Montrose Capricorn Finance Fund Suspension, August 2009

The Capricorn Finance Fund has fallen for the year to date, with performance negatively impacted by a number of issues affecting the strategy.  The more important issues are discussed below.

The global banking crisis has led to the most severe economic environment since the Great Depression of the 1930’s. Economic activity has fallen sharply and the consumer (a key driver of growth) is faced with sharply weaker house prices and rising unemployment. Severe distortions are occurring across many asset classes. Many normal banking activities have been curtailed or suspended altogether as banks attempt to repair their balance sheets and increase capital ratios. Bad debt provisions, particularly in Europe are likely to increase.

In general, asset based type lending as a strategy is focused on short term loans as opposed to longer term type lending. In many instances the natural repayment of loans has occurred through the replacement of the shorter loan with longer term capital, usually through the banking sector.  Due to the banking crisis, longer term loans and refinancing options are difficult to obtain. Consequently asset based lenders are forced to extend the terms of loans to borrowers.  In addition borrowers who were relying on refinancing to complete business plans are no longer able to meet their commitments.  Default rates have increased in line with falling economic growth rates.  Underlying funds have increased loss reserves and or written off default loans completely.  Capital will be recovered where possible through foreclosures and seizure of collateral. Recovery rates on defaulted loans will depend on collateral values. Falling asset prices have reduced the loan to value ratios.

Certain asset based lending strategies have been impacted by one off changes. Life insurance settlements and premium financing strategies were adversely affected by a significant downwards shift in industry valuation standards late last year.  Life expectancies were increased by an average of 20%, resulting in significant write downs in the values of policies held by certain underlying managers. Although once a tradable market, liquidity in this strategy has disappeared. Lower valuations in turn led to forced liquidations and lapsing of policies by insurance funds as premiums became difficult to fund.

Funds with exposure to real estate lending have been impacted by falling property values. This has been particularly noticeable in commercial real estate. Borrowers have traditionally repaid loans by either refinancing or selling the real estate backing their loans.  Recently, this has been difficult for borrowers to achieve, as real estate sales have slowed and there are few conventional lenders prepared to provide refinancing.  This has forced many real estate loans to extend or be put into default. 

As previously advised:

1. The Finance Fund is in the process of liquidating assets, which involves the redemption of all the underlying investments. 
2. All funds in the Finance Fund have decided to either suspend, gate or restructure as a result of the deteriorating economic environment and the general lack of liquidity.

Investors have specifically requested an estimation as to when capital will be returned. This has been done and the liquidity projections are attached.

The figures are based on current information, where available, regarding each fund’s ability to meet redemptions. Estimates may therefore be subject to material change. All data, which is estimated, should be taken as indicative only and does not imply or guarantee future performance or warrant that the return of capital will match the estimates. There are a number of variable and unpredictable factors that may impact on these projections, as follows:

1. Further write downs and/or provisions may need to be made and this will then impact on the amount and timing of capital returned to investors. 
2. Currency hedging for the Sterling and Euro classes may also impact on leverage levels in the Fund.  A weaker US Dollar usually generates foreign exchange profits which are then used to pay down the leverage provider. Conversely a stronger US Dollar increases the leverage levels.
3. Adverse changes in global economic conditions and changing illiquidity in various markets could also have an impact on the underlying funds. This may require the underlying funds to restructure or change the current terms applicable to investors, including the imposition of future gates and suspensions.  
4. The extent of redemptions at the level of the underlying funds and how this progresses going forward will also impact on the cash projections.

Leverage levels have been steadily reduced in the Finance Fund and as at the end of July 2009 amounted to US$6.9m. 

Since the part return of capital to investors in February 2009, redemption proceeds received have not been significant. Capital received will need to be repaid to the leverage provider in accordance with the terms of the financing agreement between the Fund and the lender. Current expectations are that the leverage provider should be repaid in full during the first half of next year, at which stage capital can be repaid to investors when received from underlying funds. Where possible the Fund will return capital to investors more expeditiously than has been set out.

The Fund is domiciled in Guernsey and there are no Government guarantees.

Liquidators have been appointed to act on behalf of all investors in funds with direct or indirect exposure to fraud committed by Petters.  The liquidators are acting on behalf of the Finance Fund to maximise recovery of assets and pursue all relevant claims against third parties, including banks, insurance companies and auditors.

Montrose Asset Management Limited