Even though this summer's credit crisis effectively brought an end to the buyout boom, private equity firms and investment banks are still looking to capitalize on the fallen subprime market.
Some well-known asset management firms have already launched distressed-debt funds to invest in mortgage-backed securities, but private equity firms are also eyeing the fallen mortgage companies themselves, with a particular interest in their loan-servicing operations.
J.C. Flowers and Lloyds TSB are both reportedly exploring deals to buyout assets from troubled mortgage bank Northern Rock. Meanwhile, Goldman Sachs is in talks to buy Litton Loan Servicing LP, the subprime-servicing wing of C-BASS. Lone Star Funds, a Dallas-based buyout firm, finalized a deal last week to buy Accredited Home Lenders, while billionaire investor Alex Ross was the high bidder for the loan-servicing unit of American Home Mortgage Investment Corp.
The mortgage servicing business is attractive to investors because, unlike the loans from risky borrowers that began to default en masse when the housing market went south, its success is not tied so closely to the changing credit cycles.
"It is often the only true value in these companies," Diane Pendley, managing director of Fitch Ratings, said at the Information Management Network's Subprime ABS conference in Las Vegas last month. "Their servicing platform is an asset."
Richard Benson, president of Specialty Finance Group, a financial broker to private finance companies, noted that investors could find value in the nuts-and-bolts business of servicing. This includes billing and collecting checks and managing escrow accounts. "When times are good, mortgage bankers do well by owning a bank because servicing leaves free cash balances that can be held at the bank," he said. "This is a low work, easy money business."
Jason Stewart, portfolio manager for investment advisor Barrier Investments, expects to see a growing number of private equity firms swooping in to buyout either pieces of or complete servicing businesses from troubled mortgage lenders.
"Ultimately, if the industry ever comes back, it will come back from that credit and servicing focus, and that will be what drives production down the road," he said. A private equity firm could possibly have a three-to-five year window in which to incubate the company and build up its back end. "[The firm] can then spin this off as a public company, and that's your exit strategy," Stewart said.
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