The merger of Aames Financial Corp. and Accredited Home Lenders - a move that is expected to create the sixth-largest subprime retail lender - is being called the first in an anticipated string of consolidations within the U.S. subprime mortgage lending industry, where participants continue to battle the higher cost of doing business. San Diego-based Accredited late last month announced plans to acquire Aames, a Los Angeles-based real estate investment trust for $340 million in cash and stock.

"We see this as a strategic consolidation in the sector ... and we would not be surprised if there are others to follow," said Jay Meyerson, chief executive of Aames, speaking during a conference call on the matter.

The deal will lift Aames out of a rut and will allow both companies greater funding and origination capacities. On top of increased securitization and whole loan sales, Accredited is independently working to increase a combined financing capacity of $7 billion by doubling the size of its ABCP warehouse facility to at least $2 billion, said Stuart Marvin, executive vice president at Accredited. The merger will also push Accredited - which, in 2005, originated 90% of its loans through its wholesale operations - further into the retail market. This transition will place the company in a less cost-competitive atmosphere, its executives say. The combination will create roughly an 80/20 split between wholesale and retail originations, respectively.

Securitization to rise

Over the last 10 years, Aames sold some $8 billion in real estate ABS, compared with about $10.5 billion from Accredited, according to Peter DiMartino, RBS Greenwich Capital's head of ABS and mortgage credit strategy. The combined entities are expected to produce larger securitizations, even though Aames will likely be increasing the portion of loans it sells on the whole loan market. Accredited intends to maintain both its quarterly securitization schedule and the portion of its loan production it typically securitizes - about 25% to 35%, Marvin said. The lender typically securitizes about $1 billion each quarter.

Post-merger combined securitizations between the two companies should save about $2.5 to $3 million each year, Marvin said, assuming an average cost per securitization of roughly $700,000. Combined securitizations will also produce tighter spreads for Aames, whose loans will be sprinkled among Accredited's higher performing collateral. Accredited typically enjoys tighter spreads on its securitizations, by about eight to 10 basis points, compared to Aames. Accredited's last deal priced in the low thirties over Libor.

When Aames initially switched to a REIT platform, a number of relationships it had maintained with the whole loan market fell off. And, due to lower FICO scores and certain underwriting factors, the lender was having a difficult time making money on their loans in the secondary market. Accredited may provide Aames account executives with its famed AE Calculator,' a spreadsheet formula that determines a loan's value on the secondary market. This move was intended to help bring Aames loans up to the level of profitability enjoyed by Accredited.

"The loans really aren't that bad, we just need to make some structuring changes," said Joseph Lydon, president and chief operating officer of Accredited, speaking during a conference call. There will be some underwriting tweaks, but I think more of the change will come from the use of the calculator, the use of the profit culture."

Industry-wide stress

Aames roughly 90 days ago laid off 120 employees and closed two loan processing centers. Like a number of other subprime lenders, it had begun to flounder as a result of the challenges facing the industry - the rising cost of funding has met a decline in new customers. As a result, its loan performance dwindled, relationships with whole loan buyers had declined and securitization spreads had widened, its executives said following the firm's first quarter performance. Aames began looking for a buyer last year and publicly announced its intentions to sell last month. The lender on March 16 announced it would shed its REIT status. It has also pared back the array of products it once offered.

Privately held ACC Capital Holdings, the parent company of Ameriquest Mortgage Co., last month announced the closure of 229 retail branches, resulting in job loss for roughly 3,800 of its employees, representing about 70% of its retail staff. The move constitutes the third round of layoffs at the company since November (ASR 05/08/06).

While subprime origination volume in 1Q06 was the second-largest first quarter on record, according to RBS Greenwich, half a dozen lenders posted declining origination volumes year-over-year. Ameriquest led the drop, with its originations falling 53%, followed by National City, which posted a 37% decline, and General Motors Acceptance Corp., which experienced a 28% decline.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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