Stearns Holdings LLC, a one-time Santa Ana-based mortgage powerhouse, declared Chapter 11 bankruptcy last week.
That broke open—temporarily, at least—a private battle between two of the nation’s preeminent investment firms—Blackstone Group and Pacific Investment Management Co.
Blackstone (NYSE: BX), the New York-based firm with a $55 billion market cap, bought nearly 70% of Stearns Lending in 2015 on undisclosed terms; founder Glenn Stearns retained the rest.
Newport Beach-based PIMCO, which has $1.8 trillion in assets, has been snapping up Stearns debt, which was issued in 2013 at an eye-opening annual interest rate of 9.375%.
The July 9 bankruptcy filing from the company—now the country’s 20th-largest mortgage lender—claimed that if a restructuring deal could not be made with PIMCO, the bond giant “would insist that the company liquidate promptly, which would result in loss of employment for 2,700 employees and termination of all operations.”
PIMCO didn’t take the Stearns claims lying down, saying in its own filing that Blackstone has “engineered a plot” to get complete control of Stearns.
Stearns and Blackstone have distorted the negotiations, thus “improperly casting PIMCO as a villain in an effort to obscure what is actually occurring here—a rigged sale of the company to Blackstone at a price that is substantially less than the value implied by restructuring proposals supported by Blackstone just months earlier,” PIMCO wrote in its July 10 court response.
Stearns Wipe Out
Glenn Stearns, who began the company in 1989, said his remaining investments in the firm will be wiped out because of the bankruptcy (see separate story, this page).
“I’ve never had an issue like this in my career,” the 55-year-old Stearns said. “I don’t like how it happened. It’s not part of my DNA. I don’t live in that world.”
After he sold the majority stake of the company in 2015, Stearns said he didn’t participate in its daily operations.
Stearns Lending generates its revenue through mortgage loan production, which results in income primarily through gains upon the sale of mortgage loans to Wall Street firms. Its main business channels are wholesale, retail, joint venture, and preferred partner.
The retail channel originates mortgage loans directly with borrowers through over 100 branch offices nationwide.
Losing Share
When the Federal Reserve began raising interest rates in late 2015, the industry began slowing, reporting a 12% decline in 2017 among the top 100 lenders, according to Inside Mortgage Finance, a newsletter that tracks the industry.
Stearns Lending fared even worse, losing market share as it fell 34% to $17.1 billion in mortgage lending in 2017.
Stearns began cutting its California workforce and shifting operations to Texas, including its headquarters.
Its Santa Ana office headcount has decreased from 583 in 2017 to 48 as of last month.
The market share loss continued in 2018 as the company’s first lien mortgage lending fell 15% to $15.5 billion, while the industry dropped 9.9%, according to the IMF newsletter.
During the first quarter, it declined 16% to $3.1 billion from the same period a year earlier; once again, the industry fell at a slower pace, 6.6%.
The Stearns court filings said it reduced $40 million in annual fixed costs through employee headcount reductions, vendor cost reductions, centralization of corporate functions, and regional operating center site closures.
“Stearns isn’t your normal nonbank lender because its majority owner is Blackstone, which has extremely deep pockets,” Guy Cecala, chief executive of the Inside Mortgage Finance newsletter, told the Business Journal. “The question would be why Blackstone didn’t just step in.
“It’s hard to tell how much financial duress they were experiencing and if something prompted this other than a negotiation.”
Blackstone reported $1.57 billion in cash and $21.2 billion in investments as of March 31, according to its first-quarter report.
Cecala said he expects Stearns to continue operations because it has a strong presence as a direct lender to consumers and the industry has seen a rebound since the end of March when interest rates began falling.
The Big Problem
As the Fed in recent months has indicated it will pause on raising rates, other mortgage lenders are reporting a pickup in business. Foothill Ranch-based loanDepot LLC plans to hire an additional 1,300 people in the second half this year.
Beyond losing market share and dealing with rising interest rates, another key problem for Stearns dates back to 2013, when it sold $250 million in senior secured notes that will mature in August 2020.
Stearns previously had a business of collecting monthly mortgage payments. However, in 2018 it sold that business to Freedom Mortgage Corp. for $224.6 million.
It only used a portion of the proceeds to pay off the soon-to-mature notes. It still owes about $183 million. Various funds affiliated with PIMCO own an estimated 67% of those outstanding notes, court filing said.
The bankruptcy was triggered by two of Stearns’ unidentified wholesale lenders telling the company they’d stop lending because of concerns about these notes coming due in August 2020, the company’s filing said.
