H&R Block Posts Huge Option One MortgageLinked Loss

Tax preparation giant H&R Block lost $502 million in its fiscal second quarter, blaming the poor performance on its discontinued subprime mortgage unit, Option One Mortgage.

H&R Block is now trying to sell Option One’s $62.3 billion servicing business after a deal to sell the entire company to hedge fund giant Cerberus Capital fell apart.

By discontinuing Option One’s operations, Block took a total pretax loss of $551 million. Included in that number is a $252 million loss on the sale of $3 billion in whole loans. It also lost $123 million due to mortgage related impairment charges tied to mortgage and servicing assets.

H&R Block Take A $34 Million Option One Mortgage Loss

An affiliate of H&R Block, the publicly traded parent of subprime giant Option One Mortgage, has tapped a $250 million credit facility, citing deteriorating conditions in the commercial paper market.

The loan is the responsibility of Block Financial Group, a subsidiary of H&R Block. The tax preparation giant is trying to sell Option One.

In a new filing with the Securities and Exchange Commission, Block cites, as one of its risks, the uncertainty surrounding the sale. Hedge fund giant Cerberus Capital has agreed to buy Option One, but it recently threw its existing subprime unit, Aegis Mortgage, into bankruptcy.

Option One Mortgage has trimmed 185 account executives from its work force as part of a restructuring plan, reporting that more cuts may lie ahead.

Meanwhile, the nation’s third-largest subprime mortgage lender said the sale of the company to hedge fund [tag-cat}Cerberus Capital[/tag-cat] is moving forward and still may close by Oct. 31, the end of its fiscal second quarter. There has been speculation in the market that Cerberus may be getting cold feet in regard to Option One.

Earlier in the week, the Cerberus-owned Aegis Mortgage of Houston stopped funding loans and trimmed hundreds of workers. In May, Option One announced plans to close 12 mortgage processing offices and trim 600 workers by early September.

In April Cerberus agreed to pay just shy of $1 billion in cash for Option One, but the price is based on Option One’s net asset value, which has dropped during the nation’s subprime crisis.

Analysis and Discussion with Joseph Mason, Professor of Finance at Drexel University about Subprime Shockwaves: Accredited Home Lenders, MBIA, Bundesbank, Global Bank Earnings, Barclays, Credit Suisse, Bank of China, American Home

Wells Fargo Home Mortgage, the fifth-largest U.S. bank, on Monday said it stopped offering a popular subprime mortgage product in response to market and regulatory pressure.

The company in an e-mail said it ended on Friday retail offerings of so-called 2/28 loans, which was 65 percent of all subprime mortgages last year and the staple of the industry.

Payments on 2/28 adjustable rate mortgage (ARM) are based on rates that are fixed for two years and then are adjusted twice a year for the remaining 28, if the loan is not refinanced. Decisions were partly driven by the $583 billion market for subprime mortgage bonds, where sales rely on opinions of rating companies such as Moody’s Investors Service, Wells Fargo said.

Rating companies in the past two weeks have unleashed a flood of downgrades on subprime bonds in response to rising delinquencies and increased their assumptions of losses that new loans will produce. “These changes are being made to align our practices with industry guidance, as well as appropriately respond to recent downgrades by key ratings agencies regarding subprime bonds,” the San Francisco-based bank said in a statement. Wells Fargo Home Mortgage is in Des Moines, Iowa.

Many big lenders including Countrywide Financial Corp. Washington Mutual Inc. Merrill Lynch & Co.’s First Franklin and H&R Block Inc.’s Option One Mortgage have also said they would stop making 2/28s.

Irvine, California based Option One Mortgage Corp. has been sold to OOMC Acquisition Corp., a newly formed company affiliated with Cerberus Capital Management, L.P today.

Parent company H&R Block announced the definitive agreement this morning stating a softening market conditions and less desire for subprime mortgages from the secondary market.

The sale price consists of the value of the tangible net assets of the business at the date of closing, minus $300 million. Jan. 31, 2007, the tangible net assets of Option One were $1.27 billion. Contingent on Option One’s future net income from mortgage loan originations, H&R Block may also receive an additional cash payment in the form of an earn out.

Option One has originated $21 billion in loans during the first nine months of fiscal 2007. Option One is an leader in mortgage servicing, with a servicing volume of approximately $68 billion in non-prime mortgages at Jan. 31, 2007. In 2006 Option One Mortgage was among the nation’s 10 largest originators of non-prime residential mortgages with $40 billion in loan originations.

H&R Block has also committed to cease operations of H&R Block Mortgage their loan originator division dealing directly with the retail borrowers. H&R Block will continue to provide its retail tax and other clients with prime residential mortgage loans through H&R Block Bank, which began operations in May 2006.

Listen to a recorded conference call beginning at 10:00 a.m. EDT April 20 by dialing (888) 286-8010 (U.S./Canada) or (617) 801-6888 (international). The replay access code is 63164608.

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