H&R Block Inc., the biggest U.S. tax- preparation company, said it may shut a subprime-mortgage unit if sale negotiations with a hedge-fund manager collapse.
Cerberus Capital Management LP, which agreed in April to purchase the entire Option One Mortgage Corp. subsidiary, may buy just the loan-servicing business as demand for mortgages continues to deteriorate, H&R Block, based in Kansas City, Mo., said today in a statement. Failure to renegotiate terms of the sale would force H&R Block to close Option One, it said.
"The loan-originations market is in the midst of the most severe dislocation it has seen in years, maybe the most severe since the 1930s," Chief Executive Officer Mark Ernst, 49, said on a conference call with analysts. "We will not put H&R Block shareholder capital at risk to sustain a commercially unreasonable business."
Option One, which H&R Block bought in 1997, has generated more than $1 billion in losses for H&R Block in the past five quarters. The company today said its net loss almost doubled to $302.6 million for the fiscal first quarter, which ended July 31. Option One was responsible for about two-thirds of the total.
Under the original terms of the sale to Cerberus, which earlier this month was pushed back to December from October, H&R Block has to keep the unit running with cash infusions until the transaction closes. Investor demand for bonds backed by mortgages has dried up as defaults on subprime mortgages, made to the riskiest borrowers, increased. The crisis has shut off access to cash for companies such as Option One.
Fewer Loans
Ernst said Option One had cut lending by 80 percent to about $200 million a month, compared with about $1 billion a month before the crisis. While that violates the original sale agreement with Cerberus, H&R Block prefers risking the sale rather than continuing to make loans that investors don't want to buy, he said.
H&R Block fell 15 percent on the New York Stock Exchange this year through yesterday as mortgage losses offset income from the tax business and raised questions about the company's ability to sell Option One. The shares rose 32 cents, or 1.6 percent, to $19.82 in composite trading at 11:24 a.m.
Renegotiating the sale accord "could potentially accelerate the disposition of Option One, which should instantly improve" H&R Block's share price, said Scott Schneeberger, an analyst at CIBC World Markets Inc. in New York, in an Aug. 28 report.
Cost of Closure
If the accord is amended, H&R Block may incur certain costs to shut down parts of Option One, the company said, without elaborating. If there's no agreement on modifications, the original terms will remain in effect, H&R Block said.
"While H&R Block hopes to conclude these negotiations soon, the company cannot be sure that it will be able to do so," H&R Block said.
Other possible outcomes include waiving a condition that requires Option One to have $2 billion in loans at closing and $8 billion of credit lines, H&R Block said.
Discontinued operations, which include the mortgage unit being sold, had a net loss of $192.8 million in the first quarter, the company said. Option One, based in Irvine, California, was the nation's eighth-biggest seller last year of subprime mortgages. Such loans typically default about six times more often than conventional mortgages.
"Option One's bleeding won't stop until it's sold or shut down," Schneeberger said in an interview this week. "It would be better if they completed the sale urgently, forgoing the expectation of receiving any money for it."
Tax Unit
Losses excluding the mortgage unit were 34 cents a share, in line with the 35-cent average of seven analyst estimates compiled by Bloomberg. Revenue from continuing operations, which excludes Option One, rose 11 percent to $381.2 million, the company said. The tax-services unit lost $172.2 million in the quarter. H&R Block typically loses money in the first half of its fiscal year before the U.S. tax season starts.
Hedge fund manager Richard Breeden is running for the H&R Block board, accusing management of failing to do enough to reverse the share price decline. Board elections will take place during the annual shareholders' meeting next week.