(Adds detail on Treasury PPIP agreement in paragraph 12)
By Al Yoon and Joe Giannone
NEW YORK, Dec 9 (Reuters) - The U.S. Treasury Department on Wednesday said it froze a $1 billion public-private investment fund set up by TCW Group Inc to buy non-performing financial assets, saying the departure of star manager Jeffrey Gundlach last week triggered a “key person event” in their partnership.
The Treasury’s move raised eyebrows in the mortgage-backed securities (MBS) market, which owes at least part of its recovery this year to expectations that some $40 billion in demand from nine U.S.-approved public-private investment partnerships (PPIP) would help establish a bottom in prices after a two-year drubbing.
At the heart of the matter is the depth of Gundlach’s experience in the MBS market and whether Treasury will accept his successor at TCW.
Gundlach is one of the best-known bond fund managers, and was responsible for raising at least $500 million from investors to seed TCW’s partnership with the Treasury. On Friday, TCW said it fired Gundlach after he “threatened to take certain actions that could have jeopardized the firm’s ability to manage clients’ fixed income assets.”
Gundlach did not return calls seeking comment Wednesday.
“Treasury has notified TCW that a key person event has occurred under the limited partnership agreement,” Treasury spokeswoman Meg Reilly said.
“Upon the occurrence of a key person event, the (TCW-managed fund) cannot make investments or dispositions,” she said in an email. “Treasury is currently evaluating its options as an equity and debt investor” in the fund.
At the time of Gunlach’s termination, TCW announced the takeover of fund manager MetWest and one result of the U.S. Treasury’s review may be the appointment of MetWest co-founder Tad Rivelle as the new key man, allowing the TCW fund to proceed with the PPIP management.
“We are in regular communication with Treasury and working to ensure we meet their contractual due diligence requirements,” TCW said in a statement. “We feel we’ve brought in a team that can match skill for skill and ensure continuity and stability in managing clients’ assets.”
TCW said about 30 MetWest managers immediately assumed control of its high-grade bond accounts following the takeover, with the remaining employees coming on board when the deal closes.
Los Angeles-based TCW on Wednesday declined to comment on client activity in its funds or the Treasury review.
Under the government’s partnership agreement, TCW has 30 days to resolve a “key person event,” or else Treasury has the right to remove the firm as a general partner.
People familiar with the situation said the suspension of TCW’s PPIP fund was a routine response based on contracts.
But clients quickly responded to the news of his departure by withdrawing money from TCW’s flagship TCW Total Return Bond (TGLMX.O) fund. About $1.2 billion was withdrawn on Monday and about half that amount on Tuesday, TCW said.
The firm on Tuesday said it sold government-backed mortgage securities and $450 million of other mortgage bonds to meet client redemption requests.
Meanwhile some 15 employees were fired or resigned from TCW, including Gundlach, or nearly one fourth of its 65-person fixed income investment team.
However, TCW contends its takeover of Metropolitan Asset Management LLC will add 115 employees and $30 billion in assets.
TCW, which oversaw $108 billion as of Sept. 30, was chosen from an estimated 100 applicants for the PPIP management in which the government matches capital and offers debt to the funds to buy distressed assets weighing on bank balance sheets.
The program is one of the anchors of the Obama administration’s plan to restore the banking industry’s health and restart lending to bolster the economy.
“The antennas are up, but in no way should there be any cause for panic” about the PPIP, said Jesse Litvak, a managing director in mortgage trading at Jefferies & Co. in Stamford, Connecticut. “There are seven other PPIP guys buying.”
The $6.7 trillion market for U.S. mortgage-backed securities owes much of its rally since March to the PPIP and general risk-taking by investors who believe the bond prices fell too far, even given high levels of defaults and foreclosures.
Prices have gained 20 percent to 30 percent from their lows, according to Guggenheim Capital Markets.
But the buying has now pushed prices too high for the funds to garner desired returns, and prices have softened. The PPIP managers will continue to have an impact, however, said Scott Buchta, a strategist at Guggenheim Capital Markets in Chicago.
“The PPIP program as a whole is still up and running and the other 7 managers will continue to be actively involved in the markets, irregardless of what the Treasury decides what to do with this fund,” he said.
Reporting by Joe Giannone and Al Yoon in New York, and Tim Ahmann in Washington