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July 8, 2019 − Stearns Holdings, LLC and six affiliated Debtors (together, "Stearns" or the "Debtors") filed for Chapter 11 protection with the U.S. Bankruptcy Court in the Southern District of New York, lead case number 19-12226. The Debtors, a leading provider of residential mortgage lending services in Wholesale, Retail and Strategic Alliances sectors, are controlled by Blackstone's private equity group (70% holding) and are represented by Jay M. Goffman of Skadden, Arps, Slate, Meagher & Flom LLP. Further board-authorized engagements include (i) PJT Partners as financial advisor, (ii) Alvarez & Marsal as restructuring advisor and (iii) Prime Clerk as claims agent.
The Company’s petition notes between 200 and 1,000 creditors; estimated assets between $1.0bn and $10.0bn; and estimated liabilities between $1.0bn and $10.0bn. Documents filed with the Court list the Debtors' three largest unsecured creditors as (i) Wilmington Trust, National Association as Indenture Trustee ($189.8mn of Senior Secured Notes due 2020, the "Notes"), (ii) Thoroughbred Capital Advisors, LLC ($9.4mn trade debt) and (iii) Loan Care Servicing Center, Inc. ($1.1mn trade debt).
In a press release announcing the filing, the Stearns advised “that it has reached an agreement with its majority equity holder, funds affiliated with Blackstone (‘Blackstone,’ NYSE: BX), on the terms of a comprehensive financial restructuring plan….Through this restructuring, Blackstone has agreed to serve as plan sponsor and contribute substantial new capital to Stearns in return for acquiring substantially all of the ownership of the Company. The Company will also have the opportunity to consider proposals from any third party that chooses to offer even more value to the Company. Blackstone has been an investor in Stearns since August 2015, when funds managed by the private equity group of Blackstone acquired a majority stake in Stearns Holdings. The company’s debt, which would be restructured through this process, was in place prior to Blackstone’s investment.
In conjunction with the restructuring, Blackstone has pledged $60 million in new money investment in its role as plan sponsor and has committed to provide up to $35 million in 'debtor in possession' financing. Upon approval by the Bankruptcy Court, this financing, combined with cash generated from the Company’s ongoing operations, will be available as needed to support the business during the court-supervised restructuring process. Additionally, as of July 8, 2019, Stearns has secured firm commitments of $1.5 billion from its warehouse providers. Blackstone will provide warehouse lenders with a limited first-loss guarantee."
Chapter 11 Objectives
In simple terms, the Debtors want to shake themselves free of Pacific Investment Management Company LLC (“PIMCO”) and avoid liquidation. As discussed further below in "Events Leading to the Chapter 11 Filing," the Debtors insist that they have been chased into bankruptcy by PIMCO which owns approximately 67% of the outstanding principal balance of the Notes and which has deliberately leveraged the fragile nature of their relationship with warehouse lenders and repeatedly raised the spectre of liquidation; driving the Debtors into a corner from which the only plausible escape was bankruptcy.
In May 2019, the Debtors committed to repurchase $42.0mn of the Notes held by PIMCO prior to July 15, 2019. The Debtors were not, however, able to access the funds necessary to make that repurchase or otherwise come to an arrangement with PIMCO in advance of that July 15th deadline. Their failure to do so precipitated a panic amongst their warehouse lenders, without whose support the Debtors cannot continue to operate.
These Chapter 11 filings are intended to enable the Debtors to make good on their PIMCO obligations without losing control of their restructuring process or facing a compelled liquidation. The Smith Declaration (defined below) states: "…Blackstone has agreed to serve as plan sponsor. In that role, Blackstone has agreed to inject an amount equal to $60 million in cash into the Debtors, all of which is earmarked to cash out the notes. Under the plan, the reorganized enterprise will assume all obligations to the agencies, including Fannie Mae, Freddie Mac and Ginnie Mae, and to the Debtors’ other investors.
The Debtors and Blackstone are prepared to subject Blackstone’s proposal to a market test. To that end, the Debtors have also filed concurrently herewith a motion to establish procedures by which other interested parties can bid on the opportunity to serve as plan sponsor in place of Blackstone. Via this process, the market will establish the 'indubitable equivalence' of the secured component of the noteholders’ claims. Under the procedures, all bids must be in cash–including any bid from the noteholders–and all bidders must assume all obligations to the agencies and investors. No one, including the noteholders, will be allowed to credit bid. Blackstone will receive no break-up fee for serving as stalking horse plan sponsor."
Prepetition Capital Structure
The Notes: On August 8, 2013, Debtor Stearns Holdings sold $250.0mn in 9.375% senior secured notes due August 15, 2020. Pursuant to the indenture governing the Notes, the proceeds from the sale of mortgage servicing rights (“MSRs”) can be used, inter alia, for repayment of debt and on May 24, 2019, the Debtors offered to repurchase $42.0mn of Notes from PIMCO using proceeds from the sale of MSRs. A commitment that the Debtors failed to honor. As at the Petition date, approximately $183.0mn of Notes were outstanding.
