Practitioners of “distressed investing” are a special Wall Street breed: Bottom-fishers with steel constitutions and a penchant for rushing into fire sales. Like short-sellers, they are often despised because they prey on the weak—companies and individuals who made bad bets or got in over their heads. “Distressed investor” is a sanitised version of less flattering terms from bygone Wall Street eras: Vultures, grave dancers, robber barons.
Among the robber barons of the new millennium, few are as secretive—or as loathed or as successful—as John Grayken of Lone Star Funds. The 59-year-old debuts on the Forbes Billionaires list with a net worth of $6.3 billion, making him the second-wealthiest private equity manager in the world, behind Blackstone’s Stephen Schwarzman. Lone Star has amassed assets of $64 billion, and since its inception in 1995 its 15 funds have logged average annual net returns of 20 percent, without a single year in the red. Schwarzman’s Blackstone, which has assets of $336 billion, has comparable average annual returns of 17 percent.
However, unlike Schwarzman, who employs a small army of professionals to help him and his firm burnish their image through various benevolent causes, Grayken appears to care little about getting good press. You won’t find any libraries or schools or hospitals with his name on them. He hasn’t signed Warren Buffett’s Giving Pledge. And he’s anything but a patriot: In an effort to avoid taxes, he renounced his US citizenship in 1999. You’ll find him on our list as a citizen of Ireland.
Since the Great Recession Grayken has made a specialty of buying up distressed and delinquent home mortgages from government agencies and banks worldwide. He’s also picked up a major payday lender, a Spanish home builder and an Irish hotel chain. Regulators hassle him, and the homeowners whose mortgages he owns or services despise his tactics. In fact, he has become accustomed to taking shots from detractors and has been the subject of protests from New York to Berlin to Seoul. Last year New York Attorney General Eric Schneiderman reportedly opened an investigation into Grayken’s heavy-handed mortgage-servicing tactics, including aggressive foreclosures, which have unleashed widespread outcries from homeowners, housing advocates and trade unions.
“There are real questions about the human costs of Lone Star Funds’ business practices,” says Elliott Mallen, a research analyst for Unite Here, a union representing 270,000 hotel and industrial workers.
It’s even doubtful Grayken, who refused to comment for this story, is well liked within his own firm. According to pension fund documents, he is the sole owner of Lone Star and its affiliated asset management firm, Hudson Advisors. Unlike other major private equity firms, which generously share equity among partners, Grayken has a tight grip on his firm’s ownership. While his top employees have become multimillionaire-rich, a number of key lieutenants have departed as Grayken has apparently never valued anyone enough to offer significant ownership in his operation.
The one group that loves Grayken: Pension fund managers, who consider him an alpha god and who happily overlook his sins. “Over the decades John has had phenomenal returns and executed a very disciplined investment strategy—he is in a league of his own,” says Nori Gerardo Lietz, a Harvard Business School professor who ran one of the largest firms that advise pension funds on their private equity investments. “Many of the other real estate and private equity players are really jealous of John Grayken.”
The Oregon Public Employees Retirement System has invested $2.2 billion in many of Lone Star’s funds. In 2013, for example, it committed $180 million in Lone Star Fund VIII and has already posted annualised net returns of 29 percent. A $4.6 billion fund Grayken raised in 2010 has returned 52 percent per year to Oregon pensioners.
With regulators all over the world forcing big banks to deleverage and retreat from various risky businesses, hedge funds and private equity firms like Lone Star have stepped in and are making a killing buying assets from banks on the cheap. Distressed specialists like Grayken, Howard Marks of Oaktree Capital and Leon Black of Apollo Group have become a new powerful class of “shadow” bankers. Among them the most shadowy is John Grayken.
Grayken denied any wrongdoing and argued that the Korean government’s actions were arbitrary and discriminatory and ignored Lone Star’s role in rescuing a big bank. Remarkably, Grayken persevered in Korea and ultimately was able to sell his KEB ownership to Hana Financial in 2012, booking a reported $4 billion profit. This, of course, wasn’t enough for Grayken, who is now pursuing arbitration to recover billions more in profits he believes he would have gotten in the original deal.
