Hedge fund bet proves that not all assets are toxic

Last week's data dump by the Federal Reserve, a spreadsheet accounting of 21,000 transactions representing its $3.3 trillion intervention in the financial system, revealed:

One, that the panic sweeping through the global financial system was perhaps even deeper and more widespread than most of us knew.

Two, that there was money to be made by anyone brave enough to bet that the prophets of doom had gotten it wrong.

That bet is paying off for G.L. (Biff) Robillard III, a Deephaven-based investment adviser and hedge fund manager who has been bullish on stocks since the fourth quarter of 2008, and who dared in the spring of 2009 to use Fed financing to buy $30.5 million worth of notes backed by subprime credit card debt.

Robillard's fund, Broad Creek Partners, appears to be the only Minnesota-based firm among the 177 listed to take part in TALF, the Term Asset-Backed Loan Facility established by the Fed to help unfreeze the market for consumer credit. Other investors included PIMCO, led by the legendary bond investor Bill Gross, and BlackRock, the death star of the hedge fund universe.

"It was electrifying," said Robillard. "It felt like we were there, on the ground, while new monetary policies were being developed in response to the crisis."

Not that it was easy. Once he understood TALF, Robillard set out to raise $100 million from investors. The money would be used to buy bonds backed by credit card debt or auto loans -- asset-backed securities, or ABS -- that qualified for the TALF program. But many potential investors took a pass. The collapse of Lehman Brothers, the panic on Wall Street and the wounds from the 38 percent plunge in the Dow industrials during the first nine weeks of 2009 were still too fresh.

Robillard spent 24 years in retail brokerage with Merrill Lynch before he and a colleague, Scott Larson, started Bannerstone Capital, an investment advisory firm, and Robillard Capital Management, which is the general partner in two hedge funds. Combined, Robillard has between $70 million and $80 million under management, much of it from individuals.

Robillard, an avid historian of capital markets and an adherent of behavioral economics and finance, knows all about financial panics. He didn't see one coming when he and Larson opened their doors for business in the summer of 2008, but both men quickly realized what was at hand: a classic credit vacuum.

The collapse of the housing market in 2007 and the toxic nature of securities backed by subprime mortgages had raised doubts among investors about the quality of all manner of assets. Automakers, credit card companies and student loan issuers depend on securitization -- selling their consumer debt to Wall Street -- to finance additional loans they extend to consumers. If the market seizes up, Ford sells fewer cars and trucks, and retailers and credit card issuers slash credit limits and close accounts.

By fall 2008, it looked like a deep freeze was setting in. ABS sales, which had averaged $19 billion a month in 2006, totaled $500 million in November 2008.

The Fed responded with TALF. It offered investors below-market interest rates, a three- to five-year term and the safety of no margin calls. Investors had to make a downpayment, but they wouldn't be required to up the ante if the value of the securities fell.

"There's no single loan or group of loans that are going to cause us a problem," said David Mahoney, a partner in Robillard Capital Management and its chief investment officer.

The charge-off rate, the balances written off as lost via bankruptcy or customer death, climbed from an annual rate of about 8 percent in mid-2009 to 10 percent by this summer, well below the threshold that would hurt returns to investors.

Broad Creek's deal expires in April 2012. Investors, who include Ken Dahlberg, a Minnesota entrepreneur who made his fortune through the creation and sale of the Miracle Ear hearing aid, will earn a return in excess of 5 percent, a far higher yield than other fixed-income investments would have provided over such a short period.

The TALF program ended in 2009, and it looks like the Fed will make money on the program. As details of the TALF transactions emerged last week, though, critics faulted the Fed for accepting subprime credit card receivables as collateral, or for creating a program that allowed so many wealthy and well-connected investors to earn above-market returns.

In hindsight, it's not hard to pick apart a program like TALF, created on the fly in response to circumstances that were changing by the hour. But consider the alternative: If the Fed had chosen to allow the market to right itself, we might still be waiting.