Last November, Stearns approached PIMCO to suggest restructuring alternatives, such as a partial pay down and extension of the maturity of the notes.
“PIMCO rejected this proposal out of hand,” the bankruptcy filing said. “It said that it would consider only two alternatives: either the Blackstone funds inject $50 million of new capital into the company, behind the notes, as a condition of a maturity extension, or, failing that, PIMCO would insist on being given ownership of the entire business.”
Blackstone shopped for alternatives, including a sale of Stearns, which didn’t find takers. In June, Stearns proposed giving the majority of the equity to PIMCO.
“PIMCO surprised the debtors and Blackstone by stating that its funds refused to take ownership of the company, despite previously having insisted on being given the keys,” the filing said.
PIMCO’s advisers said they would consider an offer by Blackstone to cash out the notes or liquidation of the business, the filing said.
Stearns has “worked at a breakneck pace to develop a plan to restructure” to preserve 2,700 jobs. “And they are going to do it with overwhelming support from Blackstone,” the filing said.
Blackstone is proposing to inject $60 million in cash to Stearns to “cash out the notes.”
The filing said as a result of its proposed restructuring plan, it has obtained commitments of $1.5 billion from Barclays Bank PLC and Nomura Corporate Funding Americas LLC to provide warehouse financing after the bankruptcy so Stearns can continue originating mortgage loans without interruption.
Conciliatory Talk?
Last week’s flurry of bankruptcy filings by the debtor included a proposed timeline to resolve the case by October.
A quicker resolution might be in the works.
Late last week, reports indicated that PIMCO and Blackstone lawyers were nearing a deal whereby the Newport Beach firm—the only major debtor thus far to object to the initial restructuring plan—would become a highly secured lender in Stearns Lending under an amended restructuring plan.
No court filings indicated that such a deal had been struck by the time the Business Journal went to press on Friday.
Company officials knowledgeable with PIMCO’s operations said that the midweek chatter could prove to be premature.
Glenn Stearns Laments Bankruptcy
Glenn Stearns says the likely result of last week’s bankruptcy is that he’ll be “wiped out” of his remaining stake in the mortgage lending firm he began in 1989 when he was 25 years old.
Stearns still retains 29% of the company he sold to the Blackstone Group in 2015 and has also lent the company “definitely more than $10 million.” Still, Stearns, who has a seat on the board of directors, ultimately agrees with the company’s decision to file Chapter 11 bankruptcy.
“I don’t like it, but for the good of the organization and the employees, they’re doing what they have to do,” he told the Business Journal.
“They’ll come out with no debt. They’re making money right now.
“I have got to choose what is in the employees’ interest. That means allowing my equity and my notes to evaporate.”
The dispute between Wall Street heavyweights Blackstone and PIMCO, which own about two-thirds of the lender’s outstanding debt, “is something way over my pay grade,” Stearns said.
Survivor, Undercover
Stearns has survived calamities before. His firm was one of the few area lenders to survive the 2008 financial crisis; he pulled out of the subprime business prior to its implosion, seeing the warning signs well before many of his competitors.
“I was proud of the company and being able to pull it off without anyone getting hurt,” he recalled. “This time, things are different and I’m on the other end of it.”
Even if he loses his current investment in the company, Stearns said he’ll be fine because of his earlier sale to Blackstone.
“I’ve been very blessed with many great investments,” said Stearns, who in 2011 became the youngest-ever member inducted into the Horatio Alger Association of Distinguished Americans.
Stearns has also invested in a Long Beach firm making pharmaceutical drugs for animals. He’s debating whether to return to mortgage lending, including possibly starting his own firm.
“I’m weighing the options of whether I’d rather compete or stay involved in the company,” he said.
Glory, Not Prize Money
The entry fee for Transpac 50 is $5,000 and while there is no prize money, there are trophies for the nearly dozen divisions that yachts are designated for in the race.
Nearly 100 vessels, including monohulls as small as 33 feet in length to several running around 100 feet, are taking part in the race, which starts at Long Beach’s Point Fermin and ends in Honolulu.
Boats, some with crews running nearly 20 people, leave in stages, with the first having departed on Wednesday, July 10.
The winning times have steadily dropped since the first race in 1906 when the Lurline won in 12 days and 10 hours.
In 2017, the Mighty Merloe set a multihull record of four days and six hours while the Comanche set a monohull boat record of five days and almost two hours.
Manouch Moshayedi’s Rio 100 won the 2017 Barn Door Trophy, which is given to the fastest monohull, manual power-only sailing yacht.
He and his 19-person crew finished in six days, 17 hours and nine minutes.
