Big Wall Street banks may be writing down billions of dollars of non-performing subprime mortgages, but the financial distress is creating buying opportunities for some.
Firms such as Calabasas startup Private National Mortgage Acceptance Corp. and hedge fund Carrington Capital Management are grabbing loans on the cheap, or buying the mortgage servicing operations from struggling lenders.
These and other investors say that not only can smart buyers pick up assets inexpensively, but there are ways to make money even if loans go into default.
“If somebody gets behind on their loan, there are a whole bunch of fees that can be charged,” said Theodore Kovaleff, a senior bank and thrift analyst at New York investment bank Sky Capital LLC.
Earlier this month, Carrington agreed to spend upwards of $200 million to acquire a portion of the mortgage servicing rights from Fremont General Corp., the former Santa Monica-based company that was forced out of the subprime lending business last year amid mounting defaults and losses.
Meanwhile, Private National Mortgage, or PennyMac, is following a mortgage business model seemingly abandoned in recent years: buying whole non-performing loans and keeping them on its books while it works with homeowners to get the loans back into shape so they can be sold at a profit.
All in all, according to Bloomberg News, about 70 new firms or funds have been established recently to sift through the debris of mortgage-backed securities and find potential for profit. Those include funds run by big private equity firm Blackstone Group and even investment bank Goldman Sachs Group.
Joint venture
PennyMac is a joint venture between one of the world’s largest investment managers, BlackRock Inc., and hedge fund Highfields Capital Management. PennyMac is being led by industry veteran Stan Kurland, who served as president and chief operating officer of Countrywide Financial Corp.
In fact, Kurland was widely seen as the successor to lead the nation’s largest independent mortgage lender when co-founder Angelo Mozilo retired. Instead, Mozilo stayed and Kurland left Countrywide in October 2006. Countrywide agreed to be bought by Bank of America in a fire sale earlier this year.
PennyMac, which is headquartered in the same city as Countrywide and has several other former executives of the lender on its management team, is seeking to raise $2 billion. The business plan is simple: Despite talk of a government bailout for lenders, the firm expects the number of distressed mortgages to grow, providing ample buying opportunities. It intends to hold the mortgages as long as it takes to work with buyers and get them performing again.
“Our plan is to bring in fresh capital from long term investors and combine that with a team with deep expertise in loan portfolio management, servicing and all aspects of the mortgage business,” said PennyMac Chief Investment Officer David Spector, a former Countrywide executive.
Meanwhile, Carrington, a Greenwich, Conn.-based hedge fund, appears to be betting it can make money by simply servicing subprime loans. But it also plans to work with homeowners to reduce foreclosures.
Last year, it acquired the loan servicing platform of New Century Financial Corp., a top subprime lender in Irvine that filed for bankruptcy protection in April. Carrington said it spent $172 million for the rights, and in a memo to investors said it hopes to reduce costs by servicing the loans itself and working “directly with borrowers to avoid foreclosure.”
Carrington was able to get New Century’s rights in a bankruptcy auction, but in Fremont’s case, it cut a deal directly with the struggling lender. Fremont, now based in Brea, operates 22 retail bank branches in the state and is struggling to stay solvent, giving the company reason to sell its servicing rights and trade long-term gains for quick up-front cash.
Last year, Fremont was forced to abandon its mortgage sales after regulators determined the company lacked sufficient oversight, prompting the bank to begin selling its mortgage assets. Earlier this month, Fremont was declared in default after its net worth sank below the threshold of $250 million, shattering a loan covenant with two creditors.
“Fremont has already been de-listed from the New York stock exchange, and they don’t have too many pennies to rub together,” Kovaleff said.
Specific financial terms of the Fremont deal were not disclosed, but Carrington will get the servicing rights for about 13 percent of Fremont’s mortgage loans valued at approximately $1.9 billion. The deal is expected to close April 1. Fremont declined to respond to a request for an interview.
Upstart entrepreneurs
The growing appetite for distressed mortgage industry assets also is luring upstarts into the market.
Los Angeles hedge fund Palisair Capital Partners launched an aggressive campaign in February to acquire a large stake in 1st Century Bancshares Inc. The newly formed fund wants the Century City-based boutique business bank to consider buying troubled mortgage lenders.
Zachary James Cohen, the managing member of Palisair, said the stock prices of many troubled lenders “are trading at below book value and clearly offer an opportunity for expansion at an attractive price.”
According to documents filed with the Securities and Exchange Commission, Palisair in February purchased nearly 600,000 shares of 1st Century, or about 6 percent of the bank company’s outstanding shares, for about $4.5 million.
It also made demands on management that the bank hire an investment banking firm to evaluate acquisitions. Cohen subsequently announced a friendly tender offer for 396,000 additional shares of common stock at a premium of about 35 percent over the market price, which would have boosted Palisair’s stake to nearly 10 percent. Cohen also demanded a seat on 1st Century’s board of directors.
In a statement, 1st Century chief executive Alan Rothenberg said the bank company would evaluate the offer, but expressed concerns that “investors could be harmed and caution should be exercised.”
Cohen later decided not to proceed with the purchase.
However, he said, “The management team should be playing offense. There are many potentially lucrative opportunities.”
