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Liquidation Sale: Subprime Loans
By Tom Dyson
March 28, 2007
| "All the other banks were failing. What better time to start a bank?" |
-Andy Beal |
Andy Beal started out mowing lawns and repairing television sets. But when a new highway came through his town and displaced people from their houses, Beal moved into the relocation business... which got him interested in real estate.
As a student at Michigan State University, he started buying and selling rental properties. He bought his first house in the early 1970s with a $500 deposit, paid $65 in monthly mortgage payments, and received $119 in rent.
In 1976, Beal transferred to Baylor in Texas, but never graduated: The Dallas property market was booming, and Beal couldn't keep his mind off real estate investing.
And then, the savings-and-loan crisis hit Texas.
Savings and loans are like mom-and-pop banks that serve the local community, looking after the townspeople's money and providing loans to the local property market. The crisis struck when the Fed raised interest rates to 15% between June 1979 and March 1980, forcing S&Ls to pay out much higher interest rates on their deposits. But regulators had capped the rate increases S&Ls could apply to their mortgages, so their loan income couldn't keep up with the interest they paid to savers.
Mortgages are long-term loans. It appeared the S&Ls were going to be stuck with these bad loans for years and years. Overnight, S&Ls became the worst businesses in America... and their loan portfolios became the financial equivalent of spent plutonium rods.
In 1981 and 1982 combined, the S&L industry collectively reported almost $9 billion in losses. Worse, in mid-1982, all S&Ls combined had a negative net worth.
Congress changed the rules to help the S&Ls dig themselves out of the crisis, but the new laws just encouraged even more risky loans, even bigger losses, and a catalog of fraudulent behavior.
In 1980, 4,600 S&Ls operated around the country. By the end of 1988, 2,000 had collapsed. Politicians' heads had rolled, high-profile businessmen had gone to jail, and the taxpayer had shelled out $125 billion to rescue the economy from the catastrophe that surely would have followed.
While everyone else was busy looking for scapegoats, Andy Beal saw incredible opportunity. "If everybody else is going broke, that simply means your competition is going away," Beal explained.
The best investors love crises because they always create deep value investments. And deep value investments have less downside risk and more upside potential than any other financial opportunity in existence.
In 1988, at the age of 35, with only $3 million, Beal formed his own bank – called Beal Bank – and started buying defaulted loans from desperate bankers. No one else had any interest, so Beal bought all the best merchandise. He paid prices that were so low they should have been illegal. "He cherry-picked and bought the good assets and bought them at the lowest price," says a fellow banker. "It was brilliant."
Within eight years, Andy Beal was a multimillionaire, and Beal Bank was among the most profitable banks in Texas.
Right now, the subprime-lending industry is in the grips of an S&L-style crisis.
When the crash hit, the bankers panicked and cancelled their credit lines with the subprime lenders... with absolutely no regard to the quality of the lenders' management. To meet these margin calls, the surviving subprime lenders had to liquidate their portfolios in a hurry... or seek bankruptcy protection.
From Bloomberg, published 10 days ago:
"Accredited Home Lenders Holding Co., a U.S. provider of loans to people with poor credit, agreed to sell $2.7 billion of mortgages to pay back creditors that had demanded cash to protect them from the loans' falling value.
"The mortgages will be sold at a 'substantial discount' to alleviate pressure from margin calls."
In other words, subprime loans have become the most hated assets in America... just like the S&L loans in the 1980s. I don't know if Andy Beal's snapping them up – he's more interested in private space tourism and math theorems these days – but I can say this:
Someone's going to make a killing off these loans.
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