With the medium-erm debt issuance announced yesterday, Citadel may be on it’s way to becoming the anti-Long Term Capital Management—a hedge fund that can increase its leverage without incurring margin call risk if it’s investments go south. LTCM ran into trouble when its investment strategy blew-up and it became clear it wouldn’t be able to make its margin-calls. With piles of unsecured debt in its coffers, Citadel should be better able to weather the sort of stormy market that toppled LTCM.
Bloomberg does a good job of describing how the bonds might help free Citadel from some of the traditional credit risks faced by hedge funds.
The plan may cut Chicago-based Citadel's reliance on financing from Wall Street investment banks, which provide leverage and trading services to hedge-fund clients through prime brokerage units. The bonds will be sold through a medium-term note program, meaning Citadel can sell the total amount of debt over time rather than in a single offering...
"This marks a historic point in the industry, a coming of age,'' said Daniel Koelsch, S&P's analyst for Citadel in Toronto. "Before, a hedge fund was always tied to a prime broker.''
The notes can be issued for any maturity. The debt is guaranteed by Citadel's two biggest hedge funds: Citadel Kensington Global Strategies Fund Ltd. and Citadel Wellington LLC. The funds would have to back the debt should either fund rating lose its investment-grade rating.
"Their design is to reduce their reliance on Wall Street firms for funding, which would eventually provide them with a competitive advantage because they won't be forced into liquidation during periods of stress,'' Fahey said.
In other words, "No Margin Calls. No Problems."
Citadel Hedge Fund May Issue $2 Billion in Bonds