By Mike Freeman
UNION-TRIBUNE STAFF WRITER
March 21, 2007

Troubled subprime mortgage firm Accredited Home Lenders has agreed to a $200 million loan from a San Francisco hedge fund that’s already one of the San Diego company’s largest shareholders.

The five-year loan from Farallon Funds could provide a lifeboat for Accredited to either survive the current liquidity crisis roiling the subprime business or be acquired.
But the financing didn’t come cheap. Farallon will receive a 13 percent interest rate on the loan, making it the corporate equivalent of a subprime residential mortgage.

Subprime lenders specialize in mortgage loans to borrowers with checkered credit, who usually pay higher interest rates and fees than borrowers with better credit would.

“It’s expensive, surely,” Morningstar analyst Ryan Lentell said. “But I don’t think it’s completely ridiculous given the situation the company is in.”

In addition to the high interest rate, Farallon will receive warrants to buy 3.3 million shares of Accredited stock at $10 a share. The warrants are good for 10 years.

Farallon and its affiliates own 1.75 million shares of Accredited stock, or nearly 7 percent of the company. The hedge fund declined to comment.

Accredited shares, which have been whipsawed in recent weeks by the turmoil in the subprime industry, gained $1.82, or 20 percent, to close at $10.77 yesterday.

Dozens of subprime lenders have melted down in the past few weeks under the weight of bad loans. The Mortgage Bankers Association said subprime loan defaults had risen to 13.3 percent – almost three times higher than the overall default percentage, which includes prime borrowers with good credit scores as well as subprime.

During the housing boom, subprime lenders loosened their lending standards to allow more borrowers with checkered credit to qualify for mortgages. Subprime loans surged from 10 percent of the overall mortgage market in 1998 to 23 percent in 2005.

But with home prices now stagnant or falling, these risky borrowers are having trouble making payments. Investors who purchased subprime mortgages on the secondary market often require lenders to buy them back if they default early in their terms.

Moreover, the prices secondary market investors are now willing to pay for subprime mortgages is less than it costs to originate the loans. Accredited sold a package of $2.7 billion in loans last week for a $150 million loss.

Consequently, subprime lenders face a credit crunch as they burn cash to buy back deadbeat loans from investors while being unable to sell the loans at a profit.

More than 30 subprime lenders have quit the business, sold to other companies or filed for bankruptcy.

Accredited is considered one of the stronger subprime companies, said Jerry Bruni, president and chief investment officer of J.V. Bruni & Co., a Colorado Springs investment firm that owns Accredited shares. He invested in the company about a year ago because he felt Accredited stood the best chance to capitalize from an industry shakeout that eliminated competitors.

“The issue that remains now is whether or not Accredited will be in a position to take advantage of a much-improved industry environment,” he said.

Bruni was careful about drawing too many conclusions about the Farallon loan. But he said the 3.3 million warrants for Accredited stock signals that Farallon sees potential value in the shares.

“That is a lot of money to lend somebody in a rapidly evolving environment,” Bruni said. “It suggests there’s a reasoned expectation of a return, and it suggests some amount of due diligence on their part that went beyond the public documents.”

In a research report, Piper Jaffray analyst Robert Napoli wrote that the Farallon loan will help but won’t be enough. He said it’s not clear how much more money Accredited needs to keep operating and financing mortgage loans.

Meanwhile, Wells Fargo & Co., the second-biggest U.S. mortgage lender, is cutting more than 500 jobs in its home-loan division after tightening lending standards for its riskiest borrowers last month.

Employees in its Tempe office were told last month that 121 jobs would be trimmed there, on top of 70 cuts announced in November, Wells Fargo spokeswoman Debora Blume said today.

They join 71 positions being cut in Concord, she said. On March 7, the lender confirmed in a statement that it had slated more than 250 mortgage-related job cuts in Fort Mill, S.C.

The Associated Press and Bloomberg News contributed to this report.