Fremont Finds Success in Move to Subprime Lending
By LAURENCE DARMIENTO
Fremont General Corp.'s headlong jump into subprime lending appears to be paying off.
The Santa Monica company, which sold off its money-losing workers' compensation unit earlier this year to concentrate on financial services, posted a whopping 91 percent gain in net income for the third quarter.
This came after the company pumped up the volume of its residential real estate loans in the controversial subprime lending market, where borrowers with dicey credit histories pay a premium for mortgages.
That market can be profitable but also can lead to big losses, and companies that service it have been attacked as predatory lenders who take advantage of poor, desperate and often minority borrowers.
"They are definitely generating good cash returns," said Robert Robotti, president of Robotti & Co., a Wall Street investment boutique who had been critical of the company's makeover. "But underneath there are still some risks if there is an economic slowdown."
The company reported net income of $30.5 million for the third quarter ended Sept. 30, compared with $16 million for the like period a year ago. Revenues were $111.3 million vs. $102.5.
Just two years ago, Fremont was the second-largest private workers' compensation underwriter in California in the highly competitive workers' compensation market, which had been deregulated in the mid 1990s. But in a race to gain market share, the company lost $547.4 million in 2000 and exited the business, selling that unit to Employers Insurance Co. of Nevada.
It has instead focused on growing Fremont Investment & Loan, a California-based bank that makes both commercial and subprime residential real estate loans nationwide. That growth has focused on the residential side of the market.
The bank wrote $1.75 billion in residential real estate loans in the third quarter, compared with $911.6 million for the like period a year earlier.
Like many retail lenders, Fremont does not hold onto its loans but either sells them wholesale or transforms them into securities, shifting all or a substantial portion of the risk to others. The company earned $54.9 million in the third quarter selling its loans, compared to $15.2 million a year ago.
Fremont also saw earnings growth from the spread between the cheap cost of its capital and the amount it charges borrowers in both the commercial and subprime markets. That spread grew to an annualized 5.08 percent in the third quarter from 4.33 percent a year earlier. As a result, its net interest income grew to $71.9 million from $52 million a year ago.
Robotti said the company is doing far better than he expected when they first announced their makeover early this year, but he fears that should home prices fall it could be harder for the company to sell its loans since foreclosures at that point could spell big losses for anyone holding the paper.
"One of the keys for them is that home values continue to rise," Robotti said.
However, Wayne Bailey, the company's chief financial officer, discounted such a scenario, saying that the company should not be lumped in with all other subprime lenders.
Fremont specializes in borrowers who are perhaps a little behind on credit card payments and are thus just shy of being considered prime borrowers. "We stay at the upper end of the market," he said.
Its borrowers are now paying in the 7 percent range for a mortgage, just a couple of points higher than a prime borrower.
The company also has a business plan that will allow it to pull back on its subprime lending should that market sour and focus on its commercial lending business, which involves writing bridge loans for renovation projects, he said.
Currently, that business has declined as new commercial construction has slowed amid concerns over the economy.
Still, there is little enthusiasm on Wall Street for subprime lenders.
Fremont has lost nearly all analyst coverage since it made itself over as a subprime lender and was trading last week at just over $4 a share, down from its 52-week high of $7.90 in late December. Its price-to-earnings ratio also dipped to $3.80 last week.
The market's ho-hum response to subprime lenders has been reflected in the $16.5 billion sale of Household International Inc. to HSBC Holdings PLC, the London-based banking giant, earlier this month.
Analysts questioned the sale, noting that the economy may be slowing at the same time consumer debt has skyrocketed and the housing market appears to have hit its peak. There were also concerns that the sale could expose HSBC to Household's problems over predatory lending.
The company has been accused of hiding the high rates it charges for loans, and has set aside $525 million to cover the costs of settlements and related expenses.
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