Fund managers and banks are under scrutiny for their methods in valuing illiquid securities, after some funds admitted they’re having trouble putting a price on complex debt instruments backed by residential mortgages and corporate loans.
Units of French bank BNP Paribas SA (BNPQY) and insurer AXA SA (AXA) have suspended redemptions on some of their funds because they said they couldn’t value them accurately, while the U.S. Securities and Exchange Commission is reportedly checking the books of U.S. brokerage firms and banks to make sure they aren’t hiding losses by misvaluing assets linked to subprime mortgages.
On Tuesday, Sentinel Management Group, a firm managing short-term cash for commodity trading firms and hedge funds, also halted client redemptions because it said it couldn’t meet them “without selling securities at deep discounts to their fair value.” The firm invests in government and corporate securities.
The lack of confidence in how funds and banks are valuing their subprime exposure – and fear that future risks haven’t been accounted for – has already led to a wave of fund redemptions by investors and a sell-off in some banks’ shares.
The securities in question are known as collateralized debt obligations, or CDOs, and are widely held by banks, insurers, pension funds and investment funds. Backed by large pools of mortgages, loans or other interest-bearing assets, these securities played an instrumental role in fueling cheap credit to home buyers, companies and other borrowers over the past several years.
The breakdown in valuing them is just one effect of the wider credit crisis that started with a sharp and unexpected rise in the number of U.S. homeowners defaulting on their mortgages.
The losses hit CDO portfolios stuffed with risky mortgages, and some funds holding CDO securities became forced sellers to meet margin calls. Investors lost their confidence in the vehicles’ underlying assumptions about default rates, and the trading value of CDOs has tumbled across the board, whether they are exposed to defaulting mortgages or not.