PRIVATE equity and hedge fund firms have bought more than 100,000 troubled mortgages at a discount from banks and federal housing agencies, emerging as aggressive liquidators for the remains of the mortgage crisis that erupted nearly a decade ago.
As the housing market nationwide recovers, this is a dark corner from which banks, stung by hefty penalties for bungling mortgage modifications and foreclosures, have retreated. Federal housing officials, for the most part, have welcomed the new financial players as being more nimble and creative than banks with terms for delinquent borrowers.
But the firms are now drawing fire. Housing advocates and lawyers for borrowers contend that the private equity firms and hedge funds are too quick to push homes into foreclosure and are even less helpful than the banks had been in negotiating loan modifications with borrowers. Federal and state lawmakers are taking up the issue, questioning why federal agencies are selling loans at a discount of as much as 30 per cent to such firms.
One company has emerged as a lightning rod, criticised by housing advocates and lawyers for borrowers, but admired by investors: Lone Star Funds, a US$60 billion private equity firm. In just a few years, Lone Star's mortgage servicing firm, Caliber Home Loans, has grown from a bit player to a major force in the market for distressed mortgages.
A pattern of complaints
An examination by The New York Times of housing data, court filings and interviews with borrowers, lawyers and housing advocates revealed a pattern of complaints that Lone Star was quick to begin foreclosure proceedings, whether the firm had bought a delinquent mortgage at a federal auction or directly from a bank.
Take Charles and Pamela Hubbard of Sacramento. They briefly lost their home when Lone Star's Caliber subsidiary dealt harshly with their request for a loan modification. The couple said they had submitted the application to reduce their monthly mortgage payments four days before a planned foreclosure sale, but the Lone Star subsidiary said the Hubbards had been late in completing the application and pushed ahead with the sale.
Within a month, the three-bedroom house that the Hubbards had lived in for two decades was auctioned off to another affiliate of Lone Star with the right to resell it later. The foreclosure was rescinded only after the couple went to court.
Caliber declined to comment on individual borrowers, but it said that in general, it was "committed to providing the best possible service to all borrowers, and identifying solutions that allow troubled borrowers to continue to pay their mortgages and stay in their homes is our top priority." It said it had one of the highest loan modification rates in the industry.
Another window into how Caliber and Lone Star operate can be seen in a rare look into one of Lone Star's biggest deals - a bundle of 17,000 distressed mortgages that had an unpaid balance of US$2.96 billion.
With money from public pension funds, Lone Star bought those mortgages in summer 2014 at an auction held by the Department of Housing and Urban Development (HUD). The loans were originally underwritten before the financial crisis by banks like JPMorgan Chase and Bank of America, with insurance guarantees from the Federal Housing Administration.
The list of those mortgages was provided to The Times by the Legal Aid Society of Southwest Ohio, which obtained them through a Freedom of Information Act request.
HUD rules barred Lone Star from foreclosing on most of the mortgages it had acquired until early March. But since then, the firm has picked up the pace of foreclosures, an analysis showed.
A majority of the homes foreclosed on by Caliber have been bought back by another Lone Star affiliate at either a trustee or sheriff's auction. The private equity firm is looking to resell the homes.
The firm said it had modified or restructured loans for 2,300 delinquent borrowers in the HUD pool. It noted that modifications were outpacing foreclosures and that it expected "the number of successful modifications to continue to increase over time". The number of foreclosures can be expected to rise as well.
In February, a HUD report analysing the status of some of the 79,000 soured mortgages it sold over the past five years - including those bought by Lone Star - reported that 20 per cent of the mortgages had been foreclosed, 9 per cent had been restructured and 6.4 per cent had been resold to other firms or investors. Borrowers remained delinquent on about half the loans.
In addition to Lone Star, other private equity firms have emerged as big buyers of troubled mortgages from federal agencies and banks. They include Bayview Asset Management, an affiliate of Blackstone Group, and Selene Investment Partners.
These firms have swarmed into troubled mortgages because they can squeeze profits from these loans by either restructuring them or by foreclosing on them and then repackaging the distressed loans into bonds that are sold to mutual funds and hedge funds..
Private equity's push into the distressed mortgage market has produced some benefits. Thousands of homes that were abandoned by borrowers are now back on the market. In the HUD sales, about 10 per cent of homes were vacant, according to the February report.
The tendency to act quickly on foreclosures is, in part, by design.
The acquisition of distressed mortgages by Lone Star is the engine in a well-oiled securitisation machine that assumes that foreclosure and resale of the homes are inevitable components of the process. In these securitisations, many of the soured loans are bundled into bonds that yield up to 4 per cent. They are then sold to hedge funds and mutual funds.
The short-term securities generate income for investors from the proceeds derived from foreclosing on the mortgages and then selling the homes on the open market. Last year, Lone Star sold 17 such securitisations, with a combined unpaid loan balance of US$10 billion, and the firm is on pace to complete a similar number of deals this year, according to Intex Solutions, a securitisation deal tracking service.
While HUD has hoped that buyers of its loans will seek to reduce permanently the principal or debt owed by a borrower, Caliber tends not to do so.
In the first half of 2015, Fitch Ratings said of the loans it had reviewed, Caliber had not completed any modifications that included permanent principal reductions.
In the Hubbards' case, it took court action to get Lone Star and Caliber to work with them.
Lone Star bought the loan on their three-bedroom home in Sacramento from Beneficial Financial, a division of HSBC, in summer 2014 for an undisclosed sum.
Soon after buying the mortgage, which had an unpaid balance of US$300,000, Caliber and Lone Star moved to foreclose.
The sale of the home on Jan 20 sent the couple running to court. They argued that the sale took place even as Caliber employees said they were trying to "find a way to escalate the submission". After the Hubbards sued, Caliber and the couple began negotiating. In May, they agreed to a short-term modification that would reduce the Hubbards' monthly payments on the mortgage by several hundred dollars, to US$1,953 for the next five years.
Caliber filed a formal notice with county officials on May 29 that rescinded the sale of the home to Lone Star - a kind of legal do-over.
"I don't know why they went through with it because it just didn't make any sense," said Hubbard, 64, a civilian employee with the Army. "Maybe people who get into these situations are categorised as no good, and they simply don't want to deal with them." NYT