Accredited Calls It a Day

The company’s $400 million merger deal with a private equity firm may signal the beginning of the end for pure-play subprime lenders

A deal announced June 4 that will marry one of the last mortgage companies specializing in subprime loans to a private equity firm may signal the end for companies whose sole line of business is making risky real-estate loans.

Accredited Home Lenders (LEND) said it had agreed to merge with Lone Star Fund V (U.S.) LP , through its affiliate Lone Star U.S. Acquisitions, LLC, in an all-cash transaction under which Lone Star will buy all of Accredited's common stock for $15.10 per share, or a total price tag of roughly $400 million. The Preferred shares isued by its subsidiary, Accredited Mortgage Loan REIT Trust, aren't covered by the merger agreement and will remain outstanding.

Accredited and other smaller subprimers may see the writing on the wall. "Given how difficult the [subprime] market is, it makes sense for small players to merge in order to survive," said Bose George, an analyst who covers the company for Keefe, Bruyette & Woods. Given that Accredited Home's management team has never come under fire, Lone Star is likely to stay out of the way and "let [Accredited] do their thing," he added.

Accredited Home's common shares were trading 11.5% higher at $15.34 on June 4.

Lone Star spokesman Ed Trissel said he couldn't comment on Lone Star's plans for the business.

With NovaStar Financial (NFI) also looking for a buyer, the monoline subprime business is over, Bose said. Another subprime lender, Delta Financial (DFC), is likely to survive only because its mortgage loans were made at a fixed rate and won't push borrowers into default as certain adjustable-rate loans have as interest rates have climbed, he added.

Besides giving it easier access to capital, merging with Lone Star will also eliminate the threat of having its common stock delisted by the Nasdaq Stock Exchange for failing to meet a deadline for filing its annual report for 2006.

Strapped for cash, Accredited Home had been shopping around for a buyer for months, George said.

In March, the company was forced to sell virtually its entire loan inventory at a deep discount. In a research note on March 27, Bear Stearns & Co. estimated the $2.7 billion portfolio was sold at 7% of the par value in order to limit the company's exposure to additional margin calls and free up about $50 million in capital that had been tied up as collateral for the loans.

The company's liquidity seemed to improve in April after it secured a $230 million financing facility from Farallon Capital Management and a $500 million credit facility from an unnamed commercial bank and renewed an existing $600 million credit line. Accredited Home ended the first quarter with $320 million in cash, funding capability of at least $1.1 billion and elimination of most of the margin call risk associated with its loan inventory, Fox-Pitt, Kelton said in a research note on April 3.

By George's calculation, Lone Star is paying about 85% of Accredited Home's book value. Although his estimate is rough without access to filings that would have showed Accredited Home's profits or loss for 2006 and the first quarter of 2007, Lone Star presumably saw the book before making a bid, George said.

"That's not a bad price, because of all the uncertainty in the market that's going to continue for a significant period of time," said George, who doesn't expect a rebound in the subprime market for another 12 to 18 months.

The company delayed filing an annual report for 2006 to allow time to re-examine any goodwill it booked in association with its acquisition of Aames Investment Corp., which closed in October. During that process, its independent auditors, Grant Thorton LLP, resigned without completing a review of the company's 2006 financial results.

The goodwill is probably worth nothing after the collapse of the subprime lending market, George said.

For Lone Star, the merger is probably a better alternative than having to create a mortgage lending business from scratch, as long as the price isn't too high, said Stuart Plesser, an analyst who covers mortgage lenders for Standard & Poor's. (S&P, like, is a unit of The McGraw-Hill Cos. [MHP].)

"People believe the subprime market is going to be a lucrative business down the road and are getting their ducks in a row," he said.

The key to survival for the smaller subprime lenders is the source of their funding. The lenders that got into trouble were relying on so-called warehouse loans – those that come from large investment banks --which were shut off when the bottom fell out of the subprime market, Plesser said. Only lenders that have a significant portion of their funding from deposits, such as Countrywide Financial (CPC) or Wells Fargo (WFC) can afford to stay in game, he added.

George doesn't own Accredited shares but Keefe, Bruyette & Woods does and tries to do investment banking with the companies it covers.

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