Warehouse Lending: The Debtors finance their mortgage origination business through warehouse lending facilities which are structured as repurchase agreements. The Debtors have four repurchase agreements with four lending institutions: (i) Bank of America, N.A., (ii) Texas Capital Bank, National Association, (iii) Wells Fargo Bank, N.A., and (iv) Barclays Bank PLC (each a “Prepetition Repo Facility” and, collectively, the “Prepetition Repo Facilities”). Pursuant to the terms of these Prepetition Repo Facilities, the Debtors sell newly originated mortgage loans to the counterparty to finance the originations of the loans, and typically repurchase the loans within 30 days of origination when the Debtors sell the loans to Fannie Mae, Freddie Mac, Ginnie Mae or other purchasers. The Debtors obtain advances of less than 100% of the principal balance of the mortgage loans from the warehouse lenders, which requires the Debtors to use working capital to fund the remaining portion of the principal balance of the mortgage loans (referred to as “haircut”). The amount of the advances provided under each Prepetition Repo Facility range from 92.5% to 99% of the principal balance of agency-eligible mortgage loans. Prior to the Petition date, there was $1.1bn of collective availability under the Prepetition Repo Facilities.
Events Leading to the Chapter 11 Filing
In a declaration in support of the Chapter 11 filing (the “Smith Declaration”), Stephen Smith, the Debtors' President and Chief Financial Officer detailed the events leading to Stearns' Chapter 11 filing. Although the Debtors' predicament is clearly the confluence of several factors, principally rising interest rates, pressure from the Debtors' warehouse lenders and the looming July 15th obligation to repurchase Notes from PIMCO, it is PIMCO that feels the visceral wrath of the Debtors who accuse PIMCO of unduly trying to leverage the Debtors' liquidity problems and of playing hide-the-ball in terms of any acceptable (to PIMCO) resolution of the Debtors' tightening liquidity woes.
The Smith Declaration begins: "The mortgage origination business is significantly impacted by interest rate trends. In mid-2016, the 10-year Treasury was 1.60%. Following the U.S. presidential election, it rose to a range of 2.30% to 2.45% and maintained that range throughout 2017. The 10-year Treasury rate increased to over 3.0% for most of 2018. The rise in rates during this time period reduced the overall size of the mortgage market, increasing competition and significantly reducing market revenues.
During this time period, the Debtors’ warehouse lenders nonetheless began to express concerns about the impact of the market contraction on overall financial results and, more importantly, the upcoming maturity of the senior secured notes –August of 2020 –and the fact that the Debtors were obligated to use $42 million of the proceeds from their MSR portfolio sale to tender for the notes in May 2019, which would put pressure on the Debtors’ liquidity.
The warehouse facilities obviously are essential to the Debtors’ operations, so the Debtors resolved to take the steps necessary to restructure their balance sheet, including the terms of the senior secured notes.
Approximately seven months ago, in November 2018, the Debtors approached representatives of PIMCO, by far the largest holder of the notes, in an effort to engage on restructuring alternatives. The Debtors initially proposed a partial paydown and extension of the maturity of the notes and relief from the $42 million tender requirement, both of which were the focus of the warehouse lenders’ concerns. However, PIMCO rejected this proposal out of hand. It said that it would consider only two alternatives: either the Blackstone funds inject $50 million of new capital into the company, behind the notes, as a condition of a maturity extension, or, failing that, PIMCO would insist on being given ownership of the entire business. Those were not acceptable alternatives to the Debtors or Blackstone. They nonetheless developed further proposals for PIMCO, but PIMCO refused to consider anything other than the two alternatives described above.
During this time period, the Debtors continued to work with their warehouse lenders in an effort to maintain access to their warehouse lines. But certain of the warehouse lenders expressed growing concern at the passage of time and the lack of a solution to the company’s balance sheet and potential impact to future liquidity if the tender payments were made. Warehouse lenders began reducing advance rates, increasing required collateral accounts and increasing liquidity covenants, further contracting available working capital necessary to operate the business. Eventually, two of the warehouse lenders advised the Debtors that they were prepared to wind down their respective warehouse facilities unless the Debtors and PIMCO agreed in principle to a deleveraging transaction by June 7, 2019. That did not happen. As a result, one warehouse lender terminated its facility effective June 28, 2019 and a second advised that it will no longer allow new advances effective July 15, 2019. The Debtors feared that these actions would trigger other warehouse lenders to take similar actions, significantly impacting the Debtors’ ability to fund loans and restricting liquidity, thereby jeopardizing the Debtors’ ability to operate their franchise as a going concern.
