Brookstreet Folds Under CMO Margin Calls

From the OC Register’s resident mortgage blogger Matthew Padilla (he gets paid to do this stuff!), broker dealer Brookstreet Securities Corp. was forced to close down today, laying 100 off as bets on collaterized mortgage obligations at the firm soured quickly. The company was an Irvine, Calif.-based broker dealer.

[Brookstreet spokesperson Julie Mains] said the company went from $16 million in capital Friday to being $3 million underwater Wednesday because its clearing firm, National Financial Services, sold the securities…

A spokesman for National Financial Services said it’s not his company’s fault that Brookstreet ran out of capital.

You might be interested to know that NFS is a Fidelity Investments company. You might also be interested to know that many investors at Brookstone lost their entire investment.

Padilla quotes an entire email circulated among Brookstreet employees Wednesday - the highlights:

To Our Valued Brookstreet Members,
Disaster, the firm may be forced to close…

Today, the pricing system used by National Financial has reduced values in all Collateralized Mortgage Obligations. Many of those accounts were on margin and have suffered horrendous markdowns and unrealized as well as realized losses.

National Financial and the regulators expect Brookstreet to pay for realized liquidated losses and take a capital charge for unrealized mark to market losses.

This firm has done a valiant if not Herculean job of managing the liquidations and capital charges to the firm’s net worth and net capital. We had reduced the margin balance significantly; we had liquidated and reduced exposure by 80%.

That still left a $70,000,000 margin balance against around 85,000,000 of value. Unfortunately the pricing service used by NF revalued many CMO positions downward last night. We went from a positive net capital of 2.4 million, down from 11 million at the end of May, a negative net capital of 2.1 million. It would take a capital infusion of at least $5,000,000 to keep the company in compliance with no guarantee that additional markdowns will not be forth coming.

I have to wonder how many hedge funds are finding themselves in a similar position right now.

Update: Tanta at CR asks a very apropos question: if we’re talking CMOs here — real REMIC CMOs — it’s pretty amazing to see NFS mark them down overnight and sell because of problems in the CDO market. Of course, it depends on what sort of securities Brookstreet had its retail clients into, but most REMICs aren’t usually seen as particularly risky.