July 5 (Bloomberg) -- H&R Block Inc.'s mortgage unit lost a $1.5 billion credit line, falling ``dangerously close'' to the minimum amount demanded by a hedge fund firm that has agreed to buy the money-losing home lender.

The so-called warehouse credit facility for Option One Mortgage Corp. wasn't renewed by Lehman Brothers Holdings Inc. when it expired on June 28, Kansas City, Missouri-based H&R Block said in a federal filing. That reduced the unit's borrowing capacity to $8 billion in committed loans and $2 billion in uncommitted lines of credit.

Cerberus Capital Management LP, a New York-based hedge fund manager, demanded Option One maintain warehouse lines of at least $8 billion when it agreed to buy the unit in April. Investors are counting on the sale to stem mortgage losses that totaled $808 million in fiscal 2007 and free H&R Block to focus on its tax preparation business, which hasn't grown in the last two years.

``This leaves Option One skirting dangerously close to the line,'' said Kathleen Shanley, an analyst at Gimme Credit who has a ``deteriorating'' credit score on H&R Block. ``The company has little margin for error.''

H&R Block shares fell 48 cents, or 2.1 percent, to $22.55 at 4:21 p.m. in New York Stock Exchange composite trading.

The company said it didn't make sense to spend money for lines of credit beyond what the sales agreement required.

``We are confident we have the current and potential lending relationships to maintain at least this amount in place through the closing of the Option One sale transaction,'' said the company in a statement. ``There's no contractual need to go any higher.''

Extra Credit

Option One was using $1.5 billion of its warehouse lines at the end of April 30, down from $7.8 billion a year earlier, according to its annual report published last month. That means the firm needs at most $4 billion to support the day-to-day operations of the mortgage lender, H&R Block said today.

Bank of America Corp., which halved its warehouse line in May, will increase the facility by about 10 percent to $2.25 billion until the sale of Option One is finished, H&R Block said. The company expects to complete the transaction by the end of October.

The sale agreement with Cerberus doesn't specify whether the minimum credit requirement includes the uncommitted lines, said H&R Block spokesman Nick Iammartino.

Cerberus spokesman Peter Duda didn't return a call seeking comment.

More May Expire

Citigroup Inc.'s $1.5 billion committed line expires on July 30, according to previous H&R Block filings. Option One has also violated minimum-income requirements in the warehouse agreements and has been getting waivers from its lenders.

Some of those waivers expire at the end of this month as well, H&R Block said in its annual report. While it didn't identify the lenders for each waiver, the July expirations affect $3.75 billion of credit lines, H&R Block said. Lenders can annul their warehouse agreements when the waivers expire.

Wall Street banks provide warehouse credit lines to mortgage lenders so they can make loans to homeowners. The warehouse provider typically buys most of those loans from the mortgage lender, holding or ``warehousing'' them until there are enough to package into securities that can be sold to investors.

Borrowing from uncommitted lines requires pre-approval from the lender and additional scrutiny of new mortgages. Committed lines can be accessed without such restrictions.

Subprime Loans

Option One makes subprime home loans, which are offered to borrowers with the worst credit records. Late payments on subprime home loans nationwide rose in the first quarter to the highest level since 2002, the Mortgage Bankers Association reported.

The danger of default has made warehouse lenders reluctant to extend credit, and at least 60 mortgage companies have halted operations, gone bankrupt or sought buyers since the start of 2006, according to Bloomberg data.

H&R Block began seeking buyers for Option One in November, with Chief Executive Officer Mark Ernst expecting as much as $1.3 billion for the business. The final price will be based on its losses until the closing of the sale and could be as low as $400 million, according to UBS AG analyst Kelly Flynn.

Investors, including fourth-largest shareholder Ariel Capital Management, have urged Ernst to go ahead with the sale regardless of the price. The sale would ``take away a major overhang,'' said Ariel's Charles Bobrinskoy in an April interview.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

Last Updated: July 5, 2007 17:14 EDT