In less than a year, the private-equity buyers of IndyMac Bank — the $32 billion-asset California thrift seized in July 2008 and run by regulators for six months — have turned a $1.6 billion profit.
Now called OneWest Bank, the company is outperforming rivals on various fronts, including working out troubled assets, and it should have plenty more opportunities: It has acquired two more failed banks in the past three months, and it's one of the few banks in the region with ample capital to do more deals.
Yet thriving on a mess that has already cost tens of thousands of IndyMac borrowers their homes is an awkward situation, and not just for the team of billionaire backers including George Soros, John Paulson and Christopher Flowers.
Shortly before OneWest's latest acquisition, the FDIC was forced to take the unusual step of publicly defending OneWest's loss-sharing agreement from a pair of video bloggers. For a bank with aspirations to become a sizable regional player, weathering the criticism may be as crucial as its ability to cobble together the assets of busted banks.
The franchise the Federal Deposit Insurance Corp. inherited featured terrible geography, reverse mortgages, securitized option adjustable-rate mortgages and the highest cost funding of any bank in the country. By paying off IndyMac's high-cost depositors, the FDIC immediately shrank the bank's deposits to $6.5 billion from $19 billion.
Under its new team, led by Chief Executive Terry Laughlin, the bank has made a limited return to lending. In the fourth quarter it originated about $1 billion of mortgages, selling half and keeping half on its balance sheet. It also built up its deposit base to more than $11 billion by yearend, filling the gap with Federal Home Loan bank advances.
But it's the terms of the FDIC deal that have yielded the bank's outsize earnings. OneWest paid $13.9 billion for IndyMac's assets — a 23% discount to their face value that more than covered OneWest's $2.5 billion "first loss" obligation. Should the amount ever be reached, and it hasn't yet, the FDIC would absorb first 80% and then 95% of further losses. In return, OneWest committed to modifying all of the IndyMac mortgages it serviced — so long as doing so would save investors money. According to the agency, none of the more than 80 potential buyers it solicited produced a better offer than OneWest's, which it estimated will cost the insurance fund more than $11 billion.
OneWest's accounting suggests that the bank believes that every penny of the losses its portfolio took this year was covered by the initial discount it got on IndyMac — it neither made provisions nor booked losses on the loans. What interest payments did roll off the portfolio were pure profit, amounting to $210 million in net income in the fourth quarter alone. On top of that, the bank earned $900 million in additional noninterest income. That total would presumably include gains in the net value of its servicing portfolio — — most servicers did well last quarter — but covering all of the difference would be a stretch, said Bert Ely of Ely & Co., suggesting that much of it may be the result of amortizing the gap between what OneWest paid and the actual value of the portfolio.
Even if the deal provided for a lot of easy money for the private-equity firm, OneWest's duties over the past year have hardly been a matter of sitting back and letting the checks roll in. It's also responsible for addressing the very cause of IndyMac's failure — a massive portfolio of terribly performing loans. Doing that has required administering the FDIC loan mod program that launched the Home Affordable Modification Program.
When the FDIC took over IndyMac, it created an ambitious effort to rehabilitate the mortgages the bank serviced, 60,000 of which were 60 or more days past due. Because securitized loans made up 90% of IndyMac's servicing portfolio, John Bovenzi, the former FDIC deputy chairman who was IndyMac's CEO during receivership, said that for most borrowers a straight principal writedown was out of the question. What the bank could do, however, was permanently drop interest rates, lowering total payments over the life of the mortgage.
Investors who owned the mortgages were initially worried that the FDIC would seek to lower payments indiscriminately. But Bovenzi said none ultimately protested after they understood that mods would only occur when they could be expected to save all parties money.
"If foreclosure made more economic sense, we weren't going to do the loan modification," he said, and this rule still applies to OneWest's current modifications done under Hamp. "When we're managing the receivership, we still have that statutory obligation to maximize value for the creditors of the failed bank," Bovenzi said.
IndyMac worked through a backlog of best candidates for mods first, Bovenzi said — the minority whose loans had solid documentation. And even getting those through the program required significant effort.
"We used Federal Express instead of regular mail because people actually open Federal Express," he recalled. When the pool of the most eligible borrowers was exhausted after a few months, the FDIC started offering conditional modifications. All together, out of 46,500 loans deemed eligible at the time of IndyMac's sale to OneWest, the FDIC had completed 8,512 mods and mailed out more than 32,000 offers. But in that same period it initiated almost 28,000 foreclosures in California alone.
Since the handoff from the FDIC, OneWest has frequently come under suspicion of "systemically working to push home loan borrowers into foreclosure," as The Sacramento Bee reported this week in describing a string of local consumer lawsuits. Indeed, OneWest's and the FDIC's IndyMac agreement has drawn howls for producing too much profit and too few loan mods. Yet while it's true that the bank's mod program was slow to yield results — the bank barely managed 1,000 permanent modifications in the first six months it was in charge — its statistics have recently jumped, with the bank modifying 3,087 and making official offers to modify 5,048 more. And though Internet critics and others have frequently said that OneWest has been eager to foreclose on homes in order to trigger its loss-sharing agreement with the FDIC, to date the opposite appears to be true.
Foreclosure Radar data for IndyMac's home market of California shows that the number of foreclosure proceedings initiated on loans OneWest services has been cut in half since the bank took over from the FDIC — a decline that far exceeds the general slowdown in foreclosures in the state. OneWest's notices of trustee sales, which immediately precede the seizure of a home, have similarly dropped.
"They are not foreclosing at a pace that makes them stand out," said Sean O'Toole, Foreclosure Radar's founder.
And while a theoretical case could be made that it would be profitable for OneWest to foreclose rapidly in order to trigger its FDIC loss-sharing agreement, the bank is contractually obligated to the FDIC not to do so. Moreover, said Michael Krimminger, FDIC special adviser for policy, "the incentives are designed to get more loans past the net present value test" required to qualify for a modification. The FDIC is monitoring OneWest's performance.
Foreclosure Radar's data shows that OneWest appears to be far better at dealing with the process than far more established lenders in the state. In instances where third-party investors buy a property in foreclosure, they pay on average 10% more of the property's market value. And when OneWest takes properties back in trustee sales, it pays less to do so.
In California, O'Toole said, OneWest seems to run a far more organized operation. It is the only lender he is aware of, he said, that regularly announces its initial bid at trustee sales a week in advance, giving third-party investors the chance to do due diligence.
"By that simple act, they get much more aggressive bidding on their properties," O'Toole said.
Those results should benefit the FDIC whenever it does start paying out on its loss-sharing agreement with OneWest. (According to the agency, it still hasn't.) Yet given the bank's massive earnings this year, observers like Ely question whether the FDIC didn't overpay for the performance.
By comparison, the purchasers of BankUnited Corp., the only other FDIC private-equity deal similar in size to OneWest, have received a 25% return on equity in the seven months since taking control of the bank. The FDIC and OneWest declined to discuss the bank's performance.