Swooping in to Help Troubled Homeowners

Lately it seems that many, if not all, conversations about the economy circle back to the housing market as a major contributor to the overall instability that triggered the recession. Although many vulture funds function in emerging markets, the following Bloomberg story from last year is an example of some domestic vulture funds that are helping to curb the foreclosure crisis on domestic soil.

Feb. 28 (Bloomberg) -- A muddy gravel road winds uphill through a redwood forest to Jake Terhune's $985,000 home just outside of Geyserville, in the heart of California's Sonoma County wine region. Terhune, 28, a self-employed cabinetmaker with tattoo-covered arms and a ginger goatee, put down $100,000 and agreed to pay about $6,900 a month for 30 years to buy the three-bedroom house in 2006.
Things started going wrong almost immediately after he moved in. Demand for Terhune's custom cabinetry dried up. His business's income, which had been about $20,000 a month, plunged 50 percent.
After making his first payment, he fell behind. Unable to persuade Irvine, California-based Ameriquest Mortgage Co. to modify his loan, he stopped paying and ignored calls threatening to take his home. By the summer of 2007, Ameriquest, once the biggest home lender to people with credit problems, put the loan up for sale.
``I was working on two houses, but they got foreclosed,'' Terhune says. ``If my customers can't pay what they owe me, the mortgage company can't get what I owe them.''
That's when Ralph Dellacamera got involved. Dellacamera, 54, is a hedge-fund manager with years of experience in vulture investing, the strategy of buying assets at distressed prices in an effort to profit when prices recover.
He is one of several investors -- among them Goldman Sachs, the world's biggest securities firm; private equity firm Equifin Capital Partners; and billionaire Wilbur Ross -- seeking to make money from the collapse of the subprime mortgage market while helping borrowers hold on to their homes.

Handling the Paperwork

By purchasing loans for as little as 50 cents on the dollar and then collecting the payments and handling the paperwork, Dellacamera can cut costs enough to offer easier terms and still make a profit, he says. Once borrowers have re-established themselves, the loans can be resold in the secondary market at a 15-20 percent gain.
``If you get the servicing right, you can make money from these mortgages,'' he says during an interview in his 33rd-floor offices in midtown Manhattan. ``We win if the homeowner gets to stay in their home.''
National Asset Direct Inc., a company set up by Dellacamera's New York-based hedge fund firm, Dellacamera Capital Management LLC, bought Terhune's mortgage last year for 69 cents on the dollar and made him an offer he couldn't refuse: In return for a $25,000 lump sum and four monthly payments at the original level, it would cut the interest rate to 6.5 percent from 8.9 percent, lowering the monthly payment to $5,174.

$150 Million of Loans

Dellacamera says he and an investor in his fund he declined to identify have put $102 million into New York-based National Asset Direct since it opened in October 2006. The company, staffed by mortgage industry veterans, has used $75 million to acquire loans with a face value of $150 million.
Through January, the return on investments that have been liquidated exceeded 20 percent, Dellacamera says. He is planning to raise $1 billion from investors willing to bet there's money to be made from the mortgage mess, one loan at a time.
The number of U.S. homeowners behind on their payments hit a 21-year high in the third quarter of 2007, according to the Mortgage Bankers Association, a Washington-based trade group. The share of all home loans with payments more than 30 days late rose to a seasonally adjusted 5.6 percent. New foreclosures hit an all-time high of 1.69 percent of loans outstanding.
Home prices had their biggest fourth-quarter drop since 1991, according to the Office of Federal Housing Enterprise Oversight. An estimated 1.35 million homes went into the foreclosure process last year and 1.44 million more are headed that way in 2008, the mortgage bankers' group says. That's up from 705,000 in 2005.

