Magnetar Defends Itself (BAC, C, UBS)

The $7 billion hedge fund, Magnetar Capital LLC, has been reported to have profited in 2007 from bets that the sub-prime housing market will collapse. However, in a letter to clients, Magnetar has said that it has not helped banks in the creation of mortgage-linked investments “built to fail”. Bloomberg reports that according to this letter, the firm had offered only limited input as regards to the selection of securities in these deals and had taken bets that would pay off if they soured. But according to Magnetar, this was a part of a “market neutral” portfolio designed to profit no matter what happened.

“There was no embedded view regarding the direction of housing prices, the rate of mortgage defaults or the subprime- mortgage market generally,” the firm said in the letter. Although Magnetar has said that its portfolio was designed to make money no matter what happened to the value of subprime mortgages, its executives have expressed views on the market. In March 2007, in an interview to Bloomberg News, David Snyderman, Magnetar’s head of global fixed income had said, “Magnetar has been concerned about the excesses in the subprime-housing market since early 2006. As a result, we have positioned our structured-credit portfolio such that we are profiting from the recent volatility.”

According to data compiled by Bloomberg, Bank of America Corp.’s (NYSE: BAC) Merrill Lynch unit, Citigroup Inc. (NYSE: C) and UBS AG (NYSE: UBS) are among at least nine banks that underwrote more than 20 collateralized debt obligations, whose riskiest slices were bought by Magnetar. In its letter, Magnetar said that it bought the riskiest piece of CDOs, known as the equity portion, as it expected it to return 20 percent annually over six to eight years if mortgage defaults remained low. The firm went on to say that it had also hedged those positions with bets against its CDOs and others at a cost of less than 6 percent annually.

Thomas Adams, a partner at New York-based law firm Paykin Krieg & Adams LLP, who worked in the CDO groups for two bond insurers, in a telephone interview to Bloomberg said that the purchase of a CDO’s equity class is usually taken as “an expression of confidence in the structure. It would definitively have been relevant” to other investors that Magnetar wasn’t simply making a bullish bet.

Magnetar has sent this 11-page letter in response to an April 9 article on the Web site of ProPublica. ProPublica is an independent, nonprofit investigative journalism project based in New York. Their article suggested its CDOs were “built to fail,” according to Magnetar’s letter. ProPublica said in a statement to Bloomberg News, “The facts in our story should allow readers to reach their own conclusions. We see nothing in the story to correct.”