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Image: Wikimedia Commons - CC-BY-SA 3.0
Image: Wikimedia Commons - CC-BY-SA 3.0

PE Firms Still Fear the Mortgage Industry – Here’s Why

NOV 1, 2012 8:12am ET
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An investment banker I know has a client who’s been looking at the mortgage industry for three years now.  He has $100 million to spend and would like to buy something because he feels residential finance is a value play – plus the returns (presently) are very nice on the origination side of the business.

Still, he hasn’t pounced on any deals, said the investment banker -- out of fear. “He’s a conservative guy with some big money but he hasn’t spent a nickel,” this source said. “He just can’t get past the macro concerns – the AG litigation, fear of the CFPB, stuff like that.”

What’s so interesting about the story is that it’s just one of many I’ve been hearing for the past two years. Private equity money, venture capital money, call it what you will, has the sense that stellar returns can be made by backing a fast growing lender and/or bottom fishing in the mortgage space but they’re just too afraid to make that leap. 

Still, there’s a feeling that this fear that freezes investors in their tracks may finally be thawing – somewhat.

Investors look at the killing that Wilbur Ross made by recently agreeing to sell Homeward Residential to Ocwen for $750 million and they realize that they can’t sit on the fence forever. On the Ross deal, rumor has it that he will clear upwards of $600 million, maybe more.

Except for Ross – who got in a few years back by buying mostly nonprime servicing rights from Option One and the bankrupt American Home – there has been little success by PE firms, at least that I know of. (Ross added a production arm to Homeward, something it didn’t previously have.) 

 

Perhaps, PE firms soured on the business when they originally committed capital to ventures that promised huge returns by purchasing nonperforming loans and then wound up earning very little or next to nothing. (Remember Kondaur Capital?)

David Fleig who runs Financial Analysis Partners in Sugar Land, Texas, notes that some of the fear about the business is tied to unknown futures of Fannie Mae, Freddie Mac, and even the Government National Mortgage Association.  “There is a long learning curve with investors if they have no prior experience with the industry due to the unique nature of business methods and vocabulary,” he told me.

The other obvious concern is over mortgage servicing rights. Fleig notes that servicing specialists have told him that it can be “extremely difficult at this point to find a clean platform with all agency approvals that is actually available, at any price.”

He adds: “If a platform can be found, repurchases/indemnifications are still a big concern.”

And yet, the talk of PE money sniffing around mortgage banking continues. The general feeling is that residential finance (and housing) has turned the corner and that no matter what happens to the GSEs and on the regulatory landscape, someone has to originate and service home mortgages.

In total, there are 60 million outstanding residential loans in the U.S. – and they won’t be paid off any time soon – or ever. When old mortgages die, new ones are written. It’s as simple as that.

The latest area of interest for PE firms is the nonprime space. Jon Daurio, a subprime veteran who ran Kondaur for a while, is out trying to raise money as are at least two other mangers I know. Will they succeed?

That’s hard to say. Bill Dallas, a former subprime executive now running an ‘A’ paper lender called Skyline Home Loans, is doubtful. He’s talked to many investors over the past few years and he’s of the opinion that when it comes to subprime the door is closed. But others say the spigot may soon start flowing again. We shall see.

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