For These Lenders, T.D. Is No Touchdown

California’s real estate downturn isn’t fun for property owners, but for those who’ve plunged heavily into the secondary mortgages commonly known as trust deeds, it can be devastating.

Just ask Irving Samit, an ostensibly sophisticated investor who plowed all his savings--more than $1 million--into deeds of trust, which are secondary mortgages on real estate. Now he’s scared stiff. Pioneer Mortgage, the San Diego-area firm that arranged his investments, has filed for Chapter 11 and erupted in a mushroom cloud of lawsuits that threatens to vaporize all $254 million invested.

The troubles of trust deed investors, many of them retirees like Samit, are a little-noticed dimension of the recession you’ve been reading so much about, a dimension particularly relevant in California, where trust deeds are popular and forever rising real estate prices are an article of faith.

Pioneer is one of two major Southern California mortgage brokers to go bust lately. The other, Property Mortgage Co. in Sherman Oaks, invested about $150 million for up to 1,000 mostly Los Angeles-area clients, including several from the Hillcrest Country Club in West Los Angeles, where PMC’s owners were members.

No one seems to know how much is invested in California trust deeds or how many brokers arrange them; all that’s needed is a real estate license. What is known is that down markets usually mean T.D. trouble.

Pioneer and PMC amply illustrate the consequences of a recession and the hazards of unconscious investing, in trust deeds or anything else. Both were reliable old companies that drew on a network of friends and neighbors who in many cases seem to have invested entirely on faith.

Consider Pioneer. Founded in 1945 by Morrie Naiman, since 1975 it was headed by his nephew, Gary, a paragon of respectability who was active in Jewish philanthropy and whose 2,500 investors were drawn primarily from neighbors, friends and their family members, most of them also Jews.

“I considered him a friend for 16 years,” says Samit. “We went to family bar mitzvahs and weddings. I had all kinds of faith in him. . . . He was named as a trustee on our living trust over our kids. That’s how close we were.”

DeDe Shulman inherited her substantial investment from her father; all their friends were in Pioneer as well. So were a rabbi’s retirement account and a six-figure building fund for San Diego’s branch of Chabad, the Jewish social service group.

“We’ve had at least three deaths related to this,” says Samit.

Theoretically, Pioneer investors were lending for perhaps three years to property owners whose real estate secured the debt. These landowners already had mortgages on their property; in fact, they often had several. And for whatever reason, they couldn’t go down to Wells Fargo or Home Savings for a relatively cheap home equity loan.

Thus, Pioneer trust deed holders weren’t dealing with the world’s best borrowers and wouldn’t be first in line in the event of foreclosure. Because of the added risk, the returns were handsome, perhaps 12% or 14%. But these aren’t junk bonds. Trust deeds can be reasonably safe if there’s plenty of equity in the property and, says George Coats, who wrote a book called “Smart Trust Deed Investment in California,” if the broker serves merely as matchmaker.

That wasn’t the case with Pioneer. Besides taking hefty loan fees up front, it made money by pocketing a portion of the interest when it collected and disbursed monthly loan payments. Crucially, it held the notes associated with the loans.

Along came the recession. Declining property prices threaten anyone holding IOUs secured by real estate, and that’s what Pioneer was all about.

When some of its loans defaulted last year, the firm apparently used other revenue to keep up its 45-year record of never missing a payment.

But Pioneer soon ran out of money. This wouldn’t matter so much, but under the law those crucial loan notes are frozen in bankruptcy and can be considered Pioneer’s. Since cases like Pioneer immediately break out in a rash of lawsuits--more than 100 in this instance already, in state and federal court--legal fees can consume most of the assets.

Worse yet, half of Pioneer’s 450 loans are in default, and some are stacked one atop another. William G. Wilson, the company’s bankruptcy lawyer, says Pioneer has six or seven--for $27 million in all--on a single property, Murietta Hot Springs Resort in Riverside County. The resort is now closed.

Another $34 million in investors’ money went into what Wilson calls blind pools, so that these individual investors can’t point to any one deed of trust they own.

Grim as the picture seems, Pioneer investors aren’t altogether out of luck. The company’s new chief executive is Dennis B. Schmucker, a turnaround expert who’s administered cardiopulmonary resuscitation at Southmark Corp., American Home Mortgage Corp. and U.S. Financial Corp. Schmucker and Wilson want U.S. Bankruptcy Court permission to release the loan notes so investors can receive payments from good properties. They also hope to withhold 10% or 15% of the money those notes generate to help cover losses on trust deeds backed by insufficient equity.

Otherwise, Schmucker says, “what you suddenly create is a permanent employment program for the legal community.”