What Would You Pay to Avoid a Mortgage Play?

LEND's a total microcosm for this moment, right down to its symbol! I am talking about Accredited Home Lenders (LEND) , which originated about a billion dollars a month in loans to people with less-than-perfect credit. The company is no fly-by-night; its executives, having survived the S&L crisis, have been lending this way for years with no real problems. Of course, when housing appreciation got taken off the table and the home equity piggybacks on top of teaser rates became the rage, the company stumbled and the stock got smashed. Somehow the company was able to get Lone Star, a private-equity firm, to pony up $15.10 a share in June and the deal was supposed to close this week.

We all know now how Lone Star balked, citing drastic deterioration in the Accredited book of business. But before you think that Accredited isn't owed anything, read the fine print. The deal can't be called off for deterioration, only for relative deterioration: are Accredited's nonperformers worse than the others in its cohort? The reality there is that the loans are actually in much better shape, with much lower defaults than almost anyone in this space, including half of what industry leader Countrywide Financial (CFC) is experiencing. Given that standard, one that Lone Star agreed to just a month and a half ago, I can't imagine how Lone Star won't be compelled to pay the shareholders the money, and the common stock might very well become the repository of that option.

Accredited will immediately go to a Delaware court to sue Lone Star for specific performance and I believe it will win, especially because that court doesn't like businesses welching on deals that they just entered on terms that were met. Of course, no one will believe what I just wrote. They will just look at Accredited and say, "It's over." I can't blame anyone. After all what business in is right might wants to pay $400 million right now to get into the mortgage loan origination business. In fact, I would rather pay $400 million not to get into the mortgage loan business, which is exactly what I think Lone Star is doing and why Accredited might be a terrific ticket on a contract's binding powers.

Put yourself in Lone Star's shoes. It knows it is obligated to pay $400 million to LEND's shareholders. It knows that if it buys the company, it will have to be self-funding for this period, so it will probably have to risk maybe $300 million to $400 million after the purchase to sustain Accredited. Why not just walk away from the company and pay the damages to the shareholders: $15.10 a share in damages, to be exact. It's better just to stop the bad trade than to drag it out. I know the Delaware law. I know that there is no way that a court won't agree with Accredited given that Lone Star just agreed to do this deal in June and the book of business at LEND has not fallen apart in the last month.

Is it outrageous what Lone Star has done? Nah, it's just real smart. But they won't get off scot-free and I believe that LEND today is a pretty good call, in my judgment.