The market for special-purpose acquisition companies has become an unexpected victim of the Archegos Capital Management scandal, as banks tightened lending to cover funds that had invested heavily in blank control companies.
Banks across Wall Street have become more cautious about how much leverage they can extend to their customers afterwards fall out of Archegos, the investment firm run by Bill Hwang, forcing hedge funds and family offices to reconsider their investments in Spacs, according to several market participants.
“The terms of prime brokers are generally stricter because of Archegos,” said a former banker working on the Spac business. “A large part of the return profile for hedge funds comes from the leverage they employ. It was a sauce train when it was mined.”
The lack of leverage influences hedge fund investment strategies that have played a major role in fueling the Spac boom, typically investing at an early stage – and then not lasting for long.
These investors receive stock allocations in Spacs before they are listed at $ 10 each, and the amount collected by the company is placed in a trust that buys US Treasuries.
By borrowing money, the funds end up earning a higher return from the underlying assets that many consider risk-free.
Many hedge funds sell then if there is a “pop” in the stock price or redeem their investment when it comes time for shareholders to vote on a possible merger with an operating company.
Such investments have proven particularly lucrative when retail traders increase shares in Spacs based on sponsors. star status. However, with the leverage becoming more restricted and interest in blank control companies declining, the returns enjoyed by hedge funds until recently will be difficult to replicate.
Leverage restrictions are yet another headwind for the Spac market after a successful year in 2020 and a blistering start until 2021. The market the show is sour in recent months amid a return to technological action and to regulatory and accounting issues.
“We see it in the price action where securities are traded below par because banks don’t offer leverage however freely and are now more expensive,” said Matthew Simpson, associate director of Wealthspring Capital, which invests in Spacs.
According to an analysis of Refinitv’s Financial Times data, more than 80 percent of Spacs still looking for acquisition targets are now trading below $ 10, the level at which shares of blank check-in companies are priced at the initial public offering.
“All the race fuel comes out of these things. If hedge funds are allowed to be exploited, hedge funds will be exploited to buy all the Spacs that operate under $ 10,” said Matthew Tuttle, CEO of Tuttle Capital Management , which manages an exchange fund dedicated to Spacs.
It’s hard to put an accurate figure on how much leverage had been extended to hedge funds for Spacs in the past, or the extension of the recent pullback, but industry participants said they had seen companies use as much as nine times the leverage before Archegos blew up.
“Primary brokers have taken the crazy leverage of the position after Archegos,” said one Spac investor.
A hedge fund manager, who had spoken with several leading primary brokers about the use of leverage for their Spac investments, said they had been repeatedly told they had reached their limits.
However, some market experts have stated that the fall of Archegos was a factor in the cooling market for Spacs, with a generally lower appetite for whiteboard control companies. The number of launches has slowed to a point, with only 13 Spacs listed in the U.S. last month compared to 110 in March, according to Refinitiv data.