Competitive pressure and investor fears appear to be behind the homebuilder Centex Corp.’s recent decision to explore “strategic alternatives” for its subprime unit, Centex Home Equity Co. LLC, some observers say.
But the Dallas builder says it is happy with the prime-focused CTX Mortgage Co. LLC, which finances three quarters of its home sales — even though it faces similar issues and has lower margins.
The prime loan operation is “very strategic to our core homebuilding business” for customer service reasons, said Leldon E. Echols, Centex’s chief financial officer, in an interview Monday.
But the subprime unit — like construction products, manufactured housing, and other businesses Centex has divested — is not so “core,” Mr. Echols said
Centex entered subprime lending in 1997, and the unit “simply reached a maturity level” at which it would do better with a more dedicated parent, he said. The possibilities include sale and a joint venture.
The builder announced Sept. 18 that it would weigh its options for the subprime unit. It retained Goldman, Sachs & Co. for advice.
Most of the large publicly traded builders have lending units or ventures, but Centex is unique among them in having a subprime unit. It has amassed a portfolio of loans and securitization residuals from the unit. “If we were to divest ourselves of the business, it would be the full business,” Mr. Echols said.
Centex Home Equity originates loans through retail offices, a consumer-direct channel, brokers, and correspondents, and it services most of them. CTX Mortgage has referred nonprime prospects to Cendant Home Equity, and would look for a situation where it could continue to do so, Mr. Echols said.
Pricing pressure, lower volume, and demand for niche products have caused other builders to rethink their mortgage businesses, sources said.
This month KB Home of Los Angeles sold its mortgage unit to Countrywide Financial Corp., and entered into a fifty-fifty venture, Countrywide KB Home Loans. KB Home said it wanted to tap Countrywide’s array of lending programs. (In July the KB unit reached a $3.2 million settlement with HUD over 13 alleged violations.)
Operating earnings of Centex’s subprime unit jumped 68% in the fiscal year that ended March 31, to $108.4 million, as revenue rose 30%. Growth slowed in the first quarter of the current fiscal year, but the subprime and prime units both remained profitable. In suprime, originations slipped 2.7% from a year earlier, to $1.4 billion; revenue rose 18.3%, and operating earnings 7.4%. In prime lending, originations rose 9.1%, revenue edged up 0.8%, and operating earnings fell by a third.
Centex blamed competition, and smaller loan balances, for the drop in subprime volume. Margins and volume remain stronger in subprime than in prime industry- wide, and Mr. Echols said the subprime unit is “consistently strong.”
But the nonprime business is clearly under pressure. On Friday, for example, New Century Financial Corp. issued its second profit warning in as many months.
In the spring, Jay Bray, Centex Home Equity’s CFO, voiced concerns about underwriting trends. Investors that take mortgage credit risk could one day “quickly realize that some of these decisions are not being prudently made,” he said at a conference in Las Vegas.
In a note last week, Gregory E. Gieber, an A.G. Edwards & Sons Inc. analyst, wrote that “the problem that many homebuilder investors and analysts have had with … [Centex Home Equity] is that it is a business we often don’t understand well.”
One worry, he wrote, is the potential for credit challenges next year when adjustable rates reset on a crop of subprime loans. On March 31, Centex held $9.3 billion of Centex Home Equity loans, according to Mr. Gieber, who wants it to also give up on prime lending.
Todd Vencil of BB&T Capital Markets wrote that though Centex Home Equity is “well run and fairly low-risk … the market penalizes Centex for owning it.”
