NEW YORK (Reuters) - The fate of two troubled hedge funds managed by Bear Stearns Cos. Inc. BSC.N was left in question after Merrill Lynch & Co. Inc. MER.N sold off assets seized from the funds and three other banks closed out their positions with them.
The Bear Stearns funds once had over $20 billion of assets, but lost billions of dollars from bad bets on securities backed by subprime mortgages. Bear Stearns earlier this week proposed adding $1.5 billion of its capital to the funds as part of a broader restructuring plan, but many Wall Street firms have already headed for the exits.
The impact of Merrill’s sale of the assets was not clear late Wednesday, but could be substantial. Many traders had feared that the auction could create big price reductions in a corner of the bond market known as the collateralized debt obligation sector, where bonds trade infrequently.
Collateralized debt obligations are essentially bonds that are portfolios of other bonds or loans, and have provided crucial financing to areas including subprime lending and leveraged buyouts.
If the prices of those securities broadly fall, Wall Street firms, hedge funds and other investors could have to take losses on their portfolios of CDOs, cutting into profits. Meanwhile, leveraged buyout funds that depend on the CDO market to help provide financing for takeovers could have more trouble completing deals.
“The implications of that extend well outside the market into the real economy, as it would reduce liquidity for mortgages,” said Josh Rosner, managing director of Graham Fisher & Co. in New York. “It could create a broader sell-off.”
Stocks fell on Wednesday, with the Standard & Poor’s 500 falling 1.36 percent to 1512.84. Shares of Bear Stearns fell 2.45 percent to $143.20, their lowest level since March, and shares of Merrill Lynch fell 2.6 percent to $87.68.
An index of bank loan credit risk dropped, and corporate bonds weakened relative to Treasuries.
Merrill Lynch sold securities from the two funds in the broader markets. On Thursday, it plans to sell derivatives, a source said.
Goldman Sachs Group Inc. (GS.N), JPMorgan Chase & Co. (JPM.N) and Bank of America Corp. (BAC.N) closed out their positions with the funds, which amounts to selling their positions back to the Bear funds.
Bear Stearns’ exposure to the funds was relatively limited — the firm and some of its executives had about $40 million of investments in the funds. Bear Stearns’ Chief Financial Officer Sam Molinaro said last week that the firm did not expect a future earnings impact from the funds.
Merrill Lynch did not sell all of the roughly $850 million of securities it put up for sale, a source said, but it is believed to have sold enough assets to cover its exposure to Bear Stearns.
The value of the collateral that Merrill was entitled to seize was higher than Merrill’s exposure to the funds.
The Bear Stearns-managed funds suffered losses after making bad bets on securities linked to subprime loans, which have suffered from rising delinquencies and defaults.
The funds, the High Grade Structured Credit Strategies Enhanced Leverage Fund and High Grade Structured Credit Strategies Fund, sold billions of dollars of assets to cover investor redemptions and expected margin calls.
The High Grade Structured Credit Strategies Fund had about $1 billion of client assets under management, while the High Grade Structured Credit Strategies Enhanced Leverage Fund had about $600 million. Both funds had borrowed to dramatically increase the investing power of the funds, and at one point controlled over $20 billion of assets.
The High Grade Structured Credit Strategies Enhanced Leverage Fund was down 23 percent for the year by the end of April, while the High Grade Structured Credit Strategies Fund was down about 5 percent.
Merrill Lynch, JPMorgan Chase, Goldman Sachs, Bank of America and Bear Stearns declined to comment.
Additional reporting by Walden Siew, Al Yoon, Jonathan Stempel and Nancy Leinfuss