Turning a vulture fund into a cash cow

What’s going on across the Pond

Paul Muolo
Paul Muolo

You remember, Angelo Mozilo, don’t you? The perpetually tanned and silver-haired Bronx native was the founder and chief executive officer of Countrywide Financial, once The Big Kahuna of mortgage banking in the US.

For several decades Mozilo was what every mortgage executive in America strived to be – hard working, successful and fabulously wealthy.

The dream ended in 2008 when the credit markets cracked up and half the sub-prime loans Countrywide had funded went south, forcing the company to sell to Bank of America for pennies on the dollar.

Today Mozilo, 73, is retired and living in southern California. He spends his time with friends and family – and his attorneys.

Last year the Securities and Exchange Commission in Washington accused him and two of his former lieutenants of securities fraud and a host of civil accounting violations, namely misleading investors about the lender’s true condition. Over time, its stock went from $45 to $3.

There’s also insider trading allegations, which he and his former management team have denied. Some time over the next year Mozilo will have his date in court, unless he settles before trial. Meanwhile, there’s another former Countrywide executive who has been in the news here of late, but for a different reason.

His name is Stanford Kurland and he manages a company called PennyMac. His aim in life is to hopefully buy billions of dollars in troubled residential loans for pennies on the dollar, if it can modify the notes or foreclosure on the home and sell it at a profit. Kurland has an interesting back story himself.

Once considered Mozilo’s successor at Countrywide, he was forced out of the company in 2006. The man doing the pushing was Mozilo.

Supposedly, Kurland wanted Countrywide to put the brakes on its then booming sub-prime business and slow its growth.

Kurland also envisioned a Countrywide where he would be CEO and Mozilo would just show up for meetings as chairman emeritus and bang the gavel.

Needless to say, Mozilo didn’t like the idea, and being one of the company’s largest shareholders – not to mention its egotistical founder – he engineered Kurland’s dismissal.

To cut a long story short, Kurland took a few years off and is now back with PennyMac, mining for gold in the distressed residential loan market.

PennyMac’s headquarters is in Calabasas, California, not too far from the old Countrywide campus.

On paper Kurland’s plan for the company looks solid – buy crummy loans low and sell high – but PennyMac is facing a cold reality that’s thrown a monkey wrench into his strategy. Banks and Wall Street firms aren’t selling their crummy loans, at least not at dirt cheap prices.

The financial garage sale of the century – with an anticipated $1trillion in trash changing hands – is a bust so far or as PennyMac noted in a recent public filing.

“Through its interactions in the marketplace, our manager [a unit of the company] has observed that during our initial period of operations, relatively few holders of distressed mortgage loans have offered these loans for sale,” it says.

In other words, PennyMac’s entire reason for being has for now turned out to be not-so-great. The company went public last summer. In its IPO filing and road show to institutional investors Kurland and other company executives talked like it was the Gold Rush of 1849. The sky was the limit. Well, maybe not.

Kurland and his team, which includes several former Countrywide executives, had hoped to raise $700m via the initial public offering but had to settle for a mere $300m.

Investors were queasy. Even though the stock market was soaring last summer, the future still looked bleak for housing. To date, PennyMac has bought just one portfolio of significant size – a $558m pool of loans from the Federal Deposit Insurance Corporation (the US bank regulator and receiver), for which it paid about $200m. That’s it. Now that the IPO is over, PennyMac isn’t talking to the press much these days.

With its stock floundering near its low of $16, compared with a high of $20, there isn’t much to say. PennyMac is not buying much because it doesn’t want to overpay.

PennyMac’s new idea has nothing to do with buying distressed loans. It wants to be a mortgage banker

So if it can’t buy distressed assets, what is its game plan? Let’s go to a recent post-IPO SEC filing. PennyMac still believes there are opportunities in distressed mortgages, but its first quarter as a publicly traded company ending September 30 was less than stellar. It lost just under $1m.

For the period ending December 31, it lost about the same. But recently it came up with a new idea that has nothing to do with buying distressed loans. It wants to be a mortgage banker. Huh? Kurland wants to re-enter the lending arena by having PennyMac start a conduit – a legal entity through which it can buy and securitise loans.

Why? I guess it’s obvious. The firm isn’t making it as a vulture fund and speciality servicer of distressed assets but it sees an opportunity acting as a middleman between Fannie Mae and Freddie Mac – the mega buyers of loans – and what it calls smaller mortgage lenders, or non-banks that don’t take deposits.

It plans to buy loans from these non-banks that are ineligible to become Fannie Mae, Freddie Mac seller/ servicers, and securitise them using its balance sheet.

PennyMac also believes that in time the private label non-Fannie/Freddie market might come back and that its conduit, which is being organised as I write this, will be in the catbird seat should such a revival occur.

The question that investors in PennyMac should ask themselves is this – Kurland, you weren’t quite right about the vulture fund thing, why should we believe you now? But perhaps I’m being too tough.

PennyMac is right about one thing – non-bank mortgage lenders need liquidity. They can’t use deposits since they don’t have any, and instead must rely on warehouse lines from banks, a business that has dried up to some degree. Maybe Kurland has finally hit on a good idea with PennyMac. Maybe running a conduit is the way to go. Or maybe not.