And if you thought banks behaving badly in America were a thing of the past, Grayken’s Texas mortgage company, Caliber Home Loans, has become infamous for its tactics as a servicer of subprime loans, some dating back to before the financial crisis. Caliber is one of the largest and fastest-growing mortgage companies in the nation, managing more than 325,000 mortgages and worth some $70 billion. A good number of Caliber’s mortgages were purchased by Lone Star Funds at a deep discount—70 cents on the dollar—during auctions held by wards of the state Fannie Mae and Freddie Mac and the Department of Housing & Urban Development.
In a stroke of brilliant financial maneuvering Lone Star bundled some of the mortgages into bonds and sold them to investors, immediately booking large profits. At the same time Caliber offered “temporary” loan modifications to distressed borrowers that consisted of five-year interest-only payment plans but failed to offer the homeowners any permanent relief through principal reduction. At the end of the five years these loans would revert back to the original payment terms, with all the deferred payments added in.
“Lone Star has bought these loans at a discount from the government—in effect, they got principal reduction. But they are not passing this benefit on to homeowners or communities,” says Lisa Donner, executive director of Americans for Financial Reform.
Technically speaking, the federal government does not require Grayken’s operation to offer principal reduction, but there has been a roar of voices claiming that Lone Star is abusing the situation. In February the National Housing Resource Center released a survey of nonprofit housing counselors that showed Caliber was the nation’s lowest-rated big servicer and among those doing the “worst job of complying with the servicing rules”. A labour union is accusing Caliber of building a new Countrywide Financial, given that its CEO and top executives are refugees from that hotbed of housing-crisis instigators.
In September the New York Times reported that many of the delinquent mortgages Loan Star bought have ended in foreclosure. Its editorial board went on to accuse Lone Star of relying on the “foreclosure and resale of the homes to make money”. New York Attorney General Eric Schneiderman reportedly opened an investigation. Lone Star and Caliber declined to comment.
None of this has slowed Grayken, who has gobbled up $120 billion in assets since the financial crisis, including Home Properties, an apartment REIT in Rochester, New York, for $7.6 billion in October. His latest Lone Star fund is now raising $5 billion trained on real estate in Europe, where banks are still rapidly deleveraging. Grayken has personally invested $250 million in the fund, his 16th, adding to the $1.3 billion he already has invested in Lone Star’s other funds.
His pension clients, including the Employees’ Retirement System of Rhode Island, the New York State Teachers’ Retirement System and Dallas’ Fire & Police Pension System, have yet to make a peep about Grayken’s sleazy subprime mortgage operation. If they have any concern about their American-born Irish golden goose, it’s over Lone Star’s succession and Grayken’s health.
Over the years a parade of talented partners, almost anyone Grayken has ever worked with closely, have left the firm because they either felt shortchanged financially or had disagreements with Grayken. His longtime number two, Ellis Short, who helped found Lone Star, left in 2007. Short did well enough at Lone Star to buy Sunderland, an English Premier League soccer team. The divorce case of another former exec, Randy Work, revealed that he had accumulated a $225 million fortune.
Still, their riches pale in comparison with those of Grayken, who rules with an iron fist and has little tolerance for mistakes. “He felt in many cases that the people beneath him were interchangeable,” says one former top Lone Star manager. (Grayken has also had turnover in his personal life. He divorced his first wife shortly after becoming a tax refugee, changed his mind, got her to take him back within a month of the final divorce decree and then got redivorced six months after that. He eventually married his secretary in London, and the couple have four children.)
Grayken recently flew to South Dakota to visit with a pension client and allay succession fears. As a South Dakota Investment Council member recently put it, “I am concerned about what happens when John passes away. It might just all end.”
But until that happens, the pension funds are happy to deposit more retirement money in the Irish billionaire’s shadow bank. Shortly after the meeting, South Dakota agreed to invest $300 million in Lone Star’s newest investment fund.
(This story appears in the 01 April, 2016 issue of Forbes India. To visit our Archives, click here.)