Jan. 12 (Bloomberg) -- Mortgage Lenders Network USA Inc., a provider of home loans to people with poor credit, said ``human error'' caused it to lend $600 million at below-market rates, fueling losses that led to the closure of its biggest unit.

The mistake cost Middletown, Connecticut-based MLN about $20 million at a time when a slowdown in the mortgage market was eroding the value of another $2 billion in loans the company planned to sell, Chief Executive Officer Mitch Heffernan said in an interview yesterday. Creditors demanded $40 million in additional collateral, half of MLN's capital.

``The economics of the market went upside-down,'' Heffernan, 49, said. ``We could continue to go down the path of funding loans at a loss or we could exit the market completely.'' The company furloughed about 900 of its 1,800 employees for two weeks and is in negotiations with ``a number'' of Wall Street firms that might buy the unit or a stake to allow operations to resume, he said.

MLN is one of at least five ``sub-prime'' lenders to shutter operations because of a slowing housing market and rising delinquencies. Securities firms and investors that buy such mortgages to package them into bonds have reduced the premium they're willing to pay and in some cases are offering less than even the face-value of the loans.

A++ Mortgages

In October, MLN cut back on lending to first-time homebuyers and to borrowers with low credit scores, Heffernan said. To fill the void, it offered new ``A++'' mortgages for borrowers with better credit who still couldn't qualify for the least-risky ``prime'' market. The company's error caused the loans to be priced so low they could only be sold at a loss, Heffernan said. Applications for about $200 million arrived in the first two weeks.

MLN employees failed to set a limit on the number of discounts customers could be given, Heffernan said. ``It turned out to be a human error,'' he said. ``Not one person in particular and it wasn't intentional.''

``The rates were so competitive that you look at it and you say, `How is this possible?''' said Michael Warshaw, owner of Warshaw Capital, a mortgage broker based in Stamford, Connecticut. ``I thought they were trying to get their name out there and win market share.'' Warshaw's firm signed up customers for about a dozen of the loans, he said.

MLN told its employees to stop selling the A++ loans while agreeing to consider applications already received as long as closings took place within 30 days, Heffernan said. Instead, an additional $400 million of the loans were accepted.

Lehman Steps In

``We had a senior officer of the company who was in charge of the sales staff who basically waved on more production while we were actually trying to stop the pipeline,'' Heffernan said. He declined to name the officer, who is no longer with the firm.

The unit that MLN shut offers loans through a network of independent brokers. The company continues to lend directly to borrowers and handles billing and collections for a $19 billion mortgage-servicing portfolio.

Closely held MLN was the 15th-biggest U.S. sub-prime lender in the third quarter of last year, with $3.3 billion of loans, according to the industry publication National Mortgage News. The wholesale unit generated about 90 percent of the company's total loans in recent months, Heffernan said.

Lehman Brothers Holdings Inc. agreed to buy about 900 loans to MLN customers who closed on them in late December and never received the money, Heffernan said. He declined to say whether Lehman was bidding on the wholesale unit. New York-based Lehman declined to comment.

Governor's Visit

``We're working like hell to make sure we still have an ongoing concern,'' Heffernan said. The company is trying to complete the negotiations with potential buyers by next week, when furloughed workers were told to expect a decision, he said.

The layoffs mostly affected employees at the company's offices in Horsham, Pennsylvania; Alpharetta, Georgia; Oak Brook, Illinois; and Phoenix.

Heffernan and six other investors founded the company a decade ago with $2.5 million of their own money, he said. MLN grew as historically low interest rates early this decade and a boom in home sales spurred record demand for sub-prime mortgages. In May, the company broke ground on a 305,000-square- foot headquarters in Wallingford, Connecticut, in a ceremony attended by Governor Jodi Rell.

In December, as investors became more leery of bonds backed by sub-prime mortgages, Wall Street banks began reducing their purchases or demanding lower prices on the loans they bought from lenders like MLN, he said.

`Getting Dinged'

As a result, the banks that provided about $3 billion of credit lines to the company began scrutinizing its loans more carefully, Heffernan said. To cover potential losses on the $2 billion of credit that MLN had tapped to fund loans, the banks demanded that the company post additional collateral equivalent to about 2 percent of the balances, he said.

A spokesman for MLN, Chris Capot, declined to name the banks.

To raise cash, the company had to sell some loans at the end of December, when many Wall Street mortgage traders were taking time off, Heffernan said. Under other circumstances MLN would have sold the loans at a premium and recouped the cash it had posted as collateral. Instead, traders demanded discounts of as much as 1.5 percent.

``If they were going to do the trade, they were going to get compensated for it,'' Heffernan said. ``Couple that with the fact that MLN is a small, private company in a potential liquidity crisis, and we started getting dinged.''

To contact the reporters on this story: Bradley Keoun in New York at bkeoun@bloomberg.net; Jody Shenn in New York at jshenn@bloomberg.net.

Last Updated: January 12, 2007 14:24 EST