Who Will Benefit From Bulk REO Sales? Meet Carrington Capital Management

In The Government’s Plan to Sell Foreclosures in Bulk is a Terrible Idea, I argued that giving bulk discounts to hedge is a travesty of justice:

This is an absolute travesty. Does anyone really doubt that this entire plan was drafted by lobbyist of the big institutions who would profit the most from this? And that those institutions have ties to Goldman Sachs and all of the other financial firms who helped create this mess in the first place?

This will do nothing to stabilize home prices. And any short-term boost to consumer confidence will be quickly eroded once all of the inevitable fraud and mismanagement starts to get reported. And once people realize that home prices are falling anyway.

This is just another lobbyist-drafted program to fleece you and me. All because we are willing to buy any piece of crap legislation sold to us in the name of propping up home prices.

So who exactly are the kinds of companies and funds that could benefit the most from this program? Meet Carrington Capital Management, who is currently negotiating a $500 million deal. CNBC reports:

The trouble is, they are looking at even bigger write-downs than forecast if they sell these distressed properties in bulk.

“One of the things that might be holding these bulk sales back is that the assets might not have been fully written down by the banks,” says Rick Sharga of Carrington Mortgage Holdings, a private equity firm. “The problem for the banks is that in that scenario, when they sell off these assets in bulk, they have to recognize pretty significant losses all at once, rather than spread those losses out over a longer period of time.”

Sharga’s firm is in the midst of a half billion dollar deal with a major U.S. bank to buy foreclosed properties.

Bank officials will tell you that the write-downs are taken when the properties are taken back as REO (real estate owned), that is, when they are officially repossessed by the lender. That value is based on the current market value of those properties. In some markets, the bank will be able to sell REOs at pretty close to the market value. But if they sell the properties in bulk to investors, they will have to offer deep bulk discounts, and that means additional write-downs.

The same could be true of any bulk program with the government, involving current and future REOs at Fannie Mae, Freddie Mac and the FHA.

Sources say there was a big meeting this week in Washington, DC about just that.

Translation: There is a big meeting in Washington to discuss how much of those additional write-downs should be covered by taxpayers.

So who is Carrington Mortgage Holdings? Well, they began with as a $25 million fund created by subprime superstar New Century. BusinessWeek explains:

Managed by ex-Citigroup banker Bruce M. Rose, the fund was launched in 2003 with $25 million in seed money from New Century, which owns about a 35% equity stake. Such an intimate tie between a lender and a hedge fund is highly unusual, say analysts. Carrington specializes in turning subprime mortgages into sophisticated bonds called collateralized debt obligations (CDOs) and selling them to other investors. Not surprisingly, New Century is one of Carrington’s biggest suppliers, providing 17% of the loans in a recent deal.

The fund bought the riskiest traunches of subprime loans and collected huge profits until the bottom fell out. FT reports:

Carrington asks for $200m to replace bank loans

Carrington Capital Management, a $1bn hedge fund specialising in mortgages, is trying to persuade its investors to lend it up to $200m to replace bank loans, in the latest sign of concern about banks pulling credit lines to hedge funds.

Carrington, part-owned by failed US subprime lender New Century, has offered investors an 18 per cent interest rate on new preferred shares it plans to issue. The fund said it was concerned about short-term reverse repurchase, or “repo”, financing, although it told investors it maintained good relations with its remaining lenders.

The move follows the failure of several hedge funds specialising in mortgage-backed securities after banks increased the margin that must be put up against loans – demanding more cash from the funds, with the threat of forced sales of assets if they could not deliver.

Carrington has frozen redemptions by its investors. It said it would focus on paying off debt before returning any cash, and that it missed a planned repayment at the end of last year.

Carrington founder Bruce Rose declined to comment.

But the most interesting part of Carrington’s story isn’t that they helped fuel the subprime fire. It’s that they found a questionable way to make huge profits from servicing troubled loans: Screw the bondholders and collect big fees under the guise of “helping” homeowners.

The American Banker explains:

By stockpiling foreclosed homes and declaring borrowers current — sometimes unilaterally — Carrington received payments that would otherwise have protected other investors from future losses. In a single deal thatAmerican Banker analyzed, Carrington’s actions likely netted its investment fund more than $20 million.

“They appear to have managed their book for their own personal benefit in a way that screws the investors,” said Laurie Goodman, an Amherst Securities analyst who flagged Carrington’s modification practices in research notes.

Carrington is not a bank; it competes with them, and its inner workings raise unsettling questions about the mortgage market and some of the proposals to fix it.

That concept led Carrington to insist on a special feature of deals in which it invested: Despite holding the lowest-ranked slices of the securitization, Carrington claimed a high degree of authority over handling troubled collateral. Among its privileges was the right, as Carrington would note later in court, to “direct the servicer regarding the disposition and sale of properties whose mortgages go into default.”

Neither the ratings agencies nor investors appear to have objected to this detail

That “absolute control” was more valuable than anyone outside the company could have guessed at the time. Three years later, despite concentrated investments in the lowest tranche of deals that are approaching 50% delinquent or foreclosed, Carrington is still standing. How the company handled its servicing duties in deals like one called CARR 2005-NC3 helps explain why.