In Everyone's Interest

``Defaults are at a record level,'' says Douglas Duncan, formerly the association's chief economist. ``It's in the interest of lenders, and owners, to modify the loans,'' says Duncan, who earlier this week was named chief economist of Fannie Mae, the largest U.S mortgage-finance company.
The collapse of the subprime mortgage market has led to more than $174 billion of asset writedowns and credit losses at securities firms and banks since the beginning of 2007. It also cost the jobs of Merrill Lynch & Co. Chief Executive Officer Stan O'Neal and his Citigroup Inc. counterpart, Charles Prince. More than 100 mortgage companies have filed for bankruptcy, been acquired or closed their operations.
The full impact may not be felt until low introductory ``teaser'' interest rates expire and push up borrowing costs. Interest rates are to reset this year on $362 billion of adjustable-rate subprime mortgages, according to research by Bank of America Corp. The Charlotte, North Carolina-based bank agreed in January to buy Countrywide Financial Corp., the nation's biggest mortgage company, for about $4 billion -- a sixth of the Calabasas, California-based company's value a year earlier.

`Being Long and Wrong'

Trying to make money in a market that is still falling is risky.
``The penalty for being long and wrong could still be extremely costly,'' says Anoop Dhakad, director of business development at MKP Capital Management LLC, a New York-based hedge fund manager with $5 billion in assets. ``Some of us are waiting on the sidelines until the bottom becomes a bit more apparent.''
Dellacamera and the other investors now picking through the subprime mortgage debris are betting nimble players can take advantage of the crisis.
``There is about half a trillion dollars of impaired loans that need to be fixed,'' says Mani Sadeghi, a managing partner at New York-based Equifin Capital Partners. That total includes both subprime mortgage and loans made to more creditworthy borrowers. ``Some will be resolved successfully; others, not.''
The key is servicing, Sadeghi, 44, says.

Linking Borrowers, Investors

``Servicing is the only direct interface between borrowers who want to protect their homes and the investors who have extended credit to them,'' he says.
Under normal circumstances, mortgage servicing is a humdrum activity. The servicer collects the borrower's interest and principal payments -- and taxes and insurance premiums in some cases -- and channels the money to lenders. It also maintains paperwork, follows up with late payers to resolve delinquency problems and, when necessary, initiates foreclosure proceedings.
Mortgage servicing companies earn fees of as much 25 basis points, or a quarter of a percentage point, on a prime loan, says Dan Measell, co-founder of Mortgage Dynamics Inc., a McLean, Virginia-based advisory company.
``For loans that are delinquent, the rate is much higher because the servicer will have to do more work.''

Pocketing Fee Income

By taking on the servicing themselves, investors buying delinquent mortgages get to pocket a stream of fee income while restructuring the loan to help the borrowers. That's particularly important at a time when property values are still falling and foreclosures are rising.
``Servicing is where the rubber meets the road,'' says Ron Greenspan, senior managing director at Baltimore-based FTI Consulting Inc. The company acted as an adviser to creditors in the bankruptcies of lenders including Irvine, California-based New Century Financial Corp., the biggest subprime mortgage lender to seek court protection.
``If you do it right, it'll give you an opportunity to maximize how you manage your investment in loans,'' Greenspan says.
National Asset Direct started out by hiring Quantum Servicing Corp., a unit of Shelton, Connecticut-based Clayton Holdings Inc., to service mortgages it bought. More recently, it created iServe Servicing Inc. in Irving, Texas, and has been moving business there.
Equifin led a group of investors including New York-based hedge fund firm Och-Ziff Capital Management Group LLC, an Equifin limited partner, in January 2007 to set up Residential Credit Solutions Inc. The Fort Worth, Texas-based company invests in mortgages and distressed loans. Equifin also acquired a home-loan billing and collections unit from San Diego-based Accredited Home Lenders Holding Co. and developed a servicing unit in-house.
`Judgment-Intensive Business'
``Servicing is now a judgment-intensive business,'' Sadeghi says. ``You have to know the mortgage markets, know when to modify the loans and have the system and technology to monitor the loans.''
Goldman Sachs, which earned a record $11.6 billion in fiscal 2007 partly by betting on declines in the subprime mortgage market, scooped up Litton Loan Servicing LP in December. The Houston-based company, which specializes in collecting payments from delinquent borrowers, was purchased from subprime mortgage investor Credit-Based Asset Servicing & Securitization LLC. Terms weren't announced.
Goldman Sachs CEO Lloyd Blankfein said at an investor conference in November that his company had raised $4.5 billion for two funds to take advantage of distress opportunities in the credit market.
``A premium is being placed on quality servicing capabilities for which Litton is very well known,'' Michael DuVally, a spokesman for Goldman in New York says. He declined to comment further or to make Litton executives available for an interview. ``This is not the time for profiles to be raised,'' he says.

