By JASON BOOTH

Staff Reporter

Aames Financial Corp. is trying to change its image.

The company that made a name for itself by selling mortgages to people with risky credit ratings is now attempting to reduce risk on its own balance sheet.

To do so, Aames announced on Jan. 28 a strategic shift in the way it makes money. Starting in the March quarter, the company will package the new mortgage loans it makes and sell them in their entirety for cash in most cases to mortgage real estate investment trusts.

The changes are intended to improve the financial stability of the company, and in turn, the price of its shares. The stock price has fallen from above $30 a share last March to the $12 range last week.

“Over the last six months there have been so many ups and downs with this stock that investors are exhausted,” said Sutro & Co. analyst Michael Abrahams.

Aames is a leader in the “sub-prime market,” which involves writing loans to people with shaky credit who put up their homes for equity. Until now, the company has been selling its mortgages as securities in the secondary market and retaining part of the interest paid on those loans.

Under the new system, Aames will sell the mortgages outright taking the origination fee and a premium when it sells the mortgage for cash. But it will no longer get a share of the interest payments on loans.

Because a larger proportion of future earnings will be in cash, Aames hopes to see improved cash flow. Plus, it will reduce its risk associated with write-downs due to increases in defaults or mortgage pre-payments, analysts said.

“It is a major issue for the company,” said Gareth Plank, analyst at UBS Securities in San Francisco. “They are trading risk for earnings. They will end up with a much more conservative company.”

Under the old strategy, the interest payments on the mortgages as well as the risks from defaults were split between Aames and other investors in the securitization.

Now, after the mortgages are sold, the buyer will receive all of the risk.

By selling its mortgages for cash, Aames should be able to put investors at greater ease. Under the old system, a significant portion of earnings were based on anticipated loan interest payments. But because Aames specialized in the sub-prime market, those earning projections were always considered suspect.

In the new strategy, the company will make less money on each loan sold, analysts said a profit of between 5 percent and 6 percent on the mortgages it sells for cash, compared with the 8.2 percent it was recently able to generate through securitizing the loans and selling them to investors.

Despite the announced change in strategy, the share price of Aames has remained relatively flat over the last few weeks.

Plank and Abrahams said the lack of investor response was understandable considering the double-edged nature of the announcement.

“Earnings will be cut, but the quality will increase, so you could say they cancel each other out in the minds of investors,”

Abrahams said.

Aames’ executives declined to estimate the impact the strategy will have on its earnings and share price.

But David Sklar, Aames’ chief financial officer, believes the change will make the company more popular with investors.

“It will give us a more positive cash low and put us in a position of strength in our sector,” he said.

In announcing the new strategy last month, the company disclosed that it is contemplating creating and spinning off a REIT that would buy the new mortgages.

“While this change will have a negative impact on earnings, it will improve the quality of those earnings and strengthen our balance sheet,” Cary Thompson, Aames’ chief executive, said in a statement. “By reducing our reliance on non-cash gain on sales accounting and relying principally on cash whole loan sales, we will build a stronger company with positive cash flow, which is in the best long-term interest for our shareholders.”

Aames is hardly alone. The stock price for other sub-prime lenders has also languished as investors worry about bad loans.

The risk of such loans was reflected in Aames’ 1997 results. In the year ended June 30, provisions for loan losses rose 300 percent, to $34 million. The company said that was a reflection of its issuing loans with higher loan-to-value ratios, which exposes the company to greater risk.

During that same period, the company saw revenues increase 82 percent to $272 million, due in large part to a doubling in the amount of loan originations.

However, net income fell more than 40 percent to $17 million due to the increased loan-loss provisions and other expenses. For example, the acquisition of retail loan-office chain One Stop Mortgage Inc. in August entails a one-time charge of $28 million.

The company has also seen some shake-ups at the corporate level. In November, Chairman Gary Judis, who had been president of Aames since 1982, resigned from the board, along with Joseph R. Cerrell. At the same time, David Sklar succeeded Gregory Witherspoon as chief financial officer.