The Collapse of Carlyle Capital

Carlyle Capital, the highly leveraged hedge fund and publicly traded affiliate of Carlyle Group, collapsed this week and its investors would lose $900 million. Banks, under enormous pressure from regulators to put their balance sheets in order, had been pressing David M. Rubenstein, William E. Conway Jr. and Daniel D’Aniello, the co-founders of Carlyle Group, to put more money into Carlyle Capital.

In early March, Deutsche Bank, J.P. Morgan Chase and others were demanding the company boost its cash reserves, in what is known as a margin call. The bankers kept raising their demands, and some even began seizing and selling Carlyle Capital’s collateral and its chief asset, its AAA-rated, mortgage-backed securities.

According to Rubenstein, they had planned a restructuring arrangement that would invest $400 or $500 million and had asked the banks to freeze seizures for a year so the company’s securities would have a chance to rise in value. Rubenstein said the securities from Fannie Mae, Freddie Mac and Ginny Mae had a historic record as safe investments that were unlikely to decline in value. But with the credit crisis, the banks were hungry for more money and the co-founders knew they could not meet the banks’ demands.

Carlyle Capital’s downfall is a shock to the private-equity giant, which holds a record of returning an average of 26 percent, net of fees, to investors of nearly 60 funds. Carlyle Group manages $81 billion in assets for unions, pensions, endowments, individuals and foreign governments. In the past two years, it returned $18 billion in profits and equity to its clients.

Its stock closed at 35 cents a share yesterday after the fund defaulted on more than $16 billion in assets. The shares have dropped 93 percent since Tuesday.
Rubenstein said the firm planned to explain what happened and do something that would soften the loss for investors in Carlyle Capital but he did not give details. Rubenstein also said he would seek to assure investors that the Carlyle Group remains healthy. It has "enormous profits embedded in its current funds," he said.

Many investors and analysts think Carlyle Capital is only the first domino to fall as banks move aggressively to seize assets from troubled funds; thus making it more difficult for funds to meet margin calls. Here are some troubled hedge funds to look out for:

· Drake Management’s three hedge funds, with nearly $5 billion under management, recently suspended investor redemptions as it considers liquidating its assets.
· Nuveen Investments faces lower profits and slower growth because of higher borrowing costs brought on by the credit crunch.
· Peloton Partners of London was forced to liquidate its funds recently.
· Thornburg Mortgage, a big U.S. lender, failed to meet margin calls by lenders last week.
· Citigroup is committing $1 billion to shore up its hedge funds.