The Subprime Story's Latest Chapter: 11

As New Century joins other subprime lenders in bankruptcy, some players are hunting for alternative funding

by Sonja Ryst and Justin Bachman

New Century Financial's tumble into bankruptcy court shocked few observers of the swift shakeout in subprime lending. Far more surprising could be the industry's difficulties in soothing nervous investors.

New Century, once the second-largest lender in the category of home mortgages for those with checkered credit histories, stopped writing new loans last month, signaling to many the demise of the company's business prospects. On Apr. 2, it filed for Chapter 11 protection in Delaware and laid off 3,200 workers—more than half its staff—"to better align the company's cost structure with the current operating environment and to properly size these businesses in preparation for possible sale," the Irvine (Calif.) company said in a news release.

"The decision to pursue the sale of the company's assets and operations through the bankruptcy process was a difficult but appropriate decision for our board to make," New Century Chief Executive Officer Brad Morrice said in the Apr. 2 announcement. "This was a very hard step for me personally and clearly not the outcome I would have preferred."

Turning to Hedge Funds

The fall of the industry's biggest player to date underscores the market's tough posture toward the whole field in the current era of rising defaults and shaky housing prices (see BusinessWeek.com, 3/14/07, "The Mounting Uncertainty Over Subprime"). "I would say to you that no matter what a NovaStar or a New Century might say to me, I don't think I'd be reassured," says Theodore Kovaleff, a senior bank and thrift analyst at Sky Capital.

That's a sentiment shared by numerous investors. Officials at mortgage lenders are fighting back in several ways. In a new bid for funding, some lenders are turning to hedge funds. Accredited Home Lenders Holding (LEND) said Apr. 2 it has obtained a $230 million loan from Farallon Capital Management. The fund, operated from San Francisco, will be able to buy 3.23 million Accredited shares for $10 as part of the deal. Company shares closed Apr. 2 at $8.48, down 8.5%. Through a spokeswoman, Farallon officials declined to comment.

Shares of San Diego-based Accredited dipped in aftermarket trading on news that its auditor had resigned, then rebounded 4% on news of the financing from Farallon. Accredited said it also has $350 million cash on hand as it works to bolster its liquidity. The company originated $1.8 billion worth of new loans in the first quarter of 2007.

Credit-Crunch Creep

Other lenders, such as Fremont General (FMT), are trying to reassure investors by disassociating themselves from the high-risk lending market as much as possible. And most are promising not to repeat their earlier mistakes and finally taking steps to tighten their lending practices, in the hope of shoring up investors' sapped confidence.

In a further troubling sign that the subprime crisis could be spreading up the mortgage food chain, M&T Bank (MTB) said in a Mar. 30 regulatory filing that it had found less investor interest for so-called Alt-A loans. That product typically falls between prime and subprime mortgages, requiring less documented information from the borrower. "At a recent auction of such loans, fewer bids than normal were received and the pricing of those bids was lower than expected," the Buffalo-based bank said in a statement. As a result, M&T said it expects first-quarter earnings to fall below Wall Street's current expectation of $1.86 per share. M&T shares fell 8.5%, to $105.95, on Apr. 2, setting a new 52-week low.