DEALTALK-Banks offering credit again in hedge fund land grab

* Prime brokers eager to rebuild businesses

* More credit on offer, funds don't need it all

* Leverage back to 1.6-times, halfway from trough to peak

* Funds worried by counterparty risk, favour 3 prime brokers

(For more Reuters DEALTALKs, click [DEALTALK/])

By Laurence Fletcher and Joseph A. Giannone

LONDON/NEW YORK, Oct 8 (Reuters) - Prime brokers are offering hedge funds more credit at a lower cost in a desperate battle for market share, although the biggest hedge funds are reluctant to move away from brokers they consider safe.

With the risk of a bank failing still a key concern, many funds now pick three top brokers from a list of JPMorgan (JPM.N), Goldman Sachs (GS.N), Credit Suisse (CSGN.VX), Deutsche Bank (DBKGn.DE) or Morgan Stanley (MS.N).

"Banks have all lowered their rates and are competing again -- at one moment they were pushing hedge funds away, now they're competing for funds," said Oliver Dobbs, chief investment officer of portfolio management at hedge fund firm CQS, talking about convertible arbitrage strategies.

"Up to five-times leverage is available on a blended basis for a relative value fund and perhaps as much as 10-times for the right individual credit," he told Reuters.

Last year's collapse of Lehman Brothers LEHMQ.PK saw many banks and hedge funds grow nervous over their relationships with one another.

Some funds had their accounts frozen, and firms such as GLG GLG.N and Augustus had to quickly move their business to other prime brokers, which provide trading and margin lending.

A number of funds left Morgan Stanley and Goldman. Morgan in particular has reported losing as much as half of its balances last autumn, although the bank, now stabilised, is winning back some fund customers.

Many banks scaled back prime brokerage lending as a quick way to cut leverage, although others used the post-Lehman chaos as an opportunity to build up their businesses. [ID:nL6258070]

Now, as hedge fund returns and assets rebound, banks across the board are actively fishing for business, with many using credit as bait. They are particularly keen on the blue chip hedge funds, seen as least likely to run into trouble, who find themselves spoilt for choice.

"Having reacted quite sharply during the downturn, prime brokers at the margin are now at the other end competing on price and quantity of credit to regain market share, almost as if nothing had happened," said Philip Vasan, global head of prime services at Credit Suisse.

Prime brokers contacted by Reuters said leverage levels have now risen back up to about halfway between their trough, when Lehman collapsed and the pre-Lehman peak, or about 1.6-times.

The UK Financial Services Authority's twice-yearly prime broker survey shows long leverage -- the ratio of the value of long positions to net equity -- rose slightly to about 1.2-times between October 2008 and April 2009.

This is well below peak levels of about 2-times in 2007 and far from what most observers would describe as reckless.

CHOOSING CAREFULLY

With banks having access to cheaper, more plentiful funding again, prime brokers see larger hedge funds as a relatively low risk bet and a way to sell a bank's full range of services.

"Every prime brokerage house is trying to rebuild or rehire in this space. Suddenly it's a crowded space for larger hedge funds, with a limited amount of business to go around," said Nick Roe, global head of prime finance at Citigroup.

"This year is not necessarily about revenue growth but about market share," he told Reuters.

However, the signs are that cheap and more plentiful credit is not enough to win back funds.

"Firms appear not to be attracting business by offering large amounts of leverage," the FSA survey said.

Meanwhile, many hedge fund managers simply do not require such high leverage to profit from still-cheap assets in many sectors. CQS's Dobbs said most convertible arbitrage funds are using no more than two- to three-times leverage.

Hedge funds remain wary of another Lehman-sized catastrophe and are picking their counterparties and the funding they used, very carefully. They are taking a hard look at banks using emergency short-term government money.

"Investors are increasingly focused on the liquidity of a prime broker and analysing the sources and duration of funding and capital strength," said Roy Martins, Credit Suisse's head of international prime services.

"As a result some have indicated that short-term government-backed funding may not necessarily be the most sustainable business model," he said.

"We've seen people pricing loans at levels just to show incremental revenue growth," said Barry Bausano, co-head of global prime finance at Deutsche Bank, a big commercial bank that gained market share as a result of the financial crisis. (To read the Reuters Hedge Fund Blog click on blogs.reuters.com/hedgehub; for the Global Investing Blog click here)