Mortgage-Market Pros
Aim to Cash In on Slump

For 27 years, former Countrywide Financial Corp. President Stanford Kurland made a fortune helping to build a mortgage-lending empire.

Now, as parts of the mortgage market collapse, Mr. Kurland and some former colleagues have a new plan -- make another fortune on the way down.

On Monday, the group will announce the launch of Private National Mortgage Acceptance Company LLC, or PennyMac, an investment firm formed as a joint venture between asset manager BlackRock Inc., under Chief Executive Laurence Fink, and Boston investment firm Highfields Capital Management.

PennyMac seeks to raise more than $2 billion to buy distressed mortgages on the cheap, work with borrowers to restructure them, and then resell them as performing mortgages at a profit.

A number of bottom-fishers are already wading into the mortgage market, but PennyMac is taking a different approach from most. Rather than buying slices of mortgage-backed securities, which are claims to pools of mortgages, PennyMac plans to buy whole mortgage loans -- the old-fashioned mortgages that banks routinely owned before the mortgage-securitization business came along.

PennyMac executives believe that troubles with whole loans are a big shoe to drop for the mortgage market, with a massive unwinding steadily under way. PennyMac executives figure that a lot of these mortgages will be sold at big discounts as banks and thrifts clean up their balance sheets.

PennyMac will operate from Calabasas, Calif., the hometown of Countrywide, the largest mortgage lender in the country. While the two firms aren't related, PennyMac will be closely watched because it employs so many former Countrywide executives. Countrywide alumnus David Spector, who until most recently was co-head of the now-downsized global residential mortgages group at Morgan Stanley, will be chief investment officer.

Others leading the firm are James Furash, a former chief executive of the Countrywide Bank unit, and Michael Muir, a former chief financial officer of the unit.

PennyMac's plan to profit from the mortgage industry's turmoil is likely to draw fire, especially from those who believe Countrywide's aggressive sales tactics and lowered lending standards helped lead to the subprime-mortgage troubles in the first place.

"The whole subprime mortgage fiasco was built on sort of Wall Street's snake-oil salesmen convincing America this is a can't-miss scheme," says Irv Ackelsberg, a consumer lawyer in Philadelphia who testified to the Senate Banking Committee on lending last spring. "It sounds like they've just morphed into some new version."

PennyMac executives disagree, saying many of them were involved in risk management while at Countrywide and its units and have little to do with the firm's recent problems.

"I don't think it's ironic; I think it's appropriate that experienced people are coming in" that have "the greatest capability and knowledge to revitalize the mortgage market." says Mr. Kurland. A Countrywide spokesman declined to comment.

In January Countrywide agreed to be sold to Bank of America Corp. for about $4 billion.

Mr. Kurland was approached by BlackRock's Mr. Fink a few months ago about the venture. The two have known each other since grade school in Van Nuys, Calif. Mr. Kurland left Countrywide in 2006, where he was in line to become chief executive after Angelo Mozilo.

The PennyMac approach could be risky, particularly if it dives in too early and purchases loans that continue to drop in price, or if the firm can't restructure the loans with terms that will ultimately lure buyers. This could leave the firm holding the bag on troubled loans, ultimately leaving its investors with losses.

"I would say the greatest risk is a very deep and very elongated recession" without "a rebound of residential housing over a very long cycle," says Mr. Fink. While "we don't believe" that will happen, we're also not suggesting we know "the bubble is over or the bottom has been reached," he says.

Despite a rebound in the mortgage bond market in recent days amid major steps by the Federal Reserve to restore confidence, PennyMac expects further problems as $1 trillion in bank-held jumbo, subprime and other loan holdings stand to become nonperforming. It thinks whole-loan losses have barely begun to materialize, and a new wave of problems is coming as certain loans with low initial "teaser" rates reset to higher rates, squeezing borrowers' ability to pay.

Already, serious delinquency and foreclosure rates are reaching new highs by some measures, and are likely to get worse as home prices continue to fall, the economy slows, and unemployment rises.

Other big players are getting in the business of acquiring distressed mortgages and restructuring them. Goldman Sachs Group Inc., for instance, recently bought Litton Loan Servicing to help identify distressed mortgage-loan portfolios. Back in the 1980s, Litton became successful servicing loans in Texas that were struggling with residential real-estate woes like today.

PennyMac considered buying one of the loan servicers, but decided most had their hands full working with existing borrowers and growing liabilities to mortgage investors. PennyMac will be buying mortgages in various degrees of distress. The prices of certain second-lien debt, which stands behind others to collect proceeds should a borrower default, have tumbled below a penny on the dollar.

Other better-quality mortgages coveted by PennyMac trade at 80 cents to the dollar. While PennyMac is hoping to resell some mortgages in a few months, executives there say they can hold mortgages for years, if necessary, as it identifies buyers.

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