Distress Specialist Lone Star Turns To Europe

Year founded: 1995

Investment strategy: Distressed debt and real estate

Key executives: John Grayken, founder; Takehisa Takamatsu, Asia; Len Allen, North America; Bruno Scherrer, Europe

Office locations: Dallas, New York, Washington, D.C., Montreal, London, Frankfurt

Assets under management: $33 billion

Fundraising status: just closed Fund VIII at its $5 billion hard cap

Web address: www.lonestarfunds.com

Investors: Dallas Police & Fire Pension System; New York State Teachers Retirement System; Oregon Investment Council; Conversus Capital LP; Washington State Investment Board

Lone Star, founded in 1995 by John Grayken, a veteran of the savings-and-loan bailout of the 1990s, closed its eighth distressed debt fund in May at its $5 billion hard cap.

The size of Lone Star Fund VIII marks a step up from its predecessor, the 2010 vintage Fund VII, which closed at $4.6 billion. But it is well below the size of 2008 vintage Fund VI, which at $7.5 billion was the largest collection of commitments ever assembled by the Dallas-based shop. The firm did not use a placement agent to raise Fund VIII.

With those capital commitments in hand, the firm appears to be turning an increasing share of its attention to Europe. (Lone Star declined comment for this story.) In late April, the firm teamed up with Credit Suisse to buy a structured credit portfolio held by the Belgian government’s “bad bank.” The pair paid 6.7 billion euros ($8.73 billion) for the portfolio, a sheaf of toxic assets tracing its roots to the break-up of the Belgian Fortis Bank at the height of the financial crisis.

Lone Star may next turn its attention to the German lender Commerzbank AG. Sister news service Reuters reported in May that Commerzbank is in intensive talks with Lone Star and Wells Fargo & Co. to sell the bulk of its Hypothekenbank Frankfurt AG U.K. unit, primarily a repository of British property loans, for 5.7 billion euros ($7.4 billion).

Lone Star would take control of the distressed debt in the portfolio and Wells Fargo would receive the performing loans, according to a report in the Financial Times, which added that bidders including The Blackstone Group LP and Starwood Capital Group Management LLC were advised that their offers were not accepted.

In a third potential European play, Lone Star was reported in January to be in talks to buy a large amount of defaulted residential mortgages from Banco Bilbao Vizcaya Argentaria, Spain’s No. 2 bank, according to the Wall Street Journal’s Deal Journal website. BBVA was said to be set to sell the firm mortgages with a face value of about $678.4 million at roughly $205 million, a nearly 70 percent discount.

To be sure, not all the world’s distressed real estate is in Europe. In a much smaller deal in March, Lone Star closed $120 million, all-cash deal with First Bancorp, the holding company for FirstBank Puerto Rico, for a portfolio of nonperforming and classified commercial real estate loans, construction loans, and commercial loans, according to National Mortgage News. Lone Star paid about 32 cents on the dollar for the portfolio, which had an unpaid principal balance of $378 million.

Still, to the extent that Europe is indeed in the Lone Star cross-hairs, it is merely the latest rotation in focus for a firm that has spent the past two decades scouring the globe in search of financial distress.

Beginnings In S&L Crisis

The firm now known as Lone Star grew out of the savings and loan crisis of the early 1990s. The Federal Deposit Insurance Corp. established a joint venture in 1993 with the Robert M. Bass Group to dispose of the assets of 1,300 troubled thrifts. That partnership, Brazos Partners LP, was led by Grayken as chairman and CEO. As Brazos worked its way through the portfolio of impaired thrift assets, Grayken launched Brazos Fund LP in 1995 with approximately $250 million in private commitments as a way to continue to invest in distress. The first institutional Lone Star fund, a $396 million vehicle, followed in 1997.

Over the years, the firm has broadened its reach, first to Canada and later to western Europe and eastern Asia. According to the Lone Star website, the firm focused much of its attention from 1998 to 2004 in Asia, following the collapse of a real estate bubble in Japan and a broader Asian financial crisis. In the middle part of the last decade, the firm began to turn its attention to Europe, as the establishment of the euro zone led to a wave of consolidation and deleveraging of financial institutions.

Today, Lone Star’s investments are weighted roughly 40 percent in the United States, 40 percent in Europe and 20 percent in Japan, according to the Oregon Investment Council, a longtime investor. The firm has more than 60 investment professionals on staff, including 20 dedicated to loan origination

As a firm that invests in distress, Lone Star has had some troublesome holdings.

Perhaps its longest-running controversy in recent years has involved its litigious holding of Korea Exchange Bank, in which it acquired a 51 percent stake in 2003 in the wake of the 1997-98 Asian financial crisis. The firm sold the asset to Hana Financial Group Inc. in early 2012 for 4.69 trillion won ($4.23 billion), after a court in Seoul found in October that Lone Star was guilty of manipulating stock prices. The drama continues in that case, as the firm announced in May of that year that it planned to file for arbitration of its claim that South Korea had improperly interfered with its efforts to sell the company, forcing the firm to hold the asset for years longer than it otherwise would have.

More recently, Lone Star has gotten into a tiff with a former target’s seller. Restaurant entrepreneur Dee Lincoln, the founder of the Del Frisco’s restaurant chain, sued the firm in March, the Dallas Business Journal reported. Lincoln charged among other things that she was shortchanged in the chain’s IPO deal following Lone Star’s 2007 buyout. (The firm reportedly declined to comment.) About the same time as the suit was filed, Lone Star scored a realization of $80.75 million by selling 4.75 million Del Frisco’s shares in a secondary public offering, according to the information service MarketLine.

But if a distress investor must learn to deal with difficult situations in its portfolio, Lone Star has developed a reputation as an LP-friendly shop, according to the Pension Consulting Alliance, the private equity consultant to the Oregon Investment Council, which committed $400 million to Fund VIII. Indeed, that commitment was actually more than the $300 million that PCA had recommended. A spokesman for the council told Buyouts at the time that the group, anticipating that the fund would be oversubscribed, made the overcommitment in the hope that its final allocation would be close to what the adviser recommended.

One issue raised by Oregon in its due diligence was the succession plan at Lone Star, where Grayken runs the shop with no heir apparent, as Bloomberg News reported at the time of the fund’s closing.

But the firm operates its own loan servicing operation, Hudson Advisors, with more than 200 employees in Dallas, New York, London, Munich, Frankfurt, Luxembourg, Madrid, Dublin and Tokyo, as PCA reported to the Oregon Investment Council. Operating as Lone Star’s dedicated asset management operation, Hudson Advisors performs due diligence on investments, along with analysis and much of the special servicing of the firm’s acquisitions. Lone Star also has a portfolio company, Vericrest Financial Inc, that provides servicing of residential mortgages and consumer loans. Together, the two operations are considered to have the resources to wind the firm down, should the need arise.

CORRECTIONS: The Pension Consulting Alliance of Portland, Oregon, is the third-party consultant employed by the Oregon Public Employees Retirement System. A version of this story originally posted on April 30, 2013, misidentified the consultant. Also, Bruno Scherrer is the firm’s senior managing director, Europe origination; the earlier version of the story misspelled his name.