Former Bankruptcy Adviser

Then there's Ross, who heads New York-based private equity firm WL Ross & Co. The 70-year-old former Rothschild Inc. bankruptcy adviser turned a $310 million investment in steelmaker LTV Corp. in 2001 into $4.5 billion in 2004 after he sold to Indian billionaire Lakshmi Mittal. Now he's getting into mortgage servicing.
Ross paid about $500 million in October to buy the home loan servicing unit of American Home Mortgage Investment Corp., a Melville, New York-based subprime lender that declared bankruptcy last August. The unit will be collecting payments on about $50 billion of mortgages, Ross says. He also joined with Richard Branson's Virgin Group Ltd. in an unsuccessful bid for Northern Rock Plc, a Newcastle, England-based lender nationalized by the British government in February after being bailed out by the Bank of England.
``I hope we are not too early,'' Ross says. ``The turmoil could last for a few years.''

Decade on Wall Street

Financial turbulence isn't new to Dellacamera. He worked as a longshoreman to pay his tuition at the University of New Haven, from which he graduated in 1975 with an undergraduate degree in marketing. After a decade on Wall Street at firms including Paine Webber Group Inc., he joined New York-based Elliott Associates LP in 1986.
Elliott is a hedge fund firm founded by Paul Singer that acquires distressed debt at a discount and demands full payment. Dellacamera started doing convertible arbitrage. In this strategy, a fund buys convertible bonds -- securities that can be exchanged for company shares -- while selling short the underlying stocks. Investors using this technique make money if the convertible is mispriced relative to the stock.
Elliott later switched strategies, buying debt of bankrupt companies such as savings and loans during the S&L crisis in the late 1980s.
``We made a lot of money,'' says Dellacamera, who became the firm's head trader and senior risk manager.

Specializing in Derivatives

Dellacamera left in 1999 to set up a broker-dealer firm, then sold his interest to a partner after a couple of years to get back into money management.
He went to work at Maxcor Financial Group Inc., a company specializing in derivatives, which are financial instruments whose value is derived from assets including stocks, bonds and currencies or from such events as changes in interest rates. Dellacamera, who became a managing director and head of the leveraged-finance division, left in September 2005, after Maxcor was acquired by a unit of New York-based Cantor Fitzgerald LP.
Dellacamera started his hedge fund in January 2006 with about $25 million in capital. It now has more than $400 million, he says.
``We are an opportunistic situational fund, looking to influence events, such as a bankruptcy,'' he says. The fund buys distressed corporate debt and then works with the company management to get a higher return. ``The rate of return is greater if you can restructure so that the loan performs,'' he says.

Eight-Hour Meeting

The decision to branch out into delinquent mortgages came after Dellacamera and Jeff Kaplan, a senior portfolio manager, met in March 2006 with Louis Amaya and Matt Stadler of General Motors Acceptance Corp., who were trying to sell a portfolio of 200 distressed mortgages. General Motors Corp. sold a majority stake in the auto and mortgage lender, now known as GMAC LLC, later that year. After an eight-hour meeting, Dellacamera and Kaplan, 39, still had questions.
``I asked them, `If you were in our position, would you buy this portfolio?''' Dellacamera recalls.
Amaya says he and Stadler said it probably wouldn't be prudent for Dellacamera Capital to purchase the loans without knowing how to manage the risk.
``At the same time, we communicated that for guys like Matt and I who had the local relationships and understood how to manage the risk, there was some money to be made,'' Amaya says.
Instead of buying the loans, Dellacamera offered Amaya and Stadler the job of setting up a company to buy delinquent mortgages and fix them.
New Century's Furniture
Amaya, 42, National Asset Direct's chief operating officer, located the company's portfolio management team in San Diego -- in a redbrick office building about 17 miles (27 kilometers) north of downtown, where space was available because of job cuts at Countrywide Financial. The furniture came from neighboring New Century, the subprime lender that had filed for bankruptcy weeks earlier.
``It was almost like free,'' Amaya says.
Amaya and Robert Willis, director of asset management, weigh the merits of pools of distressed mortgages being offered by mortgage companies and banks. The price is discounted based on factors such as loan-to-value ratio, the property's location and the borrower's credit score and bankruptcy status, says Stadler, 31, the firm's chief financial officer.

