The decision to scrap the merger agreement between Farragut Mortgage and J.I. Kislak goes deeper than the accounting issues cited in the press release, accounting to sources.

Though various and complex, the factors that led to the dissolution of the merger agreement are mostly tied to Farragut's poor performance over the past several months. "It was just not the same deal now as it was in July." said a source.

Farragut's net worth has declined precipitously since the merger was announced in July, down to $8.2 million at the end of September from $12.5 million this summer.

Shrinking Portfolio

The company has been hard hit by prepayments to its servicing portfolio, which has declined from $1.6 billion in July to around $1.4 billion at the end of September.

As a result of this, had the merger gone through, Kislak would have controlled 92% to 94% of Farragut stock, up from the 89%) envisioned at the time of the merger, sources said.

Kislak Mortgage was also concerned that it was over-paying for Farrragut's originations network. "The thinking there was that it interest rates rise, they could see a falloff in originations. It just looked worse in December than in July," said a source close to the deal.

The official reason for the cancellation of the merger was "complications related to the companies' ability to account for the transaction as a pooling of interests," according to a press release.

Alternative Was Costlier

A pooling-of-interests accounting treatment was important to the merger because a purchase treatment, the alternative, creates a higher cost basis for the transaction, thus acting as a drag on earnings, said Stephen Dickmann, president of Farragut.

Mr. Dickmann was made president of Farragut earlier this week, replacing acting president Thomas Gere. It was unclear whether Mr. Gere would remain with the company. "We would certainly hope that he stays." said George Begley, vice chairman.

With the Kistak merger now a thing of the past, Farragut has taken some steps to get its house in order. The company has retained Cohane Rafferty Securities Inc. to represent it in the sale of its servicing portfolio.

The company plans to use the proceeds of the sale to retire bank debt, according to Mr. Dickmann. Also, the sale will remove from the books all premiums paid for purchasing mortgage servicing rights.

Farragut will then go forward as primarily an originator of mortgages. "We intend to sell servicing rights as we create them," said Mr. Dickmann

No Access to Equity Markets

The fall-through of the merger leaves Kislak Mortgage without access to the equity markets. By merging with Farragut, which is listed on the American Stock Exchange, Kislak Mortgage would have been able to make a "back door initial public offering," according to sources.

Though Farragut's public status was a factor, according to Jay I. Kislak, chairman, it was not the main determining factor. Mr. Kislak pointed out that Farragut does not have a large market capitalization and that its stock is narrowly held.

Mr. Kislak also stated that the company remains committed to expansion and geographic diversification. He added that he expected that the company would want to access the debt or equity markets, "in one form or another," somewhere down the road.

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