Two specialty finance firms declared massive charges late last week, and the founder of one of them resigned, sending a jolt though the entire sector.
Green Tree Financial Corp., the leader in the manufactured home lending business and one of the pillars of the nonbank lending community, said Thursday night that it was adding $125 million to $150 million in reserves to offset rising loan prepayments.
And early Friday morning Cityscape Financial Corp., a high-flying subprime mortgage lender that has crashed to earth this year, announced a pretax charge of $95.1 million and the resignation of chief executive and founder Robert Grosser.
The one-two punch sent stock prices in the sector tumbling, raising fears that the same problems may be pervasive.
"The market has very little confidence with anyone in the sector at this point," said analyst E. Reilly Tierney, Fox Pitt Kelton. "It's just one thing after another."
An additional hit-a downgrade of United Cos., a subprime mortgage lender based in Baton Rouge, La., by Lehman Brothers analyst Tom Facciola on Friday-deepened the gloom.
The Green Tree charge, especially, struck fear in investors' hearts. Specialty finance companies assume loans will be sold at a profit. A rise in prepayments can force a change in accounting assumptions, however, and take a big bite out of earnings.
And prepayments are rising across the industry as lenders fiercely compete for business.
Tellingly, normally close-lipped Green Tree executives disclosed details of its gain-on-sale assumptions during a conference call, Mr. Tierney said. "No one can get away with hiding assumptions (from investors) anymore," he said.
Piper Jaffray immediately cut its rating on Green Tree, and reduced its 12-month price target from $58 to $40-$42. Green Tree's share price fell more than 25% on Friday, to $32.75-a $7.625 drop.
Oddly, Cityscape was one of the few specialty finance companies whose shares closed up. The Elmsford, N.Y.-based company's long awaited third- quarter earnings announcement Friday included a restructuring plan that analysts grudgingly admitted might work. Shares were up 28 cents, to $1.75.
New companies have flooded into the specialty finance market in the past few years, lured by high profit margins and helped along by Wall Street's willingness to provide capital.
Cityscape's crisis is an example of an inexperienced company growing too big, too fast, said an executive at another subprime lender.
The company will eschew securitization for less costly but less profitable whole loan sales, announced new chief executive Steve M. Miller.
Mr. Miller, 41, was Cityscape's securitization head. Previously, he was a senior vice president at Greenwich Capital Markets' asset-backed group.
Cityscape announced a $70.7 million net loss for the quarter, or $2.18 per share.
"Constant external pressures and issues within from rating agencies, capital markets, regulatory authorities, and press had devastating effects," said Mr. Miller during a conference call with analysts.
The resulting crisis of confidence in the capital markets eliminated Cityscape's ability to access funds "virtually overnight," Mr. Miller said. Instead, the company will sell off loans to raise capital.
For Mr. Grosser, the company's former chief executive and co-founder, Cityscape's endurance is unquestioned. "These changes will ensure long term value for the firm," he said. "I have the utmost faith in the company."
Mr. Grosser, who retains about four million shares of Cityscape stock, said he has made no plans for the immediate future.
