Meet the New King of Subprime LendingFortress Investment’s Wesley Edens turns $124 million into $3.5 billion; ‘it’s not a bad thing’
By Gregory Zuckerman
Aug. 10, 2015 10:34 p.m. ET
http://www.wsj.com/articles/meet-the-new-king-of-subprime-lending-1439260441 Wesley Edens still rues his decision not to bet against subprime mortgages before the financial crisis. That left Fortress Investment Group LLC, the private-equity and hedge-fund firm where he is co-founder and co-chairman, exposed to big losses that sank its stock price below $1.
On Wall Street, the best way to get over a losing trade is to bounce back with a winner. Mr. Edens is enjoying a surprising whopper: subprime loans.
A resurgence in loans to Americans with scuffed or limited credit is giving Fortress one of the largest financial windfalls in the history of the private-equity industry.
The New York company’s majority stake in subprime lender Springleaf Holdings Inc. has ballooned in value to $3.5 billion—putting the firm’s gain at more than 27 times Fortress’s original investment of $124 million in 2010. Buying the stake was Mr. Edens’s idea.
Fortress also has turned around its $1 billion investment in Nationstar Mortgage Holdings Inc., led by Mr. Edens in 2006 but soon worthless, into $350 million in paper and actual gains. Nationstar collects payments on home loans, about 20% of which are subprime.
The 53-year-old Mr. Edens, an avid mountaineer and co-owner of the Milwaukee Bucks, has personally made about $200 million in paper profits because he is the largest individual investor in the Fortress private-equity funds that own stakes in the two companies, according to someone close to the matter.
The giant gains have helped offset recent stumbles by Fortress in its “macro” hedge-fund business—and made Mr. Edens the new subprime king.
“It’s not how I want my epitaph to read,” he says of the label, “but it’s not a shameful thing helping people finance themselves. It’s not a bad thing.”
Today’s expanding subprime-loan market is different from the last one. This boom is fueled largely by auto loans, credit cards and personal loans, which appeal to borrowers straining under the limp economic recovery and puny wage gains.
Lenders like the business partly because borrowers did a better job handling those loans during the crisis than they did with mortgages. Subprime-loan delinquencies are down sharply since 2009 and have been stable lately.
As a result, more than one-third of all auto, credit-card and personal loans from the start of January to the end of April went to subprime borrowers, according to the latest available data from credit-reporting firm Equifax Inc. That is the highest percentage since 2007.
Lenders made 53.7 million auto, credit-card and personal loans in the first four months of 2015, up 46% from 2010. Originations of personal loans, like those made by Springleaf, are up 22% in the same period.
In contrast, subprime mortgages have shrunk to 0.3% of the market for first-lien loans, typically used to buy a home. In the first half of 2015, subprime mortgages totaled just $2 billion, says Guy Cecala, publisher of trade publication Inside Mortgage Finance. The business peaked at $625 billion in 2005.
Tighter regulations have pushed many banks out of subprime mortgages and sharply limited their interest in other types of subprime loans. The “vast majority” of banks make no home-purchase loans to subprime borrowers, according to the Federal Reserve’s latest survey of senior loan officers.
The retreat has opened the door to non-banks like Fortress, which are flush with cash to invest and say they have learned the lessons of the financial crisis.
For example, online lending startup Avant Inc. has secured more than $1 billion in funding from investors such as KKR & Co., Tiger Global Management LLC and Peter Thiel, one of Facebook Inc. ’s first investors.
Mr. Edens and other Fortress executives are pushing hard to get even bigger in subprime lending. In March, Springleaf agreed to pay Citigroup Inc. about $4.25 billion in cash for the bank’s OneMain Financial unit.
A new No. 1 in U.S.
If the deal is completed, Springleaf would become the largest lender focused on subprime in the U.S., with about 2.5 million customers and 2,000 branches.
Springleaf’s subprime heft is being scrutinized by regulators. The company, based in Evansville, Ind., said last Thursday that the Justice Department has expressed “concerns” about the OneMain deal. Completion of the takeover might be delayed, according to Springleaf.
The Justice Department didn’t return a request for comment.
The news hurt Springleaf and Fortress shares, though Springleaf still is up almost 47% in the past year, compared with the Dow Jones Industrial Average’s gain of about 6.3%.
The subprime exodus by many banks could help limit the damage from the next lending downturn, especially since banks rely on deposit insurance and can get emergency cash from the Fed. But some economists are concerned that the rising clout of nonbank lenders is shifting more credit risk to companies that have been historically less-regulated than banks.
Springleaf is overseen by state officials and the four-year-old federal Consumer Financial Protection Bureau, rather than the Fed and Office of the Comptroller of the Currency, which regulate giant banks such as Bank of America Corp., Citigroup and J.P. Morgan Chase & Co.
Mr. Edens says Springleaf won’t contribute to a new subprime meltdown no matter how big it gets. The reason: Unlike lenders who sank during the financial crisis, Springleaf says it verifies each applicant’s income and won’t make the loan unless it is sure the borrower can pay it back.
“Lending to people without great credit wasn’t the problem,” he says. Instead, too many Americans got too much credit from lenders based on inflated real-estate values.
“A lot of people live paycheck to paycheck, and if they don’t have financing it’s not good for the country,” Mr. Edens adds. “This is a more humane way of people dealing with credit.”
Springleaf makes secured and unsecured personal and auto loans of as much as $25,000. All the loans have fixed interest rates. The average loan is about $4,300 and usually is repaid in 19 months. The company sees a potential market of 120 million Americans who need cash.
