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Editorial: Permanent headache

As margin lenders to the two struggling Bear Stearns hedge funds High-Grade Structured Credit Strategies Enhanced Leverage Master Fund and High-Grade Structured Credit Strategies Master Fund scrambled to avert losses in late June, another vehicle with links to the funds was facing up to problems of its own. Everquest Financial, which was recently formed by Bear Stearns (and had filed a registration with the SEC on May 9 to list), is one of a raft of new listed permanent capital vehicles that have been investing in the equity and first-loss parts of structured credit investments and been hailed as a vital new source of liquidity in this market.

These equity vehicles are very unusual in structured credit in that they tap into the retail investor base (see Asset-backed securities: Funds list to ease first-loss salesEuromoney, May 2006). Everquest is one of the largest of this new breed of funds and is co-managed by Bear Stearns Asset Management (BSAM) and hedge fund Stone Tower Capital.

The two Bear Stearns High Grade (BSHG) hedge funds that have attracted so much negative attention are managed by Bear Stearns veteran Ralph Cioffi – who also happens to be co-chief executive of Everquest together with Michael Levitt of Stone Tower. The listing particulars reveal that the BSHG funds own 67% of Everquest, and have transferred equity in 10 CDOs to the permanent capital vehicle for a consideration of $548.8 million. Later in the document it is revealed that all of Everquest’s CDO holdings were contributed by BSAM and that the consideration paid "was not negotiated at arm’s length and may exceed the values that can be achieved upon the sale of such assets". What the BSAM funds were doing was buying the senior tranches of CDOs and leveraging them on repo. Given the fact that one of the funds has been widely reported to have tanked 23% in the first quarter of this year, holding the first-loss pieces of these same CDOs would not be a comfortable place to be.

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