Sunday, October 21, 2007
Wilbur Ross, a billionaire investor who specializes in resurrecting failed companies, is betting the U.S. mortgage market will rise from the dead.
"We're looking at everything that's in trouble," Ross, founder of WL Ross of New York, said in an interview.
He won an Oct. 5 auction for the home-loan servicing unit of American Home Mortgage Investment. Ross agreed to pay $435 million to $500 million for the right to collect payments and maintain escrow on about $45.3 billion of mortgages from the biggest residential lender to go bust this year.
Ross, 69, known as the "King of Bankruptcy" by clients during his quarter century at the Rothschild investment bank, is entering the market as an increasing number of borrowers quit making payments and profits sink in the servicing business, according to the Mortgage Bankers Association.
"They will probably have their hands full the next couple of years," said Bose George, an industry analyst at Keefe Bruyette & Woods in New York.
The number of borrowers behind on their payments hit a five-year peak in the second quarter, the Mortgage Bankers Association said. The figure may climb by the end of 2007 as interest rates jump for 450,000 borrowers with subprime adjustable mortgages, according to data compiled by UBS AG and Credit Suisse Group. Subprime mortgages go to borrowers with blemished credit.
"I would see an increase in the cost of servicing a loan for this year," said Marina Walsh, a senior director in the Mortgage Bankers Association's research and economics department. "Late payments can get pretty time intensive and you have to hire people with a certain skill set who have to be trained."
Per-loan profit for servicers declined by 44 percent to $58 in 2006 from $104 in 2005, Walsh said.
To succeed, Ross will have to coax delinquent borrowers to pay again, said Jeffrey Kirsch, chief executive of American Residential Equities, which specializes in getting people to pay overdue mortgage bills.
"There are not a lot of firms out there able to handle nonperforming loans," Kirsch said. American Home is not known for its expertise in the field, he said.
Many of the mortgages Ross will service went to applicants who did not document how much money they made, Keefe Bruyette's George said. Alt-A mortgages, a specialty of American Home, are available to borrowers with good credit who generally cannot or choose not to verify their income with pay stubs or tax forms.
Ross's company has also joined with Richard Branson's Virgin Group of London to bid for Northern Rock, the London lender bailed out by the Bank of England, and with Blackstone Group and six other investors for a 26 percent stake in lender IFCI of New Delhi.
Ross turned an $80 million stake in steelmaker LTV into $4.5 billion in 2004 after he sold International Steel Group to Indian billionaire investor Lakshmi Mittal. He has not always been so successful.
He bought into the coal industry in 2005, assembling International Coal Group from the mines of bankrupt Anker Coal Group and Coalquest Development. He paid $275 million in stock and then raised about $250 million in an initial public offering. Since April 2006, the company has lost more than 40 percent of its value.
Ross said he has the means and desire to expand American Home's business. His company, AH Mortgage Acquisition, would pay cash and has room to borrow, he said.
"The servicing platform that we're getting at American Home is capable of handling any kind of home mortgage product," Ross said. With little additional expense, the company could process up to three times its current volume, he said.
Default rates of Alt-A mortgages are difficult to predict because they are a new product, said Steve Moyer, a director at Tennenbaum Capital Partners, which oversees about $7 billion. The same is true of adjustable-rate mortgages, he said.
Almost half the home loans made during the past two years were adjustable, according to Inside Mortgage Finance, a trade newsletter. That means borrowers pay a lower interest rate the first two or three years and higher rates later.
"It will be a brave new world now for all of us, how those loans will perform with declining home prices," Moyer said.
Falling prices make it difficult for borrowers to sell or refinance mortgages because they may owe more than their houses are worth.
Ross's pattern has been to acquire one bankrupt company in an industry and augment it by buying similarly distressed companies.
In textiles, Ross began with Burlington Industries and Cone Mills, creating International Textile Group. Then he expanded with joint ventures in places such as Turkey and India.
In the mortgage business, Ross said, he will eventually expand into lending.
"If you want a growing business, you need to be in some form of originations," he said. "It could be jumbos, it could be subprime, it could be whatever."
Jumbo loans are mortgages of more than $417,000.
Government policy has helped boost Ross's past investments, including trade tariffs levied against overseas competitors in the steel industry.
Ross has not endorsed any particular government action in the mortgage market. Democrats in Congress have proposed that Fannie Mae and Freddie Mac, the largest buyers of U.S. home loans, be allowed to buy subprime mortgages.
"I don't think you can ever legislate people against making foolish loans," Ross said. "My guess is there will be stricter constraints against what people have come to view as predatory lending practices. In terms of solving the problem of people who simply can't pay, it's not terribly clear to me what they can do to help them. Somebody has to take the loss."
Ross is investing in the mortgage industry at the same time as Goldman Sachs Group and Bank of America. Goldman, whose third-quarter earnings rose 79 percent partly on bearish mortgage investments, may buy Litton Loan Servicing, which specializes in collecting payments from delinquent borrowers, according to people familiar with the matter.
Bank of America said Aug. 22 it would invest $2 billion in Countrywide Financial, the biggest U.S. lender, less than a week after Countrywide said it tapped $11.5 billion of emergency financing.
"The play right now is in buying these institutions and cleaning up what they did," said Peter Morici, a business professor at the University of Maryland. "Somebody is going to have to make jumbo mortgages going forward and somebody is going to have to make subprime mortgages."
The U.S. home-loan market has $10 trillion of loans outstanding, the most ever, according to data compiled by the Federal Reserve. Subprime mortgages made up about 20 percent of the mortgages issued last year and about 11 percent in the first half of 2007, according to Inside Mortgage Finance.
"There's nothing wrong with lending to weak credit," Ross said. "There is something wrong with doing it at discount rates and without proper documentation and without conservative appraisals."
Ross won't predict how much longer tightened credit will pinch the mortgage industry. The time frame does not matter, said Kirsch of American Residential Equities.
"He's not building for today, he's building on the future," Kirsch said. "He's banking on the fact it's a cycle and he'll be ready to roll when it comes around."
Jody Shenn in New York and Kartik Goyal in New Delhi contributed to this report.