The average interest rate on Springleaf’s loans is 26%. Consumer advocates criticize the high rates on many subprime loans and say lenders often pile on additional fees with products such as credit insurance. Many borrowers have to get new loans to pay off old ones, consumer advocates argue.
Springleaf says high interest rates are needed because about 6% of its borrowers default each year. The lender says its refinanced loans have the same standards as the original loans.
Mr. Edens argues it is “more fiscally responsible” to borrow from Springleaf and chip away at the loan’s principal with every payment than use payday loans with annualized rates of almost 400% or high-rate credit cards with a balance that rolls over from one month to the next.
Borrowers who refinance an older loan by getting a new one from Springleaf almost always pay “lower rates than the original loans, and our refinanced loans experience much better credit performance,” says Jay Levine, the lender’s president and chief executive.
Bob Lamb, a 52-year-old seller of recreational vehicles in Loveland, Colo., says he borrows from Springleaf because it is convenient. His credit rating fell into the subprime category after a car accident forced him to miss work.
“They know who I am, [and] they’re easier to deal with than a bank,” he says. “I call up, give some updates and pick up money that afternoon.
Interest rates on loans to Mr. Lamb have varied from 12% to 16%, he says. “I wasn’t too thrilled the first time, but you pay a little higher interest rate because you’re a bigger gamble for them,” he says. Mr. Lamb says Springleaf has charged him lower interest rates as his credit score improved.
Mr. Edens, a Helena, Mont., native who grew up on a ranch and is the grandson of a homesteader, struck it rich long before the subprime rebound.
One early triumph came in the early 1990s while he was a partner at securities firm Shearson Lehman Brothers Inc. Mr. Edens and his group bought some of the assets of insolvent savings-and-loans at fire-sale prices from the government-owned Resolution Trust Corp. The investments soared in value.
He became a partner at what is now BlackRock Inc. before leaving to help start Fortress in 1998. In 2007, it became the first private-equity and hedge-fund manager to go public in the U.S. The stock sale left Mr. Edens and the firm’s four other principal partners at the time with a combined stake worth $9.7 billion.
“He likes creative investments that aren’t on the radar screens of most private-equity investors,” says John Mack, the former chief executive of Morgan Stanley and a Fortress investor.
Mr. Mack cites Mr. Edens’s early investments in cellphone towers, medical tourism, ski resorts and senior-living facilities in China.
These days, Mr. Edens and Fortress are spending $2.8 billion to build a train line between Miami and Orlando, Fla. It would be the first privately run intercity train system in the U.S. in decades, the firm says.
Mr. Edens has invested about $75 million of his own money in an effort to build a liquefied natural-gas plant in Florida.
Mr. Edens, who has climbed Grand Teton and the Matterhorn, planned to climb Mount McKinley, North America’s highest mountain, this summer until he broke his arm in a competitive horse-jumping event.
Despite his success with financial investments, Mr. Edens and his colleagues failed to short subprime loans as signs of trouble in the housing market appeared. They didn’t think a crisis was imminent and weren’t as familiar with instruments used by bears such as hedge-fund manager John Paulson.
Trounced by Paulson
In 2007, Mr. Paulson, a merger specialist, scored $15 billion of profits for his firm, Paulson & Co. Around the same time, Fortress was hammered by declines in the value of its largest private-equity investments, including subprime losses of several hundred million dollars.
“I wasn’t happy,” Mr. Edens says in an understatement. Mr. Edens, who runs Fortress’s private-equity business, vowed to profit when the subprime market turned.
In 2010, Mr. Edens led Fortress’s purchase of an 80% stake in crisis-ravaged American International Group Inc. ’s unprofitable consumer-loan unit for $124 million. Fortress renamed the operation Springleaf Financial.
The deal seemed foolish at first. Credit-ratings firms downgraded Springleaf’s debt, debtholders fled and Fortress narrowly avoided a default. Fortress then brought in new management, led by Mr. Levine, shut down underperforming branches, stopped making mortgage loans and refocused the company on unsecured loans to consumers who have limited access to cash.
Springleaf has benefited from banks’ skittishness about subprime personal loans. At the end of the second quarter, the company had 958,000 customer accounts, up 11% from a year earlier.
Now the company is expanding in auto lending and other areas, though it has no current plans to make mortgage loans. Springleaf has told investors it will target customers with FICO scores of 500 to 750, especially those with scores of less than 699. Borrowers with scores of less than about 660 are generally considered subprime.
Mr. Edens also made the deal in 2006 for Fortress’s private-equity funds to buy Nationstar for $300 million. It looked like a disaster, too. When the deal was struck, Nationstar was considered a high-quality subprime lender. Less than a year later, borrowers began defaulting in droves on their loans, the sector collapsed and Fortress’s investment was worthless. “It couldn’t have been a more poorly timed purchase,” Mr. Edens says.
Fortress shut down Nationstar’s loan-origination business and tried a new strategy to salvage something from its bet. The firm spent $700 million to transform Nationstar into a star in mortgage servicing. Loan servicers do much of the back-end work after mortgages are made.
Since then, Nationstar, based in Dallas, has gained market share from banks, many of which have retreated from the servicing business. The company went public in 2012, and its shares are up more than 29% since then.
But the loan servicer’s compliance department has ballooned to 400 employees from 40 just a few years ago amid growing regulatory scrutiny of the industry. Nationstar’s stock price has tumbled more than 40% over the past 52 weeks, though it’s still sitting on sizable gains.
Of all his pursuits, Mr. Edens says Springleaf is “the biggest home run of my career.” He says it provides a needed service despite the high interest rates and stigma often attached to subprime lending.
“Subprime is used as an invective, but a lot of people have a problem raising financing,” Mr. Edens says. “It doesn’t mean they’re bad people.”