Change of Heart

``We've had sellers who didn't like our values and walked off but came back three months later to make the deal.''
Once a loan is acquired, the goal is to develop a restructuring plan to head off foreclosure.
``When a borrower shows commitment to work things out, that's a good sign,'' says Bradley Staley, who heads loss mitigation at the iServe Servicing arm. ``If there is a commitment to stay and an ability to pay, we can always work things out.''
In an office in Irving on a January afternoon, Staley, 28, is discussing a loan with a delinquent borrower over a speakerphone. The homeowner is hesitant; there are silences. Staley pushes for more information about his income and expenses.
The borrower, who declined to have his name made public, owes about $11,000. A self-employed van driver, he says $25,000 of merchandise was taken from his truck and he had to make good on the loss before he could resume mortgage payments. Traditional mortgage servicers typically want to see a borrower fail at three separate loan plans before offering to modify a loan.

`Quite a Cushion'

Staley doesn't wait. He offers to reduce the interest payment by 1 percentage point, in effect cutting the monthly payments by $200. He also holds out the incentive of further loan modification after four months.
``We have bought these portfolios at a discount, so we have quite a cushion,'' Staley says. ``We want to make good decisions quickly.''
Amaya and Stadler say they'll be able to resell mortgages once homeowners re-establish their creditworthiness. After a delinquent borrower makes six consecutive payments, the loan can be tagged as ``reperforming'' and sold for a gain of 15-20 percentage points, according to Stadler. National Asset Direct also has plans to develop a lending unit to originate mortgages. ``We may want to refinance our clients,'' Stadler says.
As the subprime collapse continues to reverberate throughout the real estate market, it's affecting homeowners far beyond the core states of Ohio, Indiana and Michigan. Six California cities were among the 20 U.S. metropolitan areas with the most foreclosures in 2007, according to RealtyTrac Inc., an Irvine, California, research firm with a database of more than 1 million properties.

California and Florida

``When we started, we never expected to see properties in California or Florida,'' Amaya says.
In Sonoma County, Terhune says that when he bid on his home he was confident he could handle the payments. The two-story house came with a nearby shed for his cabinetry business and 34 acres (14 hectares). He planned to use a few of them to grow grapes and build an office for his business.
By the time he moved into his new home in October 2006, housing prices were falling. Homeowners who had grown used to tapping rising equity values to finance renovations grew wary.
``The past two years have been pretty hard,'' he says as he oversees two employees unloading lumber.
Terhune was in trouble almost right from the start. When his second $6,910.89 mortgage payment came due, he didn't have the money.
``I called AMC and told them I only had $5,000,'' Terhune says, referring to Ameriquest Mortgage Co., which is no longer doing business. Its parent, ACC Capital Holdings Inc., agreed to sell its wholesale mortgage origination and servicing operation to Citigroup in August 2007. ``I asked them if we could work something out, but they were not interested,'' he says.
The following month, Terhune owed $14,000; he says he had $10,000.

Not Getting Paid

``I had worked on a house but that house got foreclosed, so I'm not going to get paid,'' he says.
A mortgage collector told him not to send any money unless he could pay the entire amount, he says. By the time National Asset Direct bought the loan and offered a plan to reduce his payments, Terhune was $70,000 in arrears. Even with the easier terms, he missed the December payment.
``I'm keeping good faith and trying to catch up,'' he says. ``I'm flying by the seat of my pants.''
Dellacamera has been around long enough to know he's in uncharted territory too. He's betting Terhune and homeowners like him can eventually become solid borrowers and, if not, that National Asset Direct paid so little for their mortgages it can at least come out whole. It's a risk Dellacamera is prepared to take.