H&R Block remains optimistic it can sell the subprime lender for a nice price. But the Street remains dubious
H&R Block (HRB) CEO Mark A. Ernst slapped a for-sale sign on Option One Mortgage Corp. back in November, confident he could get $1.3 billion. At a conference on Jan. 9 he assured investors that the subprime lending arm was "drawing strong interest from very sophisticated buyers." But as of mid-March, no formal bids have been announced and prospects look bleak.
Investment bankers familiar with the sale say big Wall Street players have taken a pass. Two weeks ago, top-tier private equity players started sniffing around, but the chances of a deal seem remote. "Nothing that has happened suggests it can sell Option One for anything approaching the $1.3 billion book value," says Gimme Credit analyst Kathleen Shanley.
H&R Block would not comment. But Ernst reiterated he would get top dollar for the mortgage unit on CNBC on Mar. 14. Wall Street remains doubtful: "He's out of touch with reality," says Ivan Feinseth of Matrix USA, a New York research shop.
Complicating matters, state regulators are cracking down. Option One voluntarily stopped doing business in Rhode Island after the state passed new predatory lending laws. Iowa enacted similar rules in February. Meanwhile, Minnesota's Commerce Dept. has started taking a closer look at the practices of subprime lenders, including Option One—a move, regulators say, prompted in part by a Dec. 25 BusinessWeek article on the problems of Option One customers Randy and Jennifer Rimstad of Minnetonka, Minn.
The worst-case scenario: States like Minnesota start issuing cease-and-desist letters that prohibit Option One from writing loans in those areas. Mortgage Lenders Network, based in Middletown, Conn., closed after, among other things, at least eight states handed out such orders. There's a similar pattern at New Century Financial, which was delisted from the New York Stock Exchange on Mar. 13. "It's a tough time to be selling," says Scott Schneeberger, an analyst with CIBC World Markets. (See BusinessWeek.com, 3/14/07, "The Mounting Uncertainty Over Subprime".)
The slide has been steep for Option One, which H&R Block bought for $218 million in 1997. For years it was the company's breadwinner, banking $2.8 billion of pretax earnings made largely during the housing boom from 2003 to 2005; at its peak, the group accounted for 60% of its parent's profits. But as the market has turned, the unit, which H&R Block now refers to as "discontinued operations," has soured. In the three months ending on Jan. 31, the mortgage business, largely Option One, posted a $162 million pretax loss, its third consecutive quarter in the red.
The losses couldn't have come at a worse time for H&R Block: Its primary business, tax preparation, has struggled in recent years. The stock has cratered by almost 20% since the beginning of February. "If the deal doesn't go through, the stock will be hit again," says Michael Millman, an analyst with the independent firm Soleil Securities.
Should H&R Block manage to find Option One a home, the buyer picks up a portfolio packed with risky borrowers like Eardine W. Ferrell of Lannett, Ala. The 71-year-old, who gets by largely on Social Security and odd jobs, saw the rate on her Option One mortgage jump from 9% in February, 2004, to 13.5% as of Mar. 1—doubling her monthly payment to $986. She says she simply doesn't have the money: "They ain't going to do nothing but take my house."