Challenging market conditions, liquidity concerns raised by warehouse lenders and an apparent impasse with a key noteholder led a top 20 mortgage originator to seek protection under Chapter 11 of the U.S. Bankruptcy Code on July 9.
Backed by Blackstone Group Inc's Blackstone Capital Partners VI LP private equity fund, Stearns Lending LLC, Stearns Holdings LLC and various affiliates reported $1.22 billion in total assets and $1.16 billion in liabilities in court documents filed in conjunction with the petition. The latter figure, according to a declaration by President and CFO Stephen Smith, most notably includes an outstanding balance of $183 million in 9.375% senior secured notes due Aug. 15, 2020, which became the trigger point for concerns among Stearns' warehouse lenders and, in turn, an escalating dispute with key noteholder Pacific Investment Management Co. LLC, or PIMCO.
Smith described Stearns as the No. 20 mortgage originator in the U.S. Blackstone-managed funds acquired a majority stake in the Stearns group in December 2015.
The financial challenges Stearns confronted have roots in an overall size reduction of the mortgage market and increased competition resulting from a rise in interest rates beginning in 2016. Smith said the company slashed fixed expenses in late 2017 and early 2018 to help counter the decline in origination volumes and the resulting reduction in revenues.
Smith said despite the savings, Stearns' warehouse lenders "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."
Stearns maintains warehouse facilities structured as repurchase agreements with units of Bank of America Corp., Texas Capital Bancshares Inc., Wells Fargo & Co. and Barclays PLC. Smith characterized the repo facilities as being "essential" to Stearns' operations, given their role in financing mortgage originations. The outstanding balances on the four facilities were $180.8 million with Bank of America, $147.1 million with Texas Capital, $270.4 million with Wells Fargo and $228.5 million with Barclays.
As Stearns was reducing internal expenses, it also exited its loan servicing business through a Jan. 31, 2018, agreement with Freedom Mortgage Corp. for the sale of mortgage servicing rights. Smith said the company was "obligated" to use $42 million of the expected gross proceeds of $224.6 million to tender in May 2019 for a portion of the outstanding secured notes — a situation that gave rise among the repo lenders to additional liquidity concerns.
Given the essential nature of the repo lines, the company retained outside advisers to assess strategic alternatives with an eye toward developing a debt restructuring proposal. In November 2018, Stearns brought its proposal to PIMCO, which Smith characterized as "by far the largest holder of the notes," that contemplated a partial paydown and extension of the maturity of the notes as well as relief from the $42 million tender requirement. But Smith said PIMCO "rejected this proposal out of hand" and countered with alternatives that included Blackstone's injection of $50 million of new capital into Stearns or control of the entire business. Smith said those options were "not acceptable" to Stearns or Blackstone.
S&P Global Ratings lowered its rating on the notes to CCC+ from B- in December 2018, as it would have considered the proposal rejected by PIMCO a de facto restructuring since the noteholders would have received less value than originally promised upon issuance.
As Stearns continued to strike out in efforts to negotiate with PIMCO, Smith said, the company encountered growing concern among the repo lenders about its balance sheet and liquidity challenges. Two of them served notice that they were prepared to terminate their facilities by June 7 unless PIMCO and Stearns came to terms on a deleveraging deal.
With the clocking ticking, Stearns and Blackstone proposed to transfer the majority of the equity in the company as well as control of the company's board to noteholders through an out-of-court exchange. Smith said PIMCO declined that offer and presented counterproposals that would have either led to Blackstone cashing out the notes or Stearns liquidating its business. Smith said Stearns and Blackstone found the latter option to be "completely and totally unacceptable." And while Blackstone developed a plan to cash out the notes at a discount to face value, Smith alleged that PIMCO reverted to its earlier insistence that the funds make a significant equity infusion, combined with a demand that the $42 million tender proceed.
Stearns and Blackstone opted not to respond to demands they found to be "unacceptable and outrageous," Smith said. Instead, they formulated a Chapter 11 restructuring plan that includes "overwhelming support" from Blackstone, which includes a $60 million cash infusion and $35 million in debtor-in-possession financing. The plan also incorporates commitments for post-petition warehouse facilities from Barclays and Nomura Corporate Funding Americas.
Smith argued that the plan would afford noteholders "the highest cash recovery possible" through a so-called market test, where other interested parties may bid to take Blackstone's place as sponsor, while it also provides "ample funding" for the operation of Stearns as a going concern.
"The noteholders advised the Debtors they do not want to own the enterprise," Smith alleged. "This market-tested, cash-out approach therefore will afford them what they have asked for."
Representatives of PIMCO or the noteholders as a group had not appeared in the bankruptcy case as of publication.