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SEPTEMBER 10, 2007
By Mara der Hovanesian Swooping Down On Subprime There's a banquet of troubled investments to pick from, but valuation is still tricky Investors in distressed sEcurities have long been whining about a dearth of opportunities. Now the subprime mess has delivered them a new bounty. Investment pools filled with troubled mortgages are selling for 50 cents on the dollar. Lenders are going belly up by the dozen. And prices on speculative corporate loans are getting slashed. It's all piquing the interest of a few steely money managers—a list that includes some familiar vultures from past periods of tumult. Investors are flocking to funds that specialize in distressed debt; they raised $23.7 billion in the first half of the year, vs. $19 billion in all of 2006, according to Dow Jones Private Equity Analyst, a newsletter. But the mad rush to those firms, ones already awash in cash, may dampen returns if competition is too fierce and the pickings too slim. "We're excited that there may be better opportunities than in the last five years, but it's definitely not easy money," says Andrew Schmeltekopf, manager of U.S. acquisitions for FirstCity Financial Corp. (FCFC ), founded in 1986 to feast on fallout from the savings and loan crisis. Complicating matters, it's hard to put a price on some distressed assets. Unlike previous downturns, today's problems have been largely driven by the risky and sometimes even fraudulent underwriting models used to sell more and more loans. So pricing gets tricky given that the values may have been inflated or unknown from the start. "It's a little bit like trying to catch a falling knife," says legendary vulture Wilbur L. Ross Jr., chairman of private equity firm WL Ross & Co. "We don't think the fundamentals will change for quite a while, so you really have to second-guess yourself." Although Ross is scanning the spectrum of investments from shaky loans to abandoned properties, he has made just one public move. On Aug. 7, he agreed to put $50 million into the bankrupt American Home Mortgage Investment Corp. (AHM ), which originated $60 billion in loans last year. Others are going after mortgages and investment pools filled with home loans, so-called mortgage-backed securities. The $5 billion Ellington Management Group, a hedge fund in Old Greenwich, Conn., that invests in mortgage securities, is raising $700 million for a separate company that will focus on subprime assets. According to the offering statement, Ellington plans to invest in, among other things, the leftover pieces of pools originally issued by New Century Financial Corp. (NEWCQ ), the defunct subprime lender that helped kick off the turmoil in February. Ellington CEO Michael Vranos, a former mortgage trader, is an old hand at the game. During the collapse of hedge fund Long-Term Capital Management in 1998, Ellington survived even though its lenders pulled their credit lines. While most funds that invest in mortgages were down for the year through July, Ellington's was up 8%. (Results for August, an especially tough month, aren't in yet.) IFFY TIMING Distressed investors are also looking at the servicing operations associated with MBS—that is, the back-office processing for loans in those pools. Ocwen Financial Corp. (OCN ), the largest independent servicer of subprime mortgages, and distressed specialist Angelo, Gordon & Co. recently launched a joint venture that will invest up to $300 million in the mortgage industry, including servicing rights. That business provides a steady stream of income from the interest that borrowers pay on their monthly mortgage. But servicers are also on the hook for reworking the troubled loans. "You have deep-value guys looking at servicing for cash returns, but they have to figure out how bad the losses are going to be," says Frederick Cannon, an analyst with Keefe, Bruyette & Woods Inc. (KBW ) "Three-fourths don't get their timing right." That sort of uncertainty has sidelined even some hard-core vultures. "It's too early," says Andrew S. Miller of Sevo Miller Inc., a real estate investor who banked huge profits buying distressed properties when the 1980s housing boom went bust. "The problems are so pervasive, we're not sure when this is going to settle."  With Nanette Byrnes and Matthew Goldstein in New York Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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