Metacapital Buys Bad Loans as Home Market Ebbs: Mortgages

Deepak Narula said he wants to take the guesswork out of investing in the U.S. housing market.

His $1.9 billion firm, Metacapital Management LP, the top-performing hedge fund in 2012, plans to start a fund to invest in the debt of delinquent borrowers who haven’t lost their homes to foreclosure, according to an April 24 letter to investors, a copy of which was obtained by Bloomberg News. The Metacapital Mortgage Loan and Credit Fund will start in the third quarter.

Narula joins money managers including One William Street Capital Management LP and Ellington Management Group LLC in acquiring non-performing loans after foreclosure starts dropped to the lowest level since 2006 and house prices jumped in Phoenix, Las Vegas and other hard-hit markets.

As U.S. home-price gains slow in some markets, profiting from the loans doesn’t require future increases, Narula said.

“The valuations at which these loans trade certainly make this strategy attractive,” Narula, who declined to comment on Metacapital’s new fund, said in a telephone interview. “They don’t require home price appreciation, that obviously would be an added benefit, but based on current valuations you don’t need to bank on home price appreciation to have a profitable strategy.”

The recovery is showing signs of stalling after mortgage rates rose from record lows. Sales of previously owned properties in March tumbled 7.5 percent from a year earlier to the slowest pace in 20 months and mortgage applications to buy homes plunged 19 percent from a year earlier, indicating slowing demand during what is typically the busiest season for deals.

Home prices in 20 U.S. cities rose at a slower pace in the 12 months through February as the residential real-estate market cooled, according to the S&P/Case-Shiller index released yesterday. It rose 12.9 percent from February 2013, the smallest 12-month gain since August. Zillow Inc. forecasts 3 percent growth in values next year, Chief Economist Stan Humphries said yesterday at the Milken Institute Global Conference in Beverly Hills, California.

Delinquent Loans

There are more than 1 million properties in the U.S. tied to loans at least 90 days late and not yet in foreclosure, according to Black Knight Financial Services. Another 4.5 million borrowers are at least 30 days delinquent or in the repossession process, according to a Black Knight report in February.

Investors in the soured mortgages can either work with borrowers to modify the loans and help them keep their homes or put the properties through foreclosure and take ownership. Then they have the option to sell or rent. Hedge-fund and private-equity firms have dominated U.S. foreclosure auctions in the last two years by buying as many as 200,000 single-family homes to rent.

The government, lenders such as Bank of America Corp. and investment firms sold about $34.7 billion in non-performing loans last year, up from $13.1 billion in 2012, according to David Tobin, principal of Mission Capital Advisors, a New York-based real estate loan broker. Investors are generally paying between 65 percent and 75 percent of the market value of properties for delinquent loans, according to Jade Rahmani, an analyst for Keefe, Bruyette & Woods Inc.

Sales Accelerate

Sales of the debt have accelerated this year because of financial regulations that force banks to pledge more capital for some assets they hold, including non-performing loans, or NPLs. More than $600 billion worth of NPLs will be sold, half of which is expected to come from government-controlled mortgage companies Fannie Mae and Freddie Mac, Narula said.

The Department of Housing and Urban Development has been auctioning loans to stem losses at the Federal Housing Administration. The next HUD auctions are scheduled for June 4 and June 20, with the government expected to sell loans with an unpaid principal balance about $5 billion, according to Altisource Residential Corp., which bought 13,500 delinquent loans last year.

Tumultuous 2013

Investors in the Metacapital fund will be required to commit capital over four years, because the loans are less liquid than securities held by the firm’s other funds, according to the letter. A smaller portion of the Metacapital fund will buy bonds and loans tied to commercial real estate, according to the letter.

Narula’s flagship fund is coming off of a tumultuous 2013 after the firm, along with other investors in government-backed mortgage bonds, was hurt by speculation about the timing of the Federal Reserve’s retreat from its debt-buying program. The main Metacapital Mortgage Opportunities Fund climbed 0.5 percent in 2013, according to the letter. This year, it rose 4.6 percent through March.

The fund returned 41 percent in 2012, mainly on investments in mortgage debt backed by the U.S. government, topping Bloomberg Markets Magazine’s list of the best-performing managers overseeing more than $1 billion. Narula started Metacapital in 2002 with $15 million from friends and his own savings.

There’s a limit to the prices investors will pay for non-performing loans, which may take more than a year of legal wrangling to collect on, said Keefe Bruyette’s Rahmani.

Price Limit

“Even if competition materially increases, and it seems like it is, there should be a limit to what NPL buyers are willing to pay because 85 percent to 90 percent of the pool will have to go through the foreclosure process,” Rahmani said.

That process will take a year to 18 months in most cases and means paying costs including real estate taxes, legal fees and insurance payments, according to Rahmani.

“This is not for the faint of heart,” he said. “It’s a very labor intensive and long process because you have to be willing to wait.”