Lehman worry, hedge fund selling hammer MLP sector

By Anna Driver - Analysis

HOUSTON (Reuters) - Energy-related master limited partnerships were slammed this week as hedge funds threw in the towel and investors fretted over bankrupt Lehman Brothers' wide exposure to the sector, and the meltdown may not be over yet.

Lehman marketed the master limited partnerships -- or MLPs -- to their high net worth customers and also runs the Lehman Brothers MLP Opportunity Fund. The firm also was a lender to some of the partnerships and has been a mergers and acquisition adviser.

"Lehman was definitely one of the bigger investment banks to support the MLP sector," Mark Easterbrook, analyst with RBC Capital markets, said. "I think we might be seeing some overall panic from the retail investors.

Investors may see additional weakness and volatility even if the sector's fundamentals stay strong as the pace of tax-loss and hedge fund selling quickens going into the fourth quarter, Easterbrook said.

As of June, Lehman Brothers Asset Management owned $1.1 billion of MLP equities, Wachovia Capital Markets said in a note to clients.

Energy MLPs are typically made up of assets such as pipelines, gas processing operations or long-lived producing fields that generate steady, stable earnings.

The partnerships have been popular with those looking for a steady stream of income because they pay out nearly all their operating cash flows to investors in the form of distributions and offer tax advantages to corporations.

But 2008 has been a tough year for MLPs, which were first hit by the global credit crunch last summer. Pressure intensified with the Lehman bankruptcy on Monday.

So far in September, the Alerian Capital index of MLP .AMZ has fallen 19 percent so far in September, outpacing a 2 percent decline in the Russell 2000 index .RUT. The Alerian index is also trading near all-time lows.

Losses are also exaggerated by the fact that many MLPs are not very liquid, analysts said.

MLPs attracted a more diverse base of investors including hedge funds that were chasing the out-sized returns the sector had been delivering in early 2007.

Lehman Brothers Holdings Inc filed for bankruptcy protection after trying to finance too many risky assets with too little capital,, becoming the largest U.S. bankruptcy.

The Wall Street firm is expected to sell most of its businesses.

MLPs owned by Lehman Brothers Asset Management include Linn Energy (LINE.O), Magellan Midstream Holdings LP (MGG.N), Eagle Rock Energy Partners LP (EROC.O) and BreitBurn Energy Partners LP (BBEP.O), data from Reuters Research showed.

Linn said in a press release that it has terminated its hedging contracts with Lehman and said it does not expect the firm's bankruptcy to have an adverse material affect on the company.

BreitBurn said it does not expect the bank's Chapter 11 filing to have an adverse effect on the partnership. Still, BreitBurn said Lehman was a counterparty on an oil hedge, an interest rate swap, and a small lender.

BreitBurn said it is currently assessing its options related to its exposure to Lehman.

Eagle Rock said it has no counterparty exposure to Lehman.

REDEMPTIONS

Heavy hedge fund selling tied to redemptions and tax-loss selling were also playing a role in the sector's sell-off.

"Trading patterns in 2008 lead us to believe that some of the selling pressure has been coming from redemption-driven selling by hedge funds," Michael Blum, analyst with Wachovia, told clients in a note on Tuesday.

Fund managers and retail brokers are in capital preservation mode and are selling MLP equities at depressed prices, Blum said.

Still, once selling tied to the end of the year and the fourth quarter eases, the sector may be poised for a rebound, the analyst said.

And some analysts, noting the stocks' cheap valuation, think now is a good time to buy.

"The market is clearly not focused on fundamentals, but we can't help liking MLPs with limited near-term capital market needs, strong general partner support, solid growth prospects and attractive valuations," research firm Tudor, Pickering, Holt & Co. Securities Inc told clients in a note on Wednesday.

MLPs they favor include Regency Energy Partners LP (RGNC.O), Williams Pipeline Partners LP (WMZ.N) and Spectra Energy Partners LP (SEP.N).

(Editing by Dave Zimmerman)