For an idea of what can go wrong in the subprime mortgage sector, consider Mego Mortgage.
Mego, based in Atlanta, is one of myriad subprime lenders to run into problems in recent quarters after their accounting assumptions proved too optimistic.
Subprime lending, or making loans to borrowers with past credit problems, has attracted banks and nonbanks alike in recent years. Lenders are drawn to the high profit margins, which are often offset by high volatility.
While other lenders appear to have escaped with only a damaging quarter, Mego's survival may now be in question, the company said last week. The company's announcement last week that it may not be able to stay in business is the latest turn in an 18-month struggle to stay afloat.
CIBC Oppenheimer took Mego Mortgage public in November 1996 with a $28 million offering priced at $14 a share. Since then, the company's stock price has headed almost consistently downward, reaching a low of $2 on May 21.
Putnam Investments, the company's largest stockholder, sold more than one million shares last May, sending Mego stock down 20% and raising questions among other investors.
In September 1997, the company's parent, Mego Financial Corp., a Las Vegas-based time-share financier, sold off its 80% stake. Since then, Mego shares have fallen 65%.
Jeffrey Moore, then chief operating officer, was made chief executive of the company, succeeding Jerome Cohen.
Mego had said Dec. 8 that it would have to take a $16 million charge to cover loan pools that were paying off faster than expected.
The company had been buying loans from two smaller lenders who were rapidly refinancing the loans, to collect fees from borrowers. The aggressive refinancing violated the lender contracts with Mego, and threw off Mego's prepayment assumption. Mego, which already had securitized these loans, was on the hook for the loss of principal and interest income on the loans.
Ditech Lending, Los Angeles, was said by some analysts to be one of the two smaller lenders.
Other lenders in the sector, including Green Tree Financial Corp., St. Paul, took much larger writedowns for the same reason.
Earlier this year, Mego's planned merger with Westmont Capital Group, a newly formed high-loan-to-value lender, had to be called off when Westmont's financing was pulled.
Mego said May 21 that it would incur an additional $12 million loss for the six months ended Feb. 28, for a total loss of $32 million.
But despite the seeming hopelessness of Mego's situation, the company's stock has yet to go to zero. The investment house Friedman Billings Ramsey has the most to lose if Mego goes bankrupt. It owns 30% of the company's stock and is soliciting private investors for Mego.
The investment firm, which has maintained a "buy" rating on the stock since December, would not comment on its exposure.
Mego's chief executive is committed to keeping it in business.
The company's business strategy is to expand retail originations, Mr. Moore said. Once Friedman completes the private placement, Mego will have the capital to make acquisitions of retail originators.
"Our private placement is going very well," said Jeffrey Moore, chief executive of the company. Interest is "over what we had assumed" it would be, he said.
Mego has hired Champ Meyercord, Greenwich Capital's head of asset-backed securities, as a consultant to assist with strategic planning, Mr. Moore said.