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Troubles for sub-prime lenders grow

New Century discloses a federal criminal probe, and Fremont says it is exiting the business. Regulators propose stricter guidelines.

March 03, 2007|E. Scott Reckard and Jonathan Peterson | Times Staff Writers

The meltdown in the business of high-cost mortgages to high-risk borrowers accelerated Friday as one major lender revealed that it was under federal criminal investigation and a second said it would quit the business after regulators accused it of making too many loans likely to end in foreclosure.

As bankruptcies, forced sales, huge loan losses and tumbling stock prices have roiled this sub-prime lending industry, fears that its woes would infect the housing markets and the broader economy contributed to this week's huge sell-off on Wall Street.

Federal regulators, meantime, on Friday proposed stricter guidelines for government-insured banks and thrifts that make such loans, to ensure that they go only to people who can afford them for the long haul.

"It's about time, don't you think?" Edward Leamer, director of economic forecasts at UCLA, said of the proposed rules.

Leamer expressed concern that the sub-prime sector's troubles could spread to the prime loan market for more creditworthy borrowers. What's more, the shrinking availability of sub-prime mortgages and rising defaults on existing loans will contribute to a likely decline in housing prices for the immediate future, he said.

The criminal investigation disclosed Friday focuses on how New Century Financial Corp. of Irvine accounted for losses when it was forced to buy back soured loans last year, and whether its executives profited by selling stock while misleading other shareholders.

The company disclosed the probe after the close of regular trading, during which its shares fell $1.20 to $14.65. Shares plummeted nearly 25% in after-hours trading to $11.02.

New Century, the largest independent sub-prime lender, shocked Wall Street last month when it said that it would restate results for the last year, erasing $268 million in profit it had reported.

Shareholder lawsuits accuse the company's officers and directors of selling stock for more than $26 million at falsely inflated levels. A company spokeswoman had said Thursday that it would defend the civil suits vigorously. She declined to elaborate on a company filing with the Securities and Exchange Commission that described the U.S. attorney's office criminal probe of its accounting and trading practices. The company said its own audit committee and the SEC also were investigating.

Federal regulators already have leveled civil accusations against the No. 2 independent sub-prime lender, Fremont General Corp. of Santa Monica.

Fremont disclosed Friday in an SEC filing that the Federal Deposit Insurance Corp. would sanction its bank subsidiary, Brea-based Fremont Investment & Loan, for failing to control the risks inherent in sub-prime lending and in its second major business, commercial real estate construction loans.

The company said it had decided to quit sub-prime lending entirely and was "engaged in discussions with various parties regarding the sale of the business."

The FDIC said Fremont failed to make proper allowances for its "large volume of poor quality loans" and operated with inadequate capital. The regulator said Fremont had increased defaults by selling loans with low "teaser" rates without verifying whether borrowers could afford the eventual full payments.

Fremont announced the sanction after the close of regular trading, where its shares fell 39 cents to $8.71. Shares tumbled 19% to $7.03 after the bell.

The FDIC also criticized Fremont loans that it said would have to be refinanced repeatedly to avoid foreclosure, and loans at or above 100% of the home's value.

Fremont said it expected to agree to a cease-and-desist order from the FDIC that would severely restrict its control over the sub-prime business. It said it would report a loss because of increased provisions for bad loans, but hadn't yet determined the size of the deficit.

Both Fremont and New Century made their disclosures in formal notices to the SEC that they were unable to meet the deadline for filing their 10-K annual reports. Yet another big independent sub-prime lender, Accredited Home Lenders Holding Co. of San Diego, also missed the filing deadline, citing the difficulties it was having in digesting its acquisition of rival Aames Home Loans of Los Angeles. It said its earnings for the year would drop at least $100 million below the $155 million it earned the previous year.

The move to stricter standards by regulators mirrors a general tightening of lending standards that loan buyers have forced on the industry. This contraction follows several years in which sub-prime borrowers, often applying online, were able to get loans without disclosing their incomes or making significant down payments.

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