Negotiations with PIMCO
The Smith Declaration proceeds with a blow-by-blow recounting of (in Smith's telling) efforts by Blackstone and the Debtors to get PIMCO happy with any solution short of liquidation, efforts which the Debtors claim were met with a failure to meaningfully engage and an ever-changing set of PIMCO demands.
"In light of the foregoing, the Debtors and their advisors worked with Blackstone to develop new restructuring alternatives consistent with PIMCO’s demands. To that end, the company made a detailed proposal to PIMCO which would have transferred the majority of the equity in the enterprise to holders of the notes. The noteholders would have acquired control of the company’s board of directors under this proposal. Both Blackstone and Stearns were ready, willing and able to enhance the proposal in any negotiations in order to effect an orderly transition of control to the noteholders via an out-of-court exchange offer. A week later, however, PIMCO surprised the Debtors and Blackstone by stating that its funds refused to take ownership of the company, despite previously having insisted on being given the keys.
PIMCO’s advisors told the Debtors’ advisors that PIMCO and its funds would accept one of two completely different alternatives. First, they said they would consider an offer by Blackstone to cash out the notes. Second, and as an alternative, PIMCO’s advisors said that the noteholders would instead insist that the Debtors liquidate the business, which would have resulted in the firing of all of the Debtors’ employees, termination of all operations, and piecemeal sale of their assets as part of a company-wide liquidation. PIMCO told the Debtors and their advisors this one week before the June 7, 2019 deadline established by the warehouse lenders. Needless to say, the liquidation alternative was completely and totally unacceptable to the Debtors and Blackstone. Indeed, PIMCO’s about-face from its previous insistence on being handed the equity put the Debtors in a highly untenable position viz. its warehouse lenders and their rapidly approaching deadline.
The Debtors and Blackstone and their advisors nonetheless scrambled to respond. They were not about to agree to the notion of an immediate, value destructive liquidation. Accordingly, Blackstone developed a proposal to cash out the noteholders at a discount to face. To support this proposal, the Debtors and their advisors prepared a liquidation analysis which demonstrated the likely consequences of closure of the enterprise: noteholder recoveries unsurprisingly would be very severely and negatively impacted in such a scenario. PIMCO’s advisors probed the Debtors’ liquidation analysis and challenged certain assumptions–without offering any detailed analysis of their own. Two days later–on June 6, 2019–the noteholders radically changed course yet again.
The noteholders did not offer a counter to Blackstone’s cash-out offer. They simply said it was not acceptable. They instead reverted back to a demand they had made in November 2018, seven months previously: they insisted that Blackstone make a significant equity infusion into the Debtors behind the full face amount of the notes in exchange for a two-year maturity extension. The noteholders also insisted that the tender for $42 million of their notes go forward, despite the destabilizing impact to the Debtors’ liquidity. The noteholders further said that if this demand was not met, then the noteholders would insist that the company liquidate promptly, which would result in loss of employment for 2,700 employees and termination of all operations. The noteholders said they would provide some form of limited backstop to the warehouse lenders so the liquidation would be more controlled, but in the Debtors’view, any such backstop would have been very difficult to achieve.
The Debtors and Blackstone determined not to respond to these completely unacceptable and outrageous demands. With only a month to go before the $42 million tender deadline, the Debtors and Blackstone therefore worked at a breakneck pace to develop a plan to restructure the Debtors’ affairs in a manner that will preserve the Debtors as a going concern, thereby preserving the jobs of 2,700 employees and maximizing value for all the Debtors’ stakeholders. And they are going to do it with overwhelming support from Blackstone.
About the Debtors
The Debtors are a leading, private, independent mortgage company that originates residential mortgage loans through its national platform. The company is the 20th largest mortgage lender in the United States, and has maintained disciplined lending standards with a focus on high credit standards and mortgage loan quality. The Debtors employ approximately 2,700 people, including employees of their joint ventures and preferred partners. They originate loans in 50 states.
The primary source of the Debtors’ revenue is mortgage loan production, which generates income primarily through gains upon the sale of mortgage loans. The Debtors’ primary production channels are wholesale, retail, joint venture, and preferred partner. The wholesale channel consists of mortgage loans that are sourced and submitted to the Debtors by independent mortgage brokers on behalf of borrowers. The retail channel originates mortgage loans directly with borrowers through over 100 branch offices nationwide. The joint venture channel is comprised of nine joint ventures. The Debtors own 47.5% of the interests in one of them; they own 50% of the interests in all the others.
The preferred partner channel consists of two independent mortgage banks. The Debtors own 50.8% of the interests in one of the preferred partners, and 51% of the interests in the other. During the twelve months ended December 31, 2018, the wholesale, retail, joint venture and preferred partner channels represented 55%, 14%, 27% and 1% of the Debtors’ mortgage loan production, respectively.
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