Refi Boom Doesn't Guarantee Successful IPOs

The refinancing boom makes this a perfect time for private mortgage companies - especially those with strong origination networks - to go public, right?

Well, maybe not. The recent problems of subprime mortgage specialists have soured investors on mortgage companies in general, and the going has proved rough for one company that came to market a week ago.

"There is no differentiation in the marketplace right now between the high-quality and low-quality companies, and investors are staying away from the sector," said Ryan Jacob, an analyst with IPO Value Monitor.

Headlands Mortgage, a predominantly wholesale originator that wrote nearly $4 billion of mortgages last year, went public at $12 a share. The company had expected to price its shares at $14 to $16, but by Wednesday shares had barely budged from the initial offering price.

Observers said they don't expect a repeat of 1992 and 1993, when falling interest rates and large levels of refinances prompted nearly a dozen mortgage companies to go public.

Nearly two-thirds of Headlands' origination volume is from so-called alternative-A loans. Fannie Mae and Freddie Mac generally do not buy these types of mortgages, but analysts said they are not as risky as B or C loans.

Because Headlands also originates home equity loans, it is being tarred with the same brush as the subprime companies. At $12 a share, Headlands is trading at only six times its 1997 earnings. Analysts think such a low multiple is unjustified, but "investors think it could be another subprime accident waiting to happen," said portfolio manager Brian E. Divney.

Mr. Divney, who manages a fund for Society Hill Capital Management, Philadelphia, said Headlands shouldn't be lumped in with subprime companies because it also originates conventional mortgages and is much more conservative.

The horror stories in the subprime sector are well known. Green Tree Financial Corp. and United Companies Financial Corp. took writedowns because loans prepaid faster than expected. FirstPlus Financial Group announced it was eliminating gain-on-sale accounting and lowered earnings projections as a result.

Most of the stocks in this sector have been beaten down. FirstPlus is trading at only seven times expected earnings, and United Cos. is trading at a multiple of six. Contifinancial Corp. and Delta Financial Corp., two companies that have not reported accounting problems, are trading at eight and seven times expected earnings, respectively.

The one mortgage lender that has benefited from the refinance boom is Countrywide Credit Industries, the second-largest originator and servicer. Countrywide's shares have risen 11% since the beginning of the year and 41% since late October as rates have fallen. The Calabasas, Calif., lender is trading at about 17 times expected 1998 earnings.

Analysts said another reason not to expect many mortgage IPOs is that there aren't many private companies left. In the last few years, banks and thrifts have bought many of the independent public mortgage companies, including most of the ones that went public in 1992 and 1993.

But private mortgage lenders weren't the only companies that tapped the public market. In 1992, Fleet Financial Group sold stakes in its mortgage company to the public. The Boston bank bought back the shares in 1995.

Bank of New York filed to offer shares in its subsidiary, Arcs Mortgage Holding, but pulled back. Chase Manhattan Corp. mulled a spinoff of its mortgage unit as well.

Analysts said banks aren't likely to sell off their mortgage companies now because they view the servicing business as a means to cross-sell other products. "One major change is that now banks think of consumer lending as integrated businesses," said Gary Gordon, an analyst with PaineWebber. "It wouldn't make sense for banks to relinquish part of that business."

Bank stocks were trading at much lower multiples in 1992 and 1993 than they are now, Mr. Gordon added. Today banks don't have a compelling reason to sell shares in their mortgage companies because they would probably trade at a lower multiple than the bank.

Still, the one major mortgage initial public offering last year, HomeSide Inc., was a combination of two banks' mortgage companies. BankBoston Corp. and Barnett Banks Inc. merged their mortgage servicing units to create HomeSide. When HomeSide went public last year, the banks kept an ownership stake.

In October, National Australia Bank agreed to buy HomeSide for more than $1.2 billion. The deal closed this week. BankBoston said it recorded a $165 million gain on the sale of its HomeSide stake. NationsBank Corp., which bought Barnett last year, is expected to record a similar gain.

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