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As Banks Shun Loans, Hedge Funds Move In

Louise Story|The New York Times
Friday, 13 Jun 2008 | 4:10 AM ET

Companies traditionally get loans from banks, but with so many lenders stretched and with credit so tight these days, businesses are turning to what might seem like an unlikely source for cash: hedge funds.

As banks retrench, hedge funds increasingly are offering loans to companies, usually at interest rates that are far higher than those that banks charge.

More than 100 funds specialize in lending, and several big ones, like Fortress Investment Group and Citadel Investment Group, are starting to follow suit.

While some funds have been offering loans for a few years, more are moving in because the credit squeeze has hobbled many banks and left hard-pressed companies hungry for cash.

"Anybody who needs money is going to a hedge fund now," said Matthew T. Hoffman, chief investment officer of Weston Capital Management, a fund of hedge funds in Westport, Conn.

"These funds have been inundated with requests. The volume of requests has gone up probably five times."

The hedge funds are hardly being generous. They often charge rates of as much as 3.2 percentage points more than bank rates.

"You’re talking to people who are very thirsty or hungry to get double-digit returns," said Ed Banks, chief investment officer of Washington Corner, a hedge fund in New Jersey.

"And they know you’re coming hat in hand."

Economists predict that it is only a matter of time before the cutback in bank lending causes a slowdown in industries far from Wall Street.

Just over half of domestic banks reported that they tightened standards on commercial lending in April in a Federal Reserve survey, up from 30 percent in January.

But hedge funds may fill a small part of the void.

The number of hedge funds that specialize in what is called "asset-based lending" has quadrupled in the last three years, according to HedgeFund.net, a hedge fund information service owned by Channel Capital Group.

New funds of this sort include the Weston Fund in Riverside, Conn., founded in January, and the Genesis Merchant Partners fund, which opened in Greenwich, Conn., last week.

These banklike hedge funds had about $12 billion in assets to lend as of the end of last year, up from $900 million three years ago, according to HedgeFund.net.

Big funds like Citadel and private equity giants like Cerberus Capital Management have even more.

Unlike banks, which raise money from depositors, hedge funds are not regulated.

The funds get their capital from wealthy investors.

Y. Judd Shoval founded a lending hedge fund, Ambit Funding, in early 2005 after a career running local banks.

Consolidation in the banking industry left a niche for hedge funds for a variety of loan types, he said, and his fund makes commercial loans in 12 states.

Mr. Shoval does much the same type of lending he did at banks.

His depositors are not banking customers who can access their money 24 hours a day, but rather investors who have a six month lock-up on their money.

And he charges the standard hedge fund fees to investors.

"We are a hedge fund, but we look at each situation through the prism of a bank," Mr. Shoval said.

To be sure, there were hedge funds that jumped in during the loose lending of recent years and lost money on loans, just as the banks did.

And hedge funds may find their investors weary of investing more heavily in loans because such debt is often illiquid and hard to value, said Michael Zupon, a managing director and head of the domestic leveraged finance group at the Carlyle Group.

And hedge funds, those often secretive, sometimes volatile investment vehicles, often arouse suspicions.

Some companies still remember tales that circulated in the late 1990s about hedge funds that purchased stakes in small companies through what was known as a "death-spiral convertible."

These shares can be converted into common stock as a company’s share price drops, and that strategy is said to be returning now.

"Hedge funds have been known to come in and profit from a company’s demise," said Meredith Jones, managing director of PerTrac Financial Solutions, a financial software company.

But, Ms. Jones said, may distressed companies have little choice but turn to hedge funds.

"It’s kind of like: do you sign a lease with your landlord? Well, if you don’t, you don’t have a place to live," she said.

Some hedge funds have been hoarding cash for the time when companies are desperate, said Michael Fuller, managing director of Private Advisors, which manages a fund of funds of direct-lending hedge funds.

The terms banks were offering in recent years were so generous, with such low interest rates, that some hedge fund managers refrained from lending, he said.

"Up until six months ago, they couldn’t compete," Mr. Fuller said.

"So they just waited and held lots of cash on their books. Now Wall Street is spitting stuff out. Some are great investments."

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