Because Carrington owned the traunches that would get wiped out first in a foreclosure sale, they rarely foreclosed on anyone. Even though the more senior investors would prefer the foreclosure to recover their money, Carrington’s unique servicing “control” allowed them not foreclose and keep the high percentage returns rolling in.

In short, the riskiest investment with the highest payout gets crushed first, but not if Carrington gets to decide who gets crushed and who doesn’t.

The article continues:

Carrington had become an ardent practitioner of capitalization modifications, in which it tacked whatever missed payments a borrower had incurred on to the top of a loan’s unpaid principal and declared the loan to again be current. Reviled by many borrower advocates for saddling a struggling borrower with a higher principal and potentially higher payments than the ones he or she failed to make previously, the modifications nonetheless buy both parties a little time.

Carrington bought a lot of it. A delinquent borrower would be given a mod, perhaps make a few payments, and then often fall back into delinquency. Then Carrington would sometimes give that borrower another mod, perhaps coupled with a rate reduction, repeating the process. In some instances, it appears to have applied three modifications over three years, allowing the loans to negatively amortize.

Carrington’s focus on capitalization mods was one of several practices that drew a lawsuit from then-Ohio Attorney General Richard Cordray, whose office alleged in a 2009 complaint that many Carrington modifications did not amount to a “good faith” effort to help borrowers stay in their home over the long term.

Carrington said it could not comment on the Ohio suit, which is still pending.

“The idea of a modification program is that you lower the payments or the principal amount to the point where the borrower can afford to live in the house,” Goodman said, contrasting that with Carrington’s activities. “All you’re doing is putting the delinquent money into the balance of the loan, and declaring the guy current on an accounting statement” Goodman said. “You’re just stalling foreclosure, because you haven’t improved the borrower’s situation.”

Eventually, Carrington’s “absloute control” generated lawsuits. Bloomberg explains their tiff with American Home Mortgage:

Carrington used its rights to force American Home to delay foreclosuresales, according to the hedge fund’s complaint. That diverted money from investors in higher-ranking bonds because the more money a servicer pays all bondholders each month, the more it recoups when the home is sold, leaving less principal for the senior bondholders.

American Home, running out of the credit it needed to continue payments on defaulted loans, stopped obeying Carrington, the suit says. On Sept. 17, two days after Lehman Brothers Holdings Inc.’s collapse sent financial markets into a tailspin, American Home told Carrington in a letter that it no longer believed the firm had the right to direct its actions.

Carrington alleges that American Home then began unloading foreclosed homes. The servicer used that money to reimburse itself and, in response to lender demands, pay down $200 million of its $1.2 billion in debt, the suit says.

HousingWire goes into further detail of Carrington’s alleged delay tactics:

According to the complaint filed by American Home, Rose and employees in his hedge funds used a variety of tactics to keep REO on the servicer’s books: some of the alleged schemes included forcing AHMSI to list REO properties at prices well above market appraisals, as well as taking weeks to respond to good-faith offers on properties and even firing certain REO brokers mid-stream in the sales process as part of what AHSMI alleges was part of a scheme to “impede the process of selling a property.”

So what’s the point? Uncle Sam is telling us that taxpayers should take unnecessary losses to give bulk discounts to companies like Carrington.

For our own good, of course.

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About Greg Fielding

I am a longtime real estate agent who has pretty much seen it all during the housing boom as bust. With experience in selling high-end property and low-end foreclosures, raw land, short sales, development work, apartment buildings, and working with investors, I bring a well-rounded perspective to my work.I also have started to do some paid real estate consulting. If you have questions or just need some good real estate advice, book an appointment at http://whattodorealestate.com/In addition to selling real estate, my insights have been featured in The New York Times, The Big Picture, and regularly on Patrick.net. I have also done consulting work with ForeclosureRadar.Starting my career, in 2003, I have sold homes throughout Alameda and Contra Costa counties, specializing in Danville, Alamo, Blackhawk, San Ramon, Dublin, Pleasanton, Walnut Creek, Lafayette, and Orinda. I live in Danville with my three kids.


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10 thoughts on “Who Will Benefit From Bulk REO Sales? Meet Carrington Capital Management

  1. Pingback: Who Will Benefit From Bulk REO Sales? Meet Carrington Capital Management « Editorials « Real Estate Sacramento

  2. Greg FieldingGreg Fielding Post author

    Carrington update:

    “Carrington Holding Company and Oaktree Capital Management formed a partnership to buy up to $450 million in vacant foreclosed homes with a plan to rent them out.

    The move falls in line with the Federal Housing Finance Agency, which said earlier in the month it was readying programs to beginning selling repossessed homes held by the government-sponsored enterprises in bulk.

    Carrington CEO Bruce Rose said that converting vacant REO into rentals will help revitalize neighborhoods crippled by sinking home prices and reduced property tax revenue stemming from blight.

    “Reducing the number of distressed properties for sale can help stabilize home prices and putting families into currently vacant homes can begin the healing process for neighborhoods that have been damaged by foreclosures,” Rose said.”

    http://www.housingwire.com/2012/01/18/carrington-oaktree-partner-to-buy-bulk-reo-for-rental

    This won’t do a damn thing to revitalize any neighborhoods.

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