Sub-Prime Lenders Going Under

Breaking News: Fremont Closes Doors
Sub-prime lender Fremont Financial in Anaheim told its employees to clean out their desks and go home this afternoon, in a report seen locally on Channel 4 news. One of the larger lenders in the sub-prime market, which last year comprised 20% of the home mortgage market, Fremont Financial was widely seen as one of the more stable lenders in this now-volatile lending sector. Early defaults leading to foreclosures have negatively impacted this section which provides home loans to marginally qualified buyers. This development portends a continued decline in housing.

While many in my industry continue to sing a happy tune, the gathering storm in the lending buisiness is the natural result of years of a Federal Reserve that was out of control with the printers churning out liquidity, lax lending standards issuing what came to be known as 'liar's loans', and option ARMs and other loan programs that absent strong appreciation, will tend to increase the default and foreclosure rate as those loans adjust to interest rates in the 10 or 12 percent range.
~~R Kutylo

New Century Stock Plunges;Lender Is at Mercy of Banks

By LINGLING WEIMarch 5, 2007 7:31 p.m.

NEW YORK -- Just last summer, New Century Financial Corp. Chief Executive Brad Morrice said his company was poised to "capitalize on" the U.S. mortgage industry's shakeout. Now, it is one of those being shaken out.

New Century, one of the largest lenders to high-risk borrowers, disclosed late Friday that it is the subject of a criminal inquiry into its accounting and trading in its stock. It also said it is at the mercy of the banks that provide it with essential credit lines -- Wall Street firms including Goldman Sachs Group Inc. and Morgan Stanley that also buy loans from the company and repackage them into tradable securities.

But its prospects for finding mercy are anything but promising. Should it fail, New Century would become one of the biggest casualties of the cratering of the mortgage market so far.

The company is "more likely to enter the death spiral than we had feared," Merrill Lynch analyst Kenneth Bruce wrote in a research note to clients Monday. Likely restricted liquidity -- as well as its delay in filing financial statements, the deterioration of its financial conditions and regulatory investigations -- could "conspire to limit its options outside of bankruptcy," Mr. Bruce said.

A New Century spokeswoman declined to comment beyond the company's regulatory filings. Shares in the Irvine, Calif., lender, tumbled $10.09, or 69%, to $4.56. The stock has dropped about 90% since last July -- when New Century traded around $46 and had just racked up a record of raising its dividend six times since its conversion to a tax-beneficial real-estate investment trust in 2004. Standard & Poor's removed New Century from its Standard & Poor's 600 index of small-capitalization shares.

Big shareholders including Greenlight Capital Inc., a New York hedge fund, stand to lose the most in the event of a bankruptcy filing. Earlier last year, Greenlight forged a deal with New Century that placed its president, David Einhorn, on the board, exempted Greenlight from a 9.8% shareholding limit and permitted ownership of up to 19.6%. Greenlight's regulatory filings show the fund owned 6.3% of New Century's outstanding shares as of Dec. 31, a position valued at about $110 million at the time. Today, the stake would be valued at less than $14 million.

The fund's current holdings or economic interest in the company couldn't be determined. A spokesman for Greenlight declined to comment for this report, citing Mr. Einhorn's position as a board member. At the same time, some investors have bet heavily on New Century's downfall, as evidenced by a 30% jump in short interest in the stock to 16.7 million shares last month from January. That represents 37% of the public float of the company's shares.
New Century was founded in 1995 by three mortgage-industry veterans, including Mr. Morrice, Bob Cole and Ed Gotschall. It went public two years later and was named to Fortune magazine's list of the 100 fastest-growing companies in 2003 and 2004. But now, New Century's rapid descent offers a cautionary tale.

The lender is plagued with problems including a surge of bad loans, costly obligations to buy back bad loans already sold to investment banks and inadequate reserves. On top of the financial stress, it faces regulatory probes and shareholder allegations that its officers and directors sold shares at inflated prices. The lender acknowledged Friday that a failure to convince its banks to ease their financing terms could prompt its auditors to warn of "substantial doubt" over its ability to remain in business.

A disruption in liquidity has already forced more than 20 independent mortgage lenders to shutter operations over the past two months. In the late 1990s, when the financial markets were rocked by Russian defaults, New Century and other mortgage lenders encountered a similar liquidity crisis but managed to get through it after U.S. Bancorp extended a lifeline.
Some analysts question the lender's ability to avoid bankruptcy or an outright liquidation this time around. Weakening loan demand and rising delinquencies have forced bigger financial services firms to become more cautious about the risks they take on, as a string of subprime lenders seek to sell out as a last-ditch alternative to closing shop.

New Century said it has $17.4 billion in short-term credit lines and had more than $350 million in cash and immediate liquidity as of Dec. 31. It also said 11 of its 16 financing pacts require it to report at least $1 of net income for two consecutive quarters. But it doesn't expect to meet this requirement for the period ended Dec. 31 and is seeking waivers from its banks, the company said.
Ed Groshans, an analyst at Fox-Pitt, Kelton, like many other analysts, is worried about the ability of the company to get all the waivers it needs.

Late last month, New Century disclosed that it had extended a $250 million uncommitted line of credit with Goldman Sachs for three months -- to May 14 -- as opposed to the more customary one-year extension. The other agreement it has with Goldman, with $1 billion in committed credit, expires in November. Many analysts have viewed the short duration of the extension as a lack of confidence on the part of Goldman about New Century's financial stability. A Goldman spokesman declined to comment.

As of Sept. 30, according to New Century's filings with the Securities and Exchange Commission, the company had a $3 billion credit line with Morgan Stanley and an outstanding balance under that agreement of $1.5 billion. The pact was supposed to expire last month. The New Century spokeswoman declined to comment on the status of the company's renegotiations with Morgan Stanley. The bank also declined to comment.

Other big providers of short-term funding to New Century include UBS AG, Bank of America Corp., Barclays PLC and Deutsche Bank AG.

--James R. Hagerty of The Wall Street Journal contributed to this report