KeyCorp, which largely abandoned the mortgage business two years ago as profits lagged, is seeking to jump in again in a big way-this time as a lender to people with tarnished credit records.
The Cleveland-based banking company has targeted as acquisition candidates Option One Mortgage, a unit of Fleet Financial Group, and Champion Mortgage Holdings Corp., investment bankers say. The two companies, which cater to homeowners with impaired credit, have both been put on the block in recent months.
If it is successful in buying either company, KeyCorp would become the largest company yet to make so complete a transition from prime to subprime lending. Many lenders have been attracted to the subprime sector because of the higher margins these loans offer.
KeyCorp would not comment on its interest in any specific company. But James Downing, chief executive officer of Key Finance Inc., KeyCorp's consumer finance arm, said the company was firmly committed to subprime acquisitions.
"Anything that gets us faster and cheaper to where we want to be is an acquisition candidate," Mr. Downing said in a telephone interview Tuesday.
KeyCorp shed the bulk of its conventional mortgage origination and servicing operations in early 1995. It still originates loans through its bank branches but sells them to Countrywide Credit Industries, Pasadena, Calif.
"Traditional mortgage banking is a difficult way to make money these days," Mr. Downing said. In addition to shopping for subprime companies, Key Finance is in the process of rolling out its own wholesale subprime originations unit. Its fundings should reach $500 million this year, Mr. Downing said.
Several different banks are doing due diligence on Option One, one investment banker said, but KeyCorp is leading the pack.
Observers are mixed about whether now is a good time to be acquiring a subprime lender. Recent blowups in subprime auto lending have raised eyebrows. But the stock prices of many of the subprime mortgage companies have fallen dramatically, making them potential bargains.
Analysts are recommending that banks proceed with caution. "Done correctly, this could be a very profitable business. But at this stage of the economic cycle, it is also a higher-risk strategy," said Sandra J. Flannigan, an analyst with Merrill Lynch & Co.
A recession would hit the already-stressed subprime borrowers hardest, potentially raising delinquencies and defaults.
Despite the cautions, KeyCorp stands by its commitment to the sector. "While there will be credit cycles and interest rate cycles that make (the subprime) sector more or less lucrative, at the end of the day these companies are very appealing because of the margins and the growth," Mr. Downing said.
The prevalent market qualms about subprime lending are temporary, he added. "I'm not making light of the skepticism, but there are always times when a particular industry gets scrutinized."
Currently, the bulk of KeyCorp's subprime loan volume comes from automobile financing. The company purchased AutoFinance Group in 1995. The unit originated $290 million in subprime auto loans in 1996. And in March, KeyCorp allied with Chicago-based St. Paul Bank for Savings. Key AutoFinance will purchase and service nonprime auto loans that St. Paul originates.
The subprime home lending division, which officially opened its doors late last year, has yet to book substantial volume. "Home equity is an area where (KeyCorp) would like to build," Ms. Flannigan said.
Option One, which has been for sale since January, could be part of that expansion. A spokeswoman for Fleet Financial said some companies have performed due diligence on Option One, but no definitive agreements have been signed. In addition to Key, First Union Corp. and NationsBank Corp. are said to be looking at Option One. Neither company would comment.
Fleet solicited bids from 35 financial institutions but received only a handful of replies, said an analyst who follows subprime lenders. Fleet was reportedly asking $300 million. In 1996, Option One funded $1 billion in subprime mortgage loans. The company has a $1.9 billion servicing portfolio.
According to Fleet's recent 10-K filing, Option One had net revenues last year of $53 million. Fleet officials have said Option One was profitable.
Champion, based in Parsippany, N.J., filed for an initial public offering earlier this year. The filing, observers said, may be a ploy to increase Champion's price to prospective acquirers.
Analysts expect the company to fetch $300 million to $400 million in a sale. Champion originated $550 million last year through 15 retail branches in the Northeast.