H&R Block sells subprime mortgage unit

updated 4:39 p.m. ET April 20, 2007

KANSAS CITY, Mo. - After three weeks of speculation, H&R Block Inc. made good Friday on a promise to offload its struggling mortgage lending business, agreeing to sell Option One Mortgage Corp. to a private equity firm.

But the continuing decline of the subprime mortgage market, which provides money for people with poor credit, will cost Kansas City-based H&R Block.

Cerberus Capital Management LP’s newly formed subsidiary, OOMB Acquisition Corp., will buy Option One for the value of Option One’s net assets minus $300 million.

The final price of the sale won’t be determined until the deal closes in H&R Block’s second quarter, ending Oct. 31.

H&R Block Chief Executive Officer Mark Ernst told analysts that even at the discounted price, he was glad to have reached a deal.

“Given the significant changes in the subprime market, we’re pleased with the outcome, including the opportunity to share in the upside of Option One’s performance over the 18 months following closing,” he said, referring to an “earnout” of up to $300 million in loan origination sales that H&R Block will receive as part of the deal.

Ernst reminded investors that the unit had once been a big money maker for the nation’s largest tax preparer, generating a total of $2.8 billion in pretax profits.

“Option One has been a very successful business for H&R Block shareholders over the last nine years,” he said.

But times have changed.

H&R Block said it expected a full-year loss because of a one-time, $290 million to $320 million charge reflecting the diminished value of Option One.

Lenders in the subprime sector have been buffeted by defaults brought on by falling home prices and higher interest rates. Many of Option One’s competitors have gone bankrupt or pulled out of the business, and the Irvine, Calif.-based company itself has been forced to slash its work force and offices.

H&R Block said it will also shutter a mortgage unit that sells loans to retail customers, taking a pretax charge of $25 million for severance and closing costs and an additional $16 million for impairment to goodwill.

Rating service Fitch said it thought the sale was good news, although it did not plan to change its ratings for H&R Block’s debt.

“While the economics of the transaction are not as attractive as they would have been should the mortgage business have been sold 12 to 18 months ago, Fitch believes that the sale of Option One will benefit (H&R Block) in the long run, as it will remove the cyclicality risk inherent in the mortgage business, and will provide management the opportunity to focus attention on the core tax business, which has historically been a consistent performer,” the service said in a research note.

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