Workout
As a hedge fund manager, Steven Persky stays in business by doing well by his clients. As a side effect, the Los Angeles financier may also contribute to the solution to the housing crisis.
Persky’s firm, Dalton Investments, is raising as much as $1 billion from wealthy individuals and institutions to buy delinquent mortgages in troubled markets like Phoenix, Las Vegas and southern California. Persky figures he can pick up the distressed paper for 50 cents on the dollar.
And then what? Is he going to put defaulting homeowners out on the sidewalk? That’s not his plan. He says he is going to cut deals with them to stay put while making smaller payments than they originally contracted to make. The eviction route would make sense only if there were new buyers willing to pay more than the mortgage balance for the house. (A lot more—evictions are expensive affairs.) For the kinds of mortgages Persky is looking at, such buyers are not to be found.
“A lot of defaulted mortgages need to be restructured, but this is a classic distressed investing opportunity,” Persky says. “This market will clear by investors restructuring distressed assets, not by government unilaterally changing credit terms.”
What happens when a junk bond issuer gets into trouble? Do the bondholders put padlocks on the doors and sell the company’s machinery for scrap? Usually not. The creditors are likely to do better keeping the factory running.
Persky concedes that the housing market has a lot more pain ahead. So far 3.3% of the mortgage borrowers in this country are 30 or more days delinquent on their payments, according to Equifax. That figure will hit 4% next year, Moody’s Economy.com predicts.
Treasury Secretary Henry Paulson is working on an interest- rate freeze with big lenders, and some politicians would go a lot beyond the Paulson plan, with moratoriums on foreclosures. In the meantime, the distressed-debt buyers are out in force. They see the mortgage fiasco as a buying opportunity as good as the one presented by junk bonds in 1990 or busted tech stocks in 2002. In 2006 private equity firms raised $18 billion for investments in distressed debt and special situations, including housing. In the first eight months of 2007 they raised another $23 billion, says Private Equity Intelligence.
So far very little of this cash has been put to work. The bottom has not been found in home prices, but it has to exist somewhere. This is what the debt workout business is all about.
Bond giant Pacific Investment Management, a subsidiary of Allianz SE, is raising $2 billion, including $20 million from its own employees, to invest in the Pimco Distressed Mortgage Fund. The firm told prospective clients it expects to earn 15% to 20% annual returns, according to the Fresno County Employees’ Retirement Association. Among other pensions plunking down funds are the Oklahoma Teachers, Orange County (Calif.) Employees and New Jersey’s Division of Investment. New Jersey is giving Pimco $125 million and the Centerbridge Distressed Credit Partners Fund another $100 million.
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“There’s a lot of competition among smart investors,” he says. “I don’t think government intervention is needed.
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