Sub-Prime Lenders' Shares Fall

By E. Scott Reckard

Aug. 26, 2006 12 AM PT

Time Staff Writer

Investors bailed out of stocks of mortgage companies catering to high-risk borrowers Friday, a day after an Irvine lender reported higher default rates.

Some analysts say the selling wave could foreshadow more trouble for the industry.

H&R; Block Inc., parent of Option One Mortgage Corp. in Irvine, said late Thursday that it would take a $102-million charge when it reports earnings next week. H&R; said it was being forced to buy back Option One loans from big investors, who purchase mortgages that have been bundled in groups for resale.

On Friday, H&R; shares tumbled $1.98, or 8.7%, to $20.81. A host of rivals were dragged lower as well, with New Century Financial Corp. of Irvine falling $2.11 to $39.94 and Fremont General Corp. of Santa Monica sliding 66 cents to $14.23.

As home prices shot up in recent years, the industry turned to riskier loans to keep business going.

With housing now slowing sharply, mortgage companies have been firing thousands of employees and putting themselves up for sale.

“At this point it’s hard to know how much this is industry issues and how much is company specific,” said analyst Kelly Flynn at financial services firm UBS. She downgraded H&R; stock Friday from “buy” to “neutral.”

She said the news “is very negative” for H&R;, which is best known for its tax preparation service. The Kansas City, Mo.-based company’s write-off would be about 40% of the mortgage earnings UBS expected from the company this year, Flynn said. There could easily be more loan losses to come, she added.

Option One caters to riskier borrowers who must pay higher interest rates and fees because their credit is flawed or their income and equity levels aren’t high enough to qualify for lower-cost prime loans.

The company and other so-called sub-prime lenders transfer the risks by selling loans or mortgage-backed securities to other firms and investors. But if the loans quickly fall into default, or if they have been misrepresented to borrowers or investors, the originators can be forced to repurchase them.

Several sub-prime lenders in addition to Option One have reported having to repurchase higher quantities of loans, Friedman, Billings, Ramsey Group Inc. analyst Scott Valentin noted in a recent report.

Many mortgage lenders, including such mainstream players as Calabasas-based Countrywide Financial Corp. and Seattle-based Washington Mutual Inc., have announced cuts in recent months to save money.

In perhaps the biggest surprise, Ameriquest Mortgage Co., whose privately held Orange-based parent company, ACC Capital Holdings, was the biggest sub-prime lender last year, said in May that it would close all 229 of its retail branches and eliminate 3,800 jobs after a steep decline in its lending volume.

The sub-prime industry is also consolidating. Among recent developments tallied by Valentin:

* Accredited Home Lenders Holding Co. of San Diego is buying Los Angeles-based Aames Investment Corp.

* Morgan Stanley is buying Saxon Capital Inc. of Glen Allen, Va.

* Cleveland’s National City Corp. is considering strategic options for its San Jose-based First Franklin Financial Corp.

Much of the recent worry over mortgages has focused on adjustable-rate loans with artificially low starting payments -- and whether borrowers would become deadbeats when the rates adjusted sharply higher.

But H&R;’s statement indicated problems of another kind: borrowers failing to make even the first few payments.

In addition to “an increase in early-payment delinquencies,” it said loan buyers were becoming less tolerant of problems and quicker to demand repayment when something goes amiss, Flynn noted.

The company declined to elaborate about its lending problems, saying it would discuss the issues with analysts when it reports earnings Thursday.

Other Southland lenders that saw their stock prices retreat Friday included IndyMac Bancorp Inc. of Pasadena, down $1.99 to $39.46, and Downey Financial Corp., which fell $1.39 to $59.84.

Countrywide Financial fell 81 cents to $32.45. The firm writes prime and sub-prime loans.

(BEGIN TEXT OF INFOBOX)

Nervous market

Mortgage lenders’ shares fell sharply on Friday and for the week.

Company: H&R; Block

%change :(Fri. --8.7%;Week --8.2%)

Company: New Century

%change :(Fri. --5.0%;Week --8.0%)

Company:IndyMac

%change :(Fri. --4.8%;Week --5.6%)

Company: Fremont Genl.

%change :(Fri. --4.4%;Week --8.8%)