Analysts have been urging specialty finance companies to reduce the premiums they pay for loans, but the first one to make the adjustment is taking it on the chin in the stock market.
Aames Financial Corp. said late Wednesday in its earnings announcement that it would be reducing bulk purchasing, which has come under fire from analysts as too expensive. Aames stock plummeted then 24.4%, to $11.625 by midday Friday.
Aames' move could cut its correspondent volume in half, said Jeffrey Evanson, a Piper Jaffray analyst who downgraded the stock on the news, reducing his rating to "hold." But Mr. Evanson added that Aames is "one of the smart companies-it will live to fight another day."
Bulk correspondent lending, in which one lender buys a large pool of closed loans from another, was touted during the last year as a low-cost way to get into the lucrative business of subprime mortgage lending. But prices for the bulk pools, often generated by small retail subprime mortgage shops, were driven up as competition for the product became increasingly sharp.
"We're looking at our pricing models ... and seeing that bulk prices are too high," said Gary Judis, chief executive of Aames. The company has not entirely eliminated its bulk business, he stressed.
Oppenheimer & Co. and Smith Barney & Co. released reports in late April pointing out the high cost of buying mortgage loans in bulk.
"At some point, companies will have to realize that this is not an economical way of doing business," wrote William Ryan, a Smith Barney analyst.
Employing a correspondent system worsens the need for capital, wrote Steven Eisman of Oppenheimer, who noted that capital available for these companies has been shrinking during this year's stock slide in the subprime sector.
Companies will have to pull back from this channel of origination, and that will cause loan volumeto decline, Mr. Eisman wrote. Aames Financial, Greentree Financial, and IMC Mortgage are all vulnerable because of their reliance on correspondent lending, he added.
But investors need to be aware of the difference between "flow" correspondent lending and "bulk" correspondent lending, said Mike Diana, an analyst at Bear, Stearns & Co. Flow correspondence, also known as "mini bulk," is still very lucrative, he added.
Mr. Diana maintained his "attractive" rating on Aames stock, saying that reducing its bulk business is "a smart move." Prudential Securities reiterated its "buy" rating on Aames.