in its CDO portfolio, to $3.55 on Monday, November 12. Although E*Trade didn’t publicly quantify the losses, they were clearly staggering, and the ﬁ rm was in desperate need of outside help. Its savior? Citadel Investment Group, the $22 billion Chicago-based hedge fund ﬁrm. Citadel and its partner in the deal, New York–based money manager BlackRock, stepped up with a comprehensive capital-infusion package: $1.6 billion in cash in exchange for a 20 percent equity stake in E*Trade and senior unsecured notes that yield 12.5 percent. Citadel ponied up an additional $800 million for E*Trade’s assetbacked-securities portfolio, which carried a paper value of $3 billion. E*Trade also agreed to hand over much of its equity-trading business and all of its options trading to Citadel. The deal, completed on November 29, instantly turned the hedge fund firm into a player in the retail trading market. In a single stroke Citadel had executed the kind of feat usually associated with big banks like JPMorgan Chase & Co. and Goldman, Sachs & Co. Bankers The Citadel-E*Trade pact — extraordinary as it was — exempliﬁes the increasingly blurry line separating commercial and investment banks from hedge funds. The change is occurring as traditional capital markets have rapidly dried up and as hedge funds have begun to market themselves as ﬁnanciers, promoting their services (and their bankrolls) on their Web sites and through intermediaries. Nowadays, says Lawrence Goldfarb, chief executive ofﬁcer of hedge fund ﬁrm LRG Capital Group in Larkspur, California, “it’s hard to tell a hedge fund from a Hedge funds, once merchant bank.” What many hedge thought of as the last funds have going for them is what borrowers want resort for companies and something that most seeking an infusion of banks have run low on these days: liquidity. Bear capital, are using their Stearns Cos. is out of the market. Citigroup has been excess cash to compete raising capital, reorganizing business units and sellwith credit-strapped ing off pieces of its loan investment banks. portfolio. UBS has restructured by writing off $37 billion in bad debt since the credit crisis started last year, selling a $15 billion mortgage portfolio to BlackRock and cutting back on staff. Once considered the last resort for troubled companies whose prospects are too dicey for traditional investors, hedge funds have become crucial ﬁnanciers even for large and stable companies simply because commercial and investment banks aren’t lending like they did in the early part of the decade. This trend has developed in part because The New By Ann Logue JULY/AUGUST 2008 • INSTITUTIONAL INVESTOR’S ALPHA • 33

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - July/August 2008

Institutional Investor's Alpha Magazine - July/August 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Mr. Big Goes Small The Good Guys: Adopt This School! Interview: Man's Great Hope Cover Story: The Gentleman Activist Strategies: The New Bankers Profile: Staying Alive Research Center: The Best of the East The Asian Sensations Alpha Bytes: Into the Light Unhedged: Commentary: Speculating on Washington

Institutional Investor's Alpha Magazine - July/August 2008

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