Hedge funds and private-equity firms are betting on delinquent home loans being sold by the Federal Housing Administration as the government agency accelerates debt sales to avert a bailout and stem foreclosures.

Investors including Lewis Ranieri's Selene Investment Partners and One William Street Capital Management LP paid an average of 36 cents on the dollar in an FHA auction of 9,500 nonperforming loans, the Washington-based agency said this month. Bayview Financial LP, a firm backed by Blackstone Group LP, paid as little as 26 cents.

The FHA, which faces a projected $16.3 billion shortfall because of failing loans made during the housing crash, is preparing to sell more than 40,000 delinquent mortgages next year to fortify its insurance fund after disclosing it may need a Treasury Department subsidy for the first time in its 78-year history. The FHA doesn't have the legal authority to use some workout tactics investors employ, such as principal forgiveness.

"We're seeing between a 15 and 20 percent better recovery than we would if those same loans went all the way through to foreclosure, and that's a pretty big change," Carol Galante, acting commissioner of the FHA, said in a telephone interview. Private buyers "have more flexibility in how they can resolve this situation to be positive for the borrowers and for them financially."

The FHA, a division of the U.S. Housing and Urban Development Department, had 734,290 seriously delinquent loans in its portfolio at the end of November, a default rate of 9.6 percent on the agency's 7.62 million loans. That's higher than the 7 percent serious-delinquency rate — those mortgages more than 90 days late or in foreclosure — for the 50 million U.S. home loans tracked by the Mortgage Bankers Association.

"The FHA could easily be the largest seller, if they sell 40,000" mortgages, Louis Amaya, chief investment officer for National Asset Direct Inc., a nonperforming loan investment firm with offices in San Diego and Stamford, Connecticut.

The FHA's recent auction had 13 loan pools that sold for 24.8 cents to 59.3 cents per dollar of unpaid principal balance. The sales prevented $1 billion in fiscal 2013 losses for the agency's insurance fund, Galante said.

Blackstone, the world's largest private-equity firm, is acquiring nonperforming loans through Coral Gables, Florida- based Bayview, which has purchased more than $22 billion in mortgages, said Peter Rose, a spokesman for New York-based Blackstone.

Bayview won bids on two of the FHA's portfolios, paying 26 cents on the dollar for a pool of 1,430 Illinois loans with an unpaid balance of $269.1 million, and 34.9 cents on the dollar for mortgages on 908 properties in 34 U.S. states with an unpaid balance of $172.9 million.

"We like nonperforming loans now in terms of the housing sector," J. Tomilson Hill, vice chairman of Blackstone, said in a Dec. 5 interview with Bloomberg Television.

Blackstone, which has spent $1.8 billion this year buying single-family rental homes, stepped up investing in nonperforming loans as part of a broader strategy to capitalize on the housing-market turnaround, according to Chairman Stephen Schwarzman.

"We are loading the boat," he said on an Oct. 18 earnings conference call.

A trust created by Selene Investment Partners, a Uniondale, New York-based firm where Ranieri is a principal, paid 37 cents on the dollar for a portfolio of 1,385 loans with an unpaid balance of $238 million. Ranieri, a pioneer of loan securitization, and other Selene executives declined to discuss the purchase because "we won't comment on any specific transaction," said Owen Blicksilver, a spokesman for the company with Owen Blicksilver Public Relations Inc.

The nonperforming loan market may grow to as much as $30 billion next year if Fannie Mae and Freddie Mac, the government- sponsored mortgage enterprises, carry out plans to sell delinquent loans, said Amaya of National Asset Direct.

The two taxpayer-owned companies are under a mandate from their federal regulator to dispose of nonperforming assets. Fannie Mae, which has nonperforming loans with a total unpaid principal balance of about $233 billion, is planning to begin qualifying potential bidders for some of those mortgages as early as the first quarter of next year.

