The Wall Street Journal Europe
Banks are boosting their lending to hedge funds and private-equity firms to levels unseen since before the financial crisis, raising their risk levels and adding fuel to the buying power of key players across the stock, debt and buyout markets.
Banks and investment banks, including Citigroup Inc., Bank of America Corp., J.P. Morgan Chase & Co. and Morgan Stanley, are offering levels of borrowing -- known as leverage -- that they haven't provided in more than two years, according to people familiar with the banks and funds.
Borrowing terms also are easing, though not to the extent witnessed several years ago.
"You'll see some funds start to crank up leverage this year," says Jon Hitchon, Deutsche Bank's co-head of global prime finance. The bank this year plans to make more leverage available to these investors, he says. It is generally "a pretty straightforward business."
Citigroup's lending to funds is up about 10% in recent months, though lending to larger funds has grown a bit more, according to a person familiar with the matter.
While leverage injects risk into the financial system, borrowed money has always been an essential lubricant to both the economy and the Wall Street money-making machine.
By borrowing, hedge funds can amplify their bets on stocks, bonds and other securities. The leverage can boost gains if the wagers pay off but can prove costly if they sour. Private-equity firms generally borrow money to take publicly traded firms private.
The eagerness to lend to investors comes as some of these banks, such as large U.S. institutions that received billions in federal government aid, have weathered criticism for failing to lend more to consumers and businesses.
Banks say lending to hedge funds and private-equity firms can be more lucrative and potentially safer than lending to businesses and consumers. The collateral that hedge funds provide, such as stocks and bonds, can often be sold quickly if a fund falls into trouble, bankers say. They say they are already sitting on ample amounts of consumer and business loans, but lending to funds was cut sharply last year.
"Capital-markets lending is the only way to make high-probable profits for the next year. Lending to Main Street through home equity and credit cards is off because there's 10% unemployment," says David Hendler, an analyst at CreditSights Inc.
Lending to hedge funds can generate other revenue for the banks, such as trading commissions. Many hedge funds and private-equity firms managed to avoid debilitating losses in 2009, making them relatively good credits, bankers argue. Some banks note that their margin requirements -- the collateral that they require investors to post -- are higher than a few years ago.
But there are risks for both sides. In the heart of the financial crisis, banks rushed to raise borrowing requirements for most funds, for fear they would fold and leave the banks with losses. About 16% of hedge funds closed down in 2009, a record number.
Fear that bankers could quickly lose their newfound enthusiasm for loans has some funds wary of taking on debt.
If the market turns, "lenders will give very little notice before they raise rates and cut credit lines," says Dan Castro of Huxley Capital Management, which manages hedge funds and other vehicles. Mr. Castro says his firm is considering adding some leverage to increase its investments in "selected" areas.
Use of leverage varies widely among hedge funds. Many funds are back to using margin loans and other types of financing equal to two or three times the capital they are investing, effectively doubling or tripling their bets, as was typical before the financial crisis, prime brokerage executives say. The level of risk they are taking on as a result depends on the type of bets they are making, ranging from straightforward long equity positions to short selling of stocks and buying of complex derivative instruments.
In 2006, Barnegat Fund, a $450 million bond-focused hedge fund, counted on 15 banks for leverage. As the financial system collapsed last year, just seven banks were willing to provide it, and only for short periods of time, says Bob Treue, Barnegat's founder.
Lately, Mr. Treue says he has received phone calls from a range of banks, including Citigroup, offering to lend money if Mr. Treue offers easy-to-sell investments as collateral. "They are being proactive, calling to ask if we want to borrow," says Mr. Treue, who has turned down the money because he doesn't see enough investment opportunities to justify extra borrowing.
An influx of competition into the "prime brokerage" business, which includes lending to hedge funds, means there are more firms vying for hedge funds' business.
Private-equity firms say there was little money available to them until late last year. Now, a senior executive at a leading buyout firm says, banks are calling to offer $700 million of loans to finance acquisitions valued at $1 billion.
That compares with $500 million of loans -- if any financing at all was available -- for similar deals a few months ago, the executive says.