H&R Block, no stranger to deadlines in its tax-preparation business, is facing another significant one as it looks to close the sale of Option One Mortgage Corp., its subprime unit, by Oct. 31.
One of the key conditions Block accepted when it reached the deal with Cerberus Capital Management in April was that Option One would have at least $8 billion of warehouse lines at the closing.
As of Tuesday, the unit was well above that minimum, with $10 billion of warehouse lines. However, $2 billion of those lines were uncommitted. And the cushion is narrower after Lehman Brothers decided recently not to renew its $1.5 billion line.
In fact, Option One's committed lines might have fallen below the minimum had Bank of America Corp. not agreed to increase its line temporarily by $250 million. That increase is good only until the sale to Cerberus closes or Oct. 31, whichever is sooner.
Moreover, a $1.5 billion warehouse line Option One has from Citigroup is set to expire this month, according to a securities filing from May. The waiver of a profitability covenant on a $750 million line from UBS is also set to expire this month.
H&R Block says the paring of its warehouse capacity is part of its plan. The reductions were aimed at eliminating fees Option One must pay for maintaining warehouse lines it does not use when origination volume lags, the parent company said.
"We obviously want to avoid paying fees for unneeded facilities," Nick Iammartino, a spokesman for H&R Block, said Thursday by e-mail.
"H&R Block's strategy has been to align total warehouse capacity with projected origination volume, while also providing a modest amount of extra capacity for any volume upturn," he wrote. "We increased total capacity significantly when Option One was growing rapidly in origination volume; now that origination volume has declined, our warehouse capacity has declined as well."
Brian Horey, an analyst with Aurelian Management in New York, said that the fees were relatively small, however, and that he suspected H&R Block "would have much rather paid the fee for three months to Lehman in order to have the deal stay all buttoned rather than having to go to BofA ... to stretch them to get some more capacity."
On a conference call last month, Bill Trubeck, H&R Block's chief financial officer, said, "We consciously brought ... [the warehouse lines] down a bit because the volumes in the industry are just that much lower, so continuing to have much more line capacity didn't make sense."
These days, Iammartino said in the e-mail, Option One needs $3 billion to $4 billion in warehouse capacity to run the business at any given time. "So we're more than double that," he wrote.
However, Kathleen Shanley, an analyst with the New York bond research firm Gimme Credit, said the Lehman line reduction could jeopardize the Option One sale.
In a note published Thursday, Shanley wrote that the reduced lines could leave "Option One skirting dangerously close to the line ... with little margin for error." She called the BofA arrangement a stopgap measure because the capital can only be used when all other lines are in use and up to the point of sale. (BofA would not discuss the matter.)
Iammartino responded that Block is "managing its total warehouse lines to the $8 billion level, and we are confident we have the current and potential lending relationships to maintain at least this amount in place through the closing of the Option One sale transaction. There's no contractual need to go any higher."
The contract with Cerberus "doesn't specify whether or not uncommitted warehouse funds are included in the $8 billion minimum," he wrote. Cerberus did not return calls by press time.
In June, Trubeck said, "We have gotten all the waivers that are required to get us to the point we need to be at at closing ... so I think with respect to the waivers we have everything that we need to proceed" with the sale.
