Fund-of-Funds Managers Target Stalled Bank Loans

U.S. Subprime Mess
Creates Opportunity
To Snag Cheap Debt

By WILLIAM HUTCHINGS and MARK COBLEY
September 7, 2007

GAM, one of the largest fund-of-hedge-funds managers, and rival Thames River Capital are primed to make substantial investments in the stalled bank-loan market, buying debt at a discount from lenders anxious to have it removed from their balance sheets.

The chance to buy loans on the cheap has arisen because banks are struggling to sell debt used to finance leveraged buyouts. Before June, banks had been able to sell leveraged loans within a few weeks, but liquidity in the credit markets has dried up as a result of uncertainty over lenders' exposures to subprime U.S. mortgage loans.

David Smith, chief investment director of the multimanager group at GAM, said there was a window of opportunity within the next six months to snap up bank loans at bargain prices, adding that GAM had lined up six hedge-fund managers to buy the debt.

Investors such as GAM, which are prepared to put their money into leveraged loans, hope to profit at the expense of the investment banks and credit-market participants that are rushing to offload the debt at knock-down prices. The loans pay high yields, more than three percentage points above the London interbank offered rate. However, these investors will be taking on the risk of the borrowers defaulting, which has grown as interest rates have increased.

If the banks can't remove the loans from their balance sheets, they will be unable to do more buyout-lending business, a source of high fees. GAM and others are waiting until banks offer existing loans at a discount to clear their balance sheets as they attempt to offer fresh financing.

Ken Kinsey-Quick, head of multimanager funds at U.K. manager Thames River Capital, said his firm had reopened one of its funds of hedge funds and was raising capital from investors to make bank-loan investments. "To say these debt assets are cheap is an understatement," he said. "The commercial-paper market is pretty much dead. That is a $1 trillion industry that has just died in the past few weeks."

Mr. Kinsey-Quick added: "As much as $500 billion needs to be refinanced in the next six weeks. Even assuming some of that gets away, there will still be the balance of the collateral sitting on banks' balance sheets. This is all triple-A-rated collateral and it will be trading very cheaply. It's a huge opportunity if you have the gunpowder and the liquidity."