Sub-prime lending shakeout heats up

The shakeout in the business of risky mortgages intensified Tuesday as Freddie Mac swore off buying certain common but foreclosure-prone loans and Ameriquest Mortgage Co., which has struggled to find a buyer, said a potential partner might come to its aid.

Lenders to shaky borrowers have been in turmoil this year, and the tremors probably will be felt by homeowners seeking to refinance their high-risk mortgages.

In another indication of stress, Santa Monica’s Fremont General Corp., which has been a major lender to borrowers with poor credit scores and no down payments, said late Tuesday that it would not release its fourth-quarter financial results today as planned.

Fremont General, which has beefed up loss reserves and backed away from its riskiest lending practices over the last year, said it would explain its decision later in a filing with securities regulators.

Several other of these sub-prime lenders have seen their shares hammered after disclosing heavy losses this month, including New Century Financial Corp. of Irvine, whose stock fell 36% in a day after it said it would have to restate its earnings for all of last year. Others have filed for bankruptcy protection, including Ownit Mortgage Solutions of Agoura Hills and ResMae Mortgage Corp. of Brea. And a host of mortgage companies, including No. 1 lender Countrywide Financial Corp., have announced layoffs.

As home prices soften and lenders adopt more stringent standards, consumers who once used “serial refinancings” to extract cash and get new low “teaser” rates are finding themselves stuck with loan payments that will soon shoot higher. With foreclosure rates on the rise, some analysts warn that woes in the sub-prime industry could spread to the prime market and affect the entire economy.

“More people who already own their homes and can’t refinance are likely to lose them,” said analyst Zach Gast, who has studied the lending scene for the Center for Financial Research and Analysis, a forensic accounting and due diligence firm.

“Think how that’s going to ripple through the economy,” he said. “It could really affect home prices.”

The effects of mortgage layoffs already are being seen in employment data for Southern California. In Orange County, ground zero for the sub-prime industry, year-over-year figures for financial services employment showed job losses beginning last summer for the first time since late 1999 through mid-2000, after the last big industry retrenchment.

All mortgage lenders will “have to reduce their workforces even further to adjust to the slower volume of loans and reducing their losses,” said Esmael Adibi, director of the Anderson Center for Economic Research at Chapman University in Orange. “This industry was the major engine of growth in Orange County and unfortunately will be a big drag on the overall job growth in 2007 and 2008.”

In an example of how loan buyers are drawing back from sub-prime loans, Freddie Mac, the government-sponsored loan company, said it would not buy mortgages that have artificially low payments for the first two or three years unless borrowers had proved they could afford the loans when the rates rise. Such “hybrid adjustable” loans make up 75% of the sub-prime market.

Freddie Mac’s pullback comes after moves by federal regulators and legislators to tighten lending standards. The decision was praised by advocacy groups that have contended sub-prime lenders often sell highly risky loans to struggling families that can’t afford the fully adjusted payments.

“With home foreclosures rising in every region of the country, Freddie Mac’s action could not be more timely,” said Martin Eakes, chief executive of the Center for Responsible Lending, which said the loans “have been pushing millions of homeowners into foreclosure.”

ACC Capital Holdings Inc., the Orange-based holding company for Ameriquest and Argent Mortgage Co., is an example of the heavy damage sustained over the last two years by sub-prime lenders. The privately held company recorded a profit of $1.34 billion for 2004, according to financial reports obtained by the Los Angeles Times. As the market boomed, the Ameriquest companies had become the biggest sub-prime lenders of all.

As the housing boom slowed and competition intensified, ACC Capital’s earnings fell to $257 million in 2005. Last year, after it paid $325 million to settle predatory lending charges in 49 states, it had fallen to seventh place among sub-prime lenders.

Its most recent financial statements couldn’t be obtained. But analyst Matthew Howlett of Fox-Pitt Kelton said he had spoken with potential buyers who were put off by what they termed huge recent losses and the potential for more deficits.

In a statement Tuesday, Ameriquest spokesman Christopher Orlando acknowledged that the company, as widely reported, “is exploring strategic alternatives.”

“That process is progressing well,” he said. “We’re in the advanced stages of negotiations with a potential partner.” He declined to elaborate and wouldn’t say whether Howlett’s account of losses was correct.

Howlett said the sorry state of independent sub-prime lenders was partly caused by their dependence on Wall Street firms that provide the funds to lend, buy the loans and fashion mortgage-backed securities out of them.

With short-term interest rates back up, those big banking firms are charging more for money to loan. Also, they are paying less for loans and forcing the original lenders to buy back huge numbers of new loans that have fallen quickly into default, Howlett said. Such early-payment defaults occurred at a faster pace in 2006 than ever before.

“You’re relying on people who are willing just to run any time there are fears of credit losses,” he said. “It’s a weakness in the business model.”

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