The Subprime Money Behind a Winning Horse

When his colt I’ll Have Another charged from behind to win the Preakness Stakes on May 19, J. Paul Reddam joined an exclusive club of thoroughbred owners who’ve been one race short of the Triple Crown. Not far from the Baltimore track, Maryland state regulators were probing the consumer loan business that helps fund Reddam’s wildly successful investment in horses.

Reddam, 56, a former philosophy professor, made his fortune with a subprime mortgage firm, DiTech Funding, which he sold to General Motors (GM) in 1999 for more than $240 million. He is now owner and chief executive officer of CashCall, which makes mortgage and short-term loans. The Anaheim (Calif.)-based company has tangled with three states over alleged violations of consumer protection laws.

West Virginia officials, among the company’s most persistent critics, allege in a civil lawsuit that CashCall violated state usury rules by using a front company to charge annual interest as high as 99 percent and engaging in abusive debt-collection practices. “CashCall created a business model intended to fly under the protective radar of West Virginia laws,” Attorney General Darrell McGraw said in a 2008 press release when the suit was filed. The case went to trial in October, and the judge has yet to render a verdict. CashCall said in legal filings that its business in West Virginia was legal under federal law and is making a similar argument in Maryland.

CashCall paid $1 million in August 2009, without admitting or denying wrongdoing, to settle claims by California that its practices included making excessive calls to borrowers demanding repayment at work and at odd hours. Maryland, which last year proposed banning the lender from offering mortgages because of a licensing violation, also brought a 2009 action against CashCall that resulted in a $5.7 million fine from an administrative judge. The fine is on hold pending an appeal in an unrelated case that involves a similar issue of law.

Reddam, whose racing team is preparing I’ll Have Another for the final leg of the Triple Crown, the Belmont Stakes in New York on June 9, has CashCall emblazoned on his jockey’s silks. He blames the firm’s legal problems on the confusing patchwork of state regulations. “Everybody has a different idea of what should and should not be done, and what’s OK in each state,” he says.

Reddam worked for several mortgage lenders before founding DiTech in 1995. He sold DiTech to GMAC Mortgage, a subsidiary of General Motors that became Ally Financial after its parent company’s bankruptcy in 2009. DiTech became part of Ally subsidiary Residential Capital, which because of subprime mortgage losses was “a millstone around the company’s neck,” Ally CEO Michael Carpenter said in 2010. The subsidiary filed for bankruptcy on May 14, days before the Preakness.

Like DiTech, CashCall advertises widely to drive traffic to its website. An early pitchman was the late Gary Coleman, who starred in the 1980s TV series Diff’rent Strokes. CashCall is on pace to originate $9 billion in mortgages this year, Reddam says. Besides mortgages, the firm makes unsecured loans in amounts of as much as $25,000, according to its website. That part of the business amounted to about $180 million in loans last year, he says.

In an example of a loan on its website, CashCall says it could offer a borrower $2,525 to be paid back in 47 installments at an annual interest rate of 184 percent. The high demand for the loans, Reddam says, demonstrates that his businesses are filling an important gap in consumer finance. “The banking industry is missing this entirely,” he says. “There is a tremendous need for people to borrow a few thousand dollars to help them over whatever crisis they are having, and the banks are not serving that need, and they should.”

The bottom line: Reddam has faced regulatory actions in three states over his finance business, which made $180 million in unsecured loans last year.

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Goldman Closes the Door on Subprime

By Karen Weise and Christine Harper

When Goldman Sachs (GS) bought Litton Loan Servicing, a firm that collects mortgage payments from homeowners, in 2007 for an unannounced price, it seemed like a simple way to get an on-the-ground view of the subprime market. The insight would help Goldman Sachs figure out how much to pay for loans, and Litton would work with borrowers to get them back on track. Other sophisticated investors, including billionaire Wilbur L. Ross and private equity firm Centerbridge Capital Partners, bought mortgage servicers with a similar strategy in mind.

It didn't work out as planned. While there were plenty of distressed mortgages and lots of eager buyers, the loan holders had little incentive to mark down prices because that would mean taking a big loss on their books. "The distressed-asset market never got as hot as people were hoping it would," says Dean H. DeMeritte, an executive vice-president at Phoenix Capital, a Denver brokerage for mortgage servicing contracts.

On June 6, Goldman Sachs agreed to sell Litton to another mortgage servicer, Ocwen Financial (OCN), for $263.7 million. The sale comes two months after Goldman Sachs wrote down the value of the business by about $200 million. "It really makes sense for them to sell it," says David B. Hilder, an analyst at Susquehanna Financial Group. "They bought it at a time when the business was easier, and it looked like there might be some insights to be gained in the mortgage market from having a servicer." Neither Goldman Sachs nor Litton would comment.

Founded in 1988 by Larry B. Litton Sr. in Houston, Litton was one of the first mortgage servicers to specialize in working with troubled loans, sometimes called "scratch and dent" servicing. It developed that skill during the savings and loan crisis, when it was hired by Resolution Trust Corp. to handle mortgages that were orphaned by failed banks.

Larry Litton Jr., who now runs the company, is known in the industry for his Texas drawl, straight talk, and vocal support for working with struggling borrowers before they get too far behind. Bruce A. Gottschall, the founder of Neighborhood Housing Services of Chicago, a nonprofit that worked with Litton a decade ago, says the company "seemed to me a little bit more flexible in terms of modifications early on." Litton Jr. currently is a member of the Federal Reserve's Consumer Advisory Council, where he has been vocal about foreclosure prevention. Ocwen would not comment on whether he will stay with the company after the sale.

Litton's business grew with the subprime market. In 1995 it serviced $1.2 billion in loans, according to Fitch Ratings. By 2007 its portfolio had ballooned to almost $54 billion; it's about $41.2 billion today. As the boom gave way to the bust, Litton was forced to hire more staff to deal with rising defaults. The company became the target of class actions alleging excessive fees and violations of consumer-protection laws as well as investigations by state and federal regulators. It has agreed to settle at least one of the lawsuits while denying liability; others are pending. It says it is cooperating with government investigations. Goldman Sachs will remain liable for fines and penalties that could be imposed by government authorities relating to Litton's foreclosure and servicing practices before the deal closes.

With the Litton sale, Goldman Sachs will no longer deal directly with homeowners. Gottschall says Goldman's unloading the mortgage servicer is part of a bigger trend: "Wall Street is probably trying to distance themselves from the problems they caused."

The bottom line: By selling Litton Loan Servicing, Goldman Sachs is out of the messy business of working with distressed homeowners.

Weise is a reporter for Bloomberg Businessweek. Harper is a reporter for Bloomberg News.

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