Castle Peak Capital Advisors LLC, founded by a group of former GMAC managers, paid 39.5 cents on the dollar for 1,392 loans with an unpaid balance of $239.4 million in the FHA auction. Most of the $1.5 billion in nonperforming loans Castle Peak has acquired since 2008 came from private sources, such as banks, said John Lynch, a managing partner at the Minneapolis- based firm.

"A lot of the pools we buy are kind of stagnating on some balance sheets," he said in a telephone interview. "The sooner you can get to the borrower and work with the situation, the less you're going to lose. So what HUD and the FHA are doing with these pools, and if other agencies follow it, I think is a good thing for the overall housing market."

Other winning bidders at the FHA auction included Tourmalet Advisors, a fund based in Fairfield, Connecticut, and One William Street, a New York-based firm headed by David Sherr, who oversaw mortgage investing at Lehman Brothers Holdings Inc. until 2007.

Sherr declined to comment on the purchase. Tourmalet Chairman Michael Corasiniti didn't respond to telephone messages seeking comment.

Investors have multiple options for making money on the loans they purchase. For eligible mortgages, they can be reimbursed as much as 63 cents per dollar of principal forgiveness under a U.S. Treasury program. Should modifications fail, investors can resell the homes or keep them as rentals.

The FHA divided its mortgage sales into two parts: Purchasers of so-called national pools of delinquent loans must agree not to foreclose for at least six months. Buyers of "neighborhood stabilization" pools — geographically concentrated in areas hard hit by foreclosures, such as Chicago; Newark, New Jersey; Tampa, Florida; and Phoenix — additionally agree to keep at least half of the properties and rent rather than sell them. The FHA isn't allowed to rent homes back to their former owners after a foreclosure.

The FHA was founded during the Great Depression to spur loans to low- and middle-income borrowers. The agency provides liquidity to the housing market by insuring lenders against losses on mortgages with down payments of as little as 3.5 percent. Lenders are made whole if the borrowers default.

The FHA usually takes ownership of a property after it has gone into foreclosure and the mortgage servicer has received its insurance payout. The loan-sale program allows servicers to transfer delinquent loans to the agency before foreclosure — though only after they've attempted to work with borrowers to bring mortgage payments current.

The FHA is selling loans in areas where the costs of foreclosing are highest, Galante said. More than 2,300 of the auctioned loans were on properties in Florida, where borrowers were an average of 1,114 days delinquent — the most of any state — by the time of foreclosure, according to Lender Processing Services Inc. The U.S. average was 728 days.

It costs the FHA an average of $28.78 per day to maintain and market a property acquired after an insurance payout. The agency is now losing about 71 cents on the dollar on its repossessed properties nationwide — and more in areas where most of the loans are being auctioned off, Galante said.

Ed Pinto, a senior fellow at the Washington-based American Enterprise Institute who has criticized the FHA's accounting practices, said his calculations show the agency's typical loss on a foreclosure is 63 cents on the dollar — close to the loss from the average winning auction bid.

"I'm having a hard time figuring out where they're making up much financial benefit," he said in an interview. Pinto, who served as Fannie Mae's chief credit officer in the 1980s, said the auctions are a "back door" way of implementing principal reductions on FHA loans and "doling out other pots of money" authorized for community development.

By buying the loans at a discount, investors can offer more generous payment modifications to delinquent borrowers, thus helping prevent foreclosures, said Wayne Meyer, president of New Jersey Community Capital, a not-for-profit community-development financial firm. It won bids for two portfolios, including a pool of 150 loans in Newark that sold for 24.8 cents per dollar of the $47 million unpaid balance.

The Newark portfolio had an average outstanding loan of $315,000 and an estimated market value of $150,000 per home, Meyer said. The auction sale price was about $77,500 per mortgage, giving New Jersey Community Capital the ability to cut principals in half, Meyer said in a telephone interview.

"Our view is to keep owners in their homes," he said.

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