D.E. Shaw to Start Fund to Buy Europe Bank Loans, Mortgages

D.E. Shaw to Start Fund to Buy Europe Bank Loans, Mortgages
The European Central Bank in Frankfurt. Photographer: Hannelore Foerster/Bloomberg

D.E. Shaw & Co., the $26 billion New York-based hedge fund that uses computer models to pick trades, plans a fund whose investments will include European loans.

The Alkali Fund, which will start in July, will invest in residential mortgage-backed securities, consumer asset-backed debt, troubled loans, credit extensions to borrowers who do not have access to bank financing, and corporate credit, according to a document dated April 2012 that was obtained by Bloomberg News. The Alkali Fund will be managed mostly by D.E. Shaw’s asset-backed securities team, with some help from the corporate-credit managers, according to the document.

“We believe that a substantial portion of Alkali Fund’s opportunity set will result from pressure on European banks to reduce their leverage,” the firm said in the document. “We expect that a deleveraging in Europe will occur both actively through asset sales and passively through a reduction in origination of credit and willingness to roll over debt as it matures.”

Marc Lasry’s Avenue Capital Group LLC, Leon Black’s Apollo Global Management LLC and Bruce Richards’ Marathon Asset Management LP are among hedge funds and private-equity firms that have targeted European distressed assets as managers seek to take advantage of opportunities fueled by the region’s sovereign-debt crisis. D.E. Shaw did not say how much has been raised for the Alkali Fund in assets or commitments.

Size of Europe Opportunity

European banks hold about 500 billion euros ($652 billion) worth of nonperforming loans, with estimates of assets not core to their main businesses ranging from 1.7 trillion to 2.5 trillion euros, D.E. Shaw said in the document. Lasry said last week he estimates the size of the European distressed debt market to be about $1 trillion.

D.E. Shaw’s asset-backed securities team was formed in August 2008, and has been responsible for $800 million in gross trading profits for one of the firm’s multistrategy funds, according to the document.

The firm has “in many cases established commercial relationships with a number of loan servicing partners, particularly in Spain and the United Kingdom,” it said. The fund may partner with servicers for joint ventures.

The European Central Bank’s 1 trillion-euro long-term refinancing operation, initiated in December to provide liquidity to the region’s lenders, may limit short-term investments because it allows banks to delay asset sales, D.E. Shaw said. The Alkali Fund may also capitalize on opportunities in the U.S. and other regions, the firm said.

“We believe the short-term opportunities for investors to benefit from buying large portfolios of non-core assets as a means of gaining exposure to European credit beta may be limited,” the firm said in the document.

Mortgage-Backed Securities

U.S. residential mortgage-backed securities and consumer asset-backed securities will comprise “a meaningful, and possibly the largest, portion” of the Alkali Fund, D.E. Shaw said.

Hedge fund managers including Kyle Bass’s Hayman Capital Management LP and Deepak Narula’s Metacapital Management LP have sought cash for new mortgage funds. Cerberus Capital Management LP, CQS U.K. LLP and Canyon Partners LLC started similar investment pools after prices slumped last year.

European banks are estimated to own about 100 billion euros worth of U.S. residential mortgage-backed securities, which they may sell to reduce U.S.-dollar funding, a “potentially rich source of inefficiently priced assets,” D.E. Shaw said. The firm also expects U.S. financial institutions will serve as a source of the holdings.

David Shaw, a former Columbia University computer science professor, founded D.E. Shaw in 1988. A spokeswoman for D.E. Shaw declined to comment on the fund.

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