Rescue Talks Fail As Carlyle Capital Nears Collapse

Rescue Talks Fail As Carlyle Capital Nears Collapse

After coming to an impasse with lenders on a new financing deal, Carlyle Capital is on the verge of collapse.

The bond fund, which is affiliated with the Washington-based private-equity firm Carlyle Group, made an announcement on March 12 that lenders intend to seize the fund's assets. Until recently, Carlyle Capital owned $21.7 billion in mortgage securities.

Executives of the Carlyle Group own 15 percent of Carlyle Capital. Following news of the fund's financing issues, shares dropped significantly: more than 80 percent in one week.

Problems for two-year-old Carlyle Capital first began last year when it was forced to postpone an initial public offering of stock. When the fund went public in July, shares were sold at a discount. One month after the initial public offering, the Carlyle Group had to extend $200 million so that the fund could meet margin calls.

The more recent troubles for Carlyle Capital came one week after the Carlyle Group tried, without success, to hold off margin calls and the liquidation of its mortgage assets. Lenders, which reportedly included Deutsche Bank, Merrill Lynch & Co., Bear Stearns Cos. and J.P. Morgan Chase & Co., proceeded to sell the fund's assets, and by March 11, $5.7 billion had been sold.

As of March 12, the fund had defaulted on approximately $16.6 billion of its loans, and expects to default on the rest.

The demise of Carlyle Capital is yet another example of how the credit crunch affects far more than just subprime mortgages. Carlyle Capital's portfolio consisted solely of AAA-rated mortgage backed securities issued by Fannie Mae and Freddie Mac.

Moreover, the collapse of Carlyle Capital shows how the relationship between investment banking firms and clients has changed dramatically, as banks take a more cautionary approach regarding their own loan exposures. In Carlyle Capital's case, 12 banks had provided approximately $21 billion, or $20 for every dollar of initial capital.

In the beginning, the investment strategy for Carlyle Capital looked simple: the fund would exploit the difference between interest earned on its mortgage securities investments and the costs of financing the investments. But as with several hedge funds lately, Carlyle predicament began to unfold when it borrowed too much money. The fund had $670 million in clients' money, but it used borrowings to increase its bonds portfolio to $21.7 billion. That means, before dealers began selling the fund's assets last week, it was about 32 times leveraged.

The excessive leverage, in addition to tightening credit markets, was the final straw for Carlyle Capital.

Carlyle Group was founded in 1987 in Washington, D.C., and manages approximately $75 billion in 59 funds. In recent years, it has partnered with other private-equity firms to finance such buyouts as Kinder Morgan Inc., Hertz Corp. and Freescale Semiconductor Inc.

Carlyle Capital is headed by John Stomber. Stomber also is managing director at Carlyle Group.

In the summer of 2007, our group, which individually and collectively has extensive experience in representing investors against Wall Street, formed an affiliation. Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage related investment losses. Contact us.