Sunday, July 3, 2016

The less than benign effects of PE investments

Fascinating investigative report in the Times on the increasing role of private equity firms in the delivery of essential public services, especially emergency services, in the US since 2008. It documents the problems faced by ambulance service providers TransCare and Metro/Rural whose promoters aggressive cost cutting, revenues increasing, and financial efficiency driven strategies  not only led to their bankruptcies but also seriously compromised emergency services. It writes,
Unlike other for-profit companies, which often have years of experience making a product or offering a service, private equity’s primary expertise is in making money. And in many of these businesses, The Times found, private equity firms applied a sophisticated moneymaking playbook: a mix of cost cuts, price increases, lobbying and litigation. In emergency care and firefighting, this approach creates a fundamental tension: the push to turn a profit while caring for people in their most vulnerable moments. For governments and their citizens, the effects have often been dire. Under private equity ownership, some ambulance response times worsened, heart monitors failed and companies slid into bankruptcy... Private equity gained new power and responsibility as a direct result of the 2008 crisis. As cities and towns nationwide struggled to pay for basics like public infrastructure and ambulance services, private equity stepped in... Since the 2008 financial crisis, private equity firms have gone from managing $1 trillion to managing $4.3 trillion — more than the value of Germany’s gross domestic product — according to the advisory firm Triago. Retirement nest eggs are fueling the growth and sharing in private equity’s risks and returns: Nearly half of private equity’s invested assets come from pensions...
Warburg Pincus, Kohlberg Kravis Roberts & Company, and other major private equity firms have invested in emergency services, a business that routinely holds the lives of customers in its hands. While this represents one small corner of private equity, which traditionally used debt to seize underperforming companies, it captures the industry’s newfound pervasiveness. K.K.R. — a firm memorialized in “Barbarians at the Gate,” a book that chronicled a defining 1980s Wall Street deal — also invested in public water services. Blackstone is now America’s largest landlord of rental houses. And in the mortgage industry, until recently the province of banks, the Fortress Investment Group controls a huge bill collector.
Another article documents similar problems in the housing market by tracking the activities of three of the dozen or so largest PE firms. Their entry was facilitated in the aftermath of the sub-prime crisis when the Federal government agencies sold tens of thousands of discounted mortgages to PE investors, with limited safeguards and protections for homeowners. Further, big banks and regional lenders too pulled back after regulatory backlash for aggressive foreclosures. The PE firms that swept into that space, mopping these houses up as another one of their distressed assets, applied their standard industry practices on individual homeowners, with less than benign consequences. The Times writes,
The rising importance of private equity in the housing market is one of the most consequential transformations of the post-crisis American financial landscape. A home, after all, is the single largest investment most families will ever make. Private equity firms, and the mortgage companies they own, face less oversight than the banks. And yet they are the cleanup crew for the worst housing crisis since the Great Depression...

Lone Star Funds’ mortgage operation has aggressively pushed thousands of homeowners toward foreclosure, according to housing data, interviews with borrowers and records obtained through a Freedom of Information request. Lone Star ranks among the country’s biggest buyers of delinquent mortgages from the government and banks. Nationstar Mortgage, which leaped over big banks to become the fourth-largest collector of mortgage bills, repeatedly lost loan files and failed to detect errors in other documents. These mistakes, according to confidential regulatory records from a 2014 examination, put “borrowers at significant risk of servicing and foreclosure abuses.” Unlike the banks, Nationstar wears many hats at once: mortgage bill collector, auction house for foreclosed homes and lender to new borrowers. By working every angle, and collecting fees at each step, the company faces potential conflicts of interest that enable it to make money on what is otherwise a costly foreclosure process.
In the rental market, The Times found, other big private equity firms largely bypassed the nation’s poorest neighborhoods as they scooped up and renovated foreclosed homes across the country. Those firms include Blackstone, a huge private equity firm and the nation’s largest private landlord of rental houses. These decisions point to shortcomings of the government’s response to the housing crisis. Rather than enact sweeping changes to housing policy, the government largely handed the problems to a new set of companies.
The script that invited PE firms into the housing market has not played out as expected,
In 2012, America was still in the grips of the worst housing crisis in decades. Foreclosure signs lined the American landscape, casting a shadow on more than 3.5 million homes... And soured mortgages made by banks were weighing on the government because it had insured them against default. The government, eager to stem its own losses, decided to ramp up the sale of distressed mortgages to investors. In all, it has sold more than 100,000 soured mortgages to investors — one of the largest such series of sales. The mortgage sales enticed private equity firms like Lone Star into the mortgage market, where they saw bargains.
Housing officials reckoned that private equity firms would bring about change. For one thing, these firms were among the only investors with pockets deep enough to take on billions of dollars worth of ailing mortgages. And they could be more flexible than the banks in keeping Americans in their homes because they had bought the mortgages at steep discounts. But instead of showing greater flexibility, Lone Star — much like the banks before it — has often remained rigid about modifying mortgages. And in some cases it has moved quickly to foreclose, taking possession of homes to sell them, according to dozens of court proceedings, as well as interviews with borrowers and housing advocates.
Further, as Rana Faroohar has written in her recent book, the concentrated entry (into a few markets) of PE firms may have forced up property prices in those areas, a fact reflected in the continuing decline in share of Americans who call themselves homeowners, and spawning a widening inequality in the market,
PE investors have become the single largest group of buyers in the residential housing market, purchasing $20 bn worth of steeply discounted properties between 2012 and 2014 alone and reaping huge rewards as housing prices have slowly risen from their troughs. Blackstone, the biggest PE firm, with more than $330 bn in assets under management, has become the richest investor landlord in the country, with a portfolio of 46,000 homes and other properties that generated $1.9 bn worth of income in 2014, making real estate the largest profit center for the firm... One study of the housing market in cities and towns across America found that the top 10% richest markets, ranked by the aggregate value of owner-occupied homes, held 52% of total housing wealth, equivalent to nearly $4.4 trillion. The bottom 40%, by contrast, held only 8%. It's a stark statement about who has profited, and who hasn't, from the housing recovery. 
The causal chain has played perfectly to script. As the flush of institutional money has raised property prices, housing has become unaffordable for an increasing number, who have sought to rent than own, thereby forcing up rents, and increasing the profitability of PE investments,
Not since 1986 have fewer rental properties been empty in the US, and rents are rising sharply in many cities as a result. According to Harvard's Joint Center for Housing Studies, the share of moderately to severely cost-burdened renters (meaning those who pay at least 30% of their income in rent) grew to represent half of all American renters in 2013, up from 38% in 2000. "We get losts of people coming to us saying, we wanted to own, but all the affordable properties have been bought up, so now, we're renting from Blackstone for more than the price of a mortgage," says Atlanta-based Tony Romano, the organizing director for the nonprofit Right to the City alliance , which has produced a number of studies on the consequences of PE moving into the housing market. 
Update 1 (02.08.2016)
Times has this excellent interactive graphic on the increasing role of PE firm's in American lives.

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