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Invest in a Bad-Mortgage IPO? Look Who's Running the Firm

PennyMac is preparing to go public to raise $400 million to help it buy portfolios of bad mortgages. Twenty million shares are expected to price today at $20 a share, higher than previous estimates, and start trading tomorrow under the ticker PMT.

A home is advertised for sale at a foreclosure auction in Pasadena, California.
Reed Saxon
A home is advertised for sale at a foreclosure auction in Pasadena, California.

Why would anyone want to invest in bad mortgages?

Because the company, formed last year by a group of former Countrywide executives, is run by people who know more about mortgages than anyone else.

PennyMac has already raised enough private capital to buy at least $800 million in risky loans. The largest loan portfolio so far came from the FDIC, which retained some of the risk, after selling PennyMac bad loans from First National Bank of Nevada after that bank failed.

CEO Stanford Kurland told CNBC in January that the loans in that portfolio were mostly subprime and Alt-A, bought at a discount of between 30 cents and 50 cents on the dollar.

"Our ability to buy the loans at the discount is what gives us the ability to work aggressively with the borrower in terms of reducing their payment," Kurland said at the time.

Company officials are currently not speaking during this quiet period, but the IPO's prospectus says that PennyMac's objective "is to provide attractive risk-adjusted returns to our investors over the long-term, primarily through dividends and secondarily through capital appreciation."

The company hopes to do that by reworking each loan individually, reducing payments usually through lower interest rates, but occasionally by reducing principal. And, if necessary, Kurland has said the company will liquidate the loan and take possession of the house.

Expected returns are very attractive. The company's roadshow has reportedly told potential investors that its business model could have annual returns of 18 percent to 25 percent, before fees. Five percent of the shares are going to PennyMac executives and its two initial investors, BlackRock and Highfields Capital Investments.

How long can the business model last? Kurland said in January that he expects home prices to bottom out by the end of this year.

"We're prepared, in terms of our opportunities funds, to work through these mortgages through a five to eight year kind of period."

After that, he says the company is in the process of being licensed in all 50 states to start originating mortgages, returning to Kurland's roots at Countrywide.

Some have been critical of PennyMac and Kurland for trying to profit from a mortgage mess Countrywide helped create.

"I don't like to spend a lot of time going through the history," he said. "I had a successful and long career in mortgage lending, and basically built a company from nothing to a very sizable player and the largest mortgage lender and servicer. I left Country in 2006, and much of the things that you're criticizing, or that people criticize, occurred quite a ways after I left."

Investors will judge whether Kurland's new venture is the perfect bet for these interesting times — a formula which both helps people stay in their homes and also rewards investors who take over those mortgages at a steep discount.

Not only has the FDIC been interested in offloading troubled loans to PennyMac, Kurland has said that other banks which don't have the resources to service and modify these loans may be interested in getting rid of them at a loss. Just this month PennyMac was hired to service $2 billion in troubled loans held by AIG.

"Everyone at PennyMac is very encouraged and interested in helping people maintain home ownership," Kurland said in January. "At the same time, we have to bring in capital to invest in these mortgages, and we think that we can marry the capital to the operational activities that will enhance investments for our investors, while at the same time improve the likelihood that borrowers will be able to maintain the home ownership."

To see large portions of CNBC's interview with CEO Stanford Kurland last January, click here.

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