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Tequesta Mortgage Fund - Jumbo Mortgages

2008-03-07

Count of distinct funds: 1
Capital base: $150 mm
Loss: 20% or more?

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stories: cnn.com

From CNN money comes word that Tequest Mortgage Fund has "collapsed" after failing to "meet demands for more collateral from its prime broker ... Citigroup".

The article indicates that Tequesta's implosion was set off by the balance sheet problems of commercial and investment banks:

In July and August of last year, and then again in October and November, the secondary market for jumbo mortgage bonds came to a standstill. At the same time, Tequesta's primary brokers - including Bear Stearns (BSC, Fortune 500), Citigroup, Credit Suisse (CS) and UBS (UBS) - were grappling with balance sheets loaded with billions of dollars worth of subprime mortgages, CDOs and other fixed-income derivatives and loans.

This, in turn, created problems for smaller, less-liquid markets. Jumbo mortgage bonds, for instance, saw valuations drop as dealers and rival mortgage hedge funds refused to indicate at what price they would be willing to buy this paper. Lacking bidders, Tequesta's bonds fell in value.

...

Tequesta's portfolio managers watched on the sidelines as banks dumped billions of dollars worth of mortgage bonds to free up capital. Even bonds backed by loans to the wealthiest Americans traded lower.

This raised alarms among Tequesta's lenders. Executives at investment-bank prime brokerage operations saw the sharp drop in the value of Tequesta's holdings and demanded additional collateral. In turn, they forced the fund to make additional sales to meet the margin calls.

As a result, Tequesta lost nearly 20% in 2007.

Citigroup's involvement in Tequesta's implosion is particularly interesting:

Making matters worse: Unlike other lenders making margin calls, Citigroup was willing to liquidate inventory below loan values - the value it had assigned the bond when they initially provided the fund its margin - and recognize losses just to get the bonds off its books. A Citigroup spokeswoman declined comment.

In one case, Citigroup seized collateral from Tequesta and put it up for sale in a bid-list auction. According to a trader at another firm, however, Citigroup's mortgage trading desk offered to sell Tequesta's bonds to regional brokerage firms at prices even lower than listed prices. In another instance, Tequesta's portfolio managers were told by Citigroup rivals that its seized bonds had been offered to other hedge funds for more than $25 below where they had been trading in the previous days.

It was under these sustained pressures that Tequesta decided to close the fund down just days ago.

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Important: This fund is on our list of hedge funds that have "imploded" (see also ailing lenders). However, please note that "imploded" is a somewhat subjective. The "imploded" list contains hedge funds (or other unregulated and autonomous speculative investment funds) which have gone through some sort of permanent adverse change. This is a somewhat subjective call, and does not necessarily mean total shutdown or bankruptcy. It can also mean steep and rapid mark-downs in net asset value; or abnormal "bail-out" by corporate parents or peers in order to avoid write-downs and provide liquidity. The funds are of any type and sector.