Lone Star Funds – Distressed Investors or Vultures?

Distressed investing is the politically correct term these days for buyers of distressed properties.  There will always be property owners that find themselves in over their heads. Sometimes their problems arise from unforeseen market events and at other times, it is just from being inexperienced or undercapitalized.


One’s man’s problem property is often another man’s treasure. Vulture funds and distressed investors seek out properties that are performing poorly and try to buy them on the cheap. It’s the way a free market economy works.


Some call distressed investors “vultures,” while others call them grave robbers. Back in the early days of the industrial revolution, these folks were often both revered and reviled as robber barons.


And then there is John Grayken and his billion-dollar Lone Star Funds. In our opinion, Lone Star is the most reviled distressed investor in the nation.


We certainly don’t begrudge successful businesses. And Lone Star is certainly successful. Forbes says that Lone Star Funds has amassed $70 billion in assets since 1995. Even more impressive, the company’s 15 funds have shown average annual net returns of 20% and never had a down year. Even Bernie Madoff couldn’t make those claims and Madoff was a fraud.


So how did Lone Star Funds become so successful? In our opinion, through dubious business practices. Making money the honest way is noble. Cheating borrowers and property owners is not.


Lone Star Funds have become such a dominant player that few property owners are willing to stand up and fight. There are a few commercial borrowers and mortgage holders willing to do so. Residential borrowers who have seen their loans purchased by a Lone Star fund are in for a truly difficult struggle.


Lone Star Funds Residential Mortgages and Regulators


The biggest regulatory challenge to Lone Star Funds to date has been from New York State. In October of 2015, the New York Attorney General announced it was investigating the company’s residential mortgage servicing company, Caliber Home Loans.


Most of the consumer complaints against Caliber appear to center on aggressive foreclosure practices and their proprietary in-house loan modifications. Caliber’s loan mods often involve giving homeowners a 5-year modification with reduced payments. Some homeowners claimed they were surprised on the 6th year when they learned that the difference between the reduced payments and full payment and interest was simply deferred and all became due at once.


Caliber figured out how to buy distressed properties at a steep discount, get borrowers to start making payments and still take the property, albeit in 5 years when it becomes worth more. From a purely business standpoint, some would call the move brilliant. For homeowners, it is cold and callous. These folks didn’t get a permanent solution, just a short term Band-Aid with a nasty surprise on the 61st months.


In 2016, the media announced that New York’s investigation of Lone Star Funds and Caliber Home Loans was expanding. That investigation still centered on residential borrowing and foreclosure practices, however.


Lone Star Funds and Commercial / CMBS Loans


In our opinion, Lone Star saves it most aggressive tactics for the commercial and CMBS arena.


Having litigated several cases against individual funds or loan pools controlled by Lone Star Funds, we have a unique insight into the how the company behaves with commercial borrowers.


Lone Star, and its Grayken owned asset manager Hudson Advisors, typically make an early assessment as to the financials on both the distressed property and its owners. If the property has equity, Lone Star will devise a strategy to deplete as much equity as possible from the property in the forms of fees and charges.


Only when all the reserves have been depleted and all the equity stripped will Lone Star try to take the property. Ironically, that gives owners of upside down properties more leverage than a property owner that has never missed a payment yet finds itself in a nonmonetary or technical default.


Commercial loan documents give lenders and servicers tremendous power. Most borrowers never look at the forms that come with commercial and CMBS funded loans. The pooling and servicing agreement itself may be 600 or more pages.


Often buried in those documents are provisions that let the noteholder accelerate a loan if a tenant leaves, if certain asset rations fall below a specified percentage or even if the noteholder feels uncomfortable.


How do noteholders get away with this? There are two primary reasons.


First companies like Lone Star Funds are not banks. They don’t have to answer to the alphabet soup of regulators like banks. Although the Office of the Comptroller of the Currency claims it can reach commercial loan servicers like Lone Star Funds, they don’t.


The other reasons that companies like Lone Star get away with so much is that courts typically allow commercial borrowers and lenders more leeway in what they can negotiate. The problem, of course, is that borrowers never read all the loan documents. Another problem occurs when a company like Lone Star acquires loans from a third party. You may have entered into a contract with U.S. Bank, for example, but suddenly one day you receive a notice indicating your loan was purchased by a Lone Star Funds fund.


We have even seen another interesting dynamic. Many property owners don’t know they are dealing with Lone Star until they have lost many months and millions in equity. Why? Lone Star Funds often go by other names. This is especially true when the actual noteholder is a CMBS trust.


Lone Star Funds have dozens of affiliates. The individual notes or loan servicer is often a company that begins with the letters “LSREF.” The names Lone Star Funds, Hudson Advisors and John Grayken may set off alarm bells with certain lawyers and property owners, many others are not concerned when they receive a document from a company called LSREF2 Chalk or LSREF Wight Limited LLC.


Once an investor receives a default notice from their servicer, it becomes imperative to find experienced counsel immediately. We all want to avoid lawyers and litigation. (We get it!) But cooperate too long with a company like Lone Star and suddenly you will find many months have elapsed with default interest and various fees compounding daily.


Unsuspecting borrowers also run the risk of signing an innocuous titled document called a prenegotiation agreement or PNA. Servicers claim this is a necessary first step before that allows both sides to speak freely and not have their negotiations later used in court. While technically accurate, the pre-negotiation agreements that we have seen also often contain a one-sided waiver clause in which the borrowers waive all they claims they may have against the noteholder or servicer. Sign that and your case becomes extremely difficult to win.


Need more information? Contact Attorney Chris Katers at [hidden email] or call 877.858.8018. The author of this post, attorney Brian Mahany, can be reached at [hidden email]. You can also read our CMBS modification and refinance page for more information on CMBS type loans. 


MahanyLaw and Judge, Lang & Katers – We Sue Servicers!


*PLEASE NOTE: We are unable to take individual residential mortgage cases. Our practice is limited to commercial and CMBS loans with a value of $5 million or more.

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