Option One May Revise Deal with Cerberus

H&R Block conceded in its quarterly earnings statement what many had suspected in recent weeks: that a deal to sell Option One Mortgage Corp. to Cerberus Capital Management is in trouble.

As MSN went to press, H&R Block said certain closing conditions upon which the deal is contingent currently are not being met. Instead of a sale of the entire Irvine, Calif.-based Option One subsidiary, H&R Block said it is working on a deal to sell its servicing platform to Cerberus while H&R Block would then pursue "divesting or winding down" its loan origination business.

Already, H&R Block executives said the company has laid off some 615 Option One loan origination employees. About 400 remain on the staff.

H&R Block said it is "engaged in discussions" with Cerberus to modify terms of the proposed sale of Option One that was negotiated in May, before turmoil in the credit markets largely crippled the subprime mortgage origination business.

H&R Block said it is negotiating to waive a requirement that Option One fund $2 billion in loans within 60 days of closing and have a minimum of $8 billion in warehouse lines of credit.

In turn, H&R Block would be responsible for "divesting or winding down" Option One's remaining loan origination business.

Cerberus would continue its planned purchase of the Option One loan-servicing platform without the origination business.

H&R Block said it hopes to conclude the negotiations with Cerberus soon, but the company said it cannot be sure that it will reach an agreement to modify the original April agreement.

The company said it will have no further comment until the discussions are concluded.

The company said that Option One and related "discontinued businesses" lost $193 million in the quarter ending July 31.

It's easy to see why the business is in the red. H&R Block said that based on loan funding volume of $3.1 billion in the quarter, the business incurred losses from origination activities leading to a 586 basis point net loss on the gross margin of sales during the quarter.

"Given the unprecedented disruption in the credit markets, in August we took action to limit any more exposure to nonprime mortgage originations by stopping all but Fannie Mae and Freddie Mac-eligible loans," chairman and CEO Mark Ernst said in the company's earnings statement.

That and other changes scaled back the company's monthly loan origination flow to an estimated amount of $200 million, Mr. Ernst said in the company's conference call. The company expects to take further charges related to the closing down of the home loan origination unit.

While the mortgage origination business improved in May and June, those improvements were reversed in July when changes in rating agency guidelines reduced the value of loans held in warehouse, according to Mr. Ernst. That made certain loan products unprofitable.

He said the company is taking steps to "simplify the company's business mix and sharpen our focus on our tax, accounting and related financial services businesses."

During the company's conference call, he said the company will not put shareholders at risk to sustain the volatile mortgage operation and that efforts to wind down or dispose of the origination unit will begin promptly.

He described current market conditions in the mortgage industry as "the most severe dislocation seen in years." (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com/