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Lender’s Failure May Be Warning

October 11, 1998

PORTLAND, Ore. (AP) _ Southern Pacific Funding Corp. had gotten pretty good at walking a financial high wire between struggling homebuyers and well-heeled Wall Street investors until the stock market nose-dived and investors started looking for safer places to put their money.

Last week, Southern Pacific Funding was forced into liquidation after declaring bankruptcy on Oct. 1.

The Oregonian, which tracked the failure of a company whose stock value went from $350 million to zero, says many in the high-risk mortgage industry see it as a dire warning.

``This is not company-specific, it’s industry-specific,″ said Robert W. Howard, who was ousted as Southern Pacific Funding’s chief executive in late September.

Until recently, the company’s top executives lounged in 600-square-foot offices with leather floor tiles. Bonuses for two executives hit $1.3 million apiece last year while the company backed more than $2 billion in home mortgage loans.

The company’s spectacular flameout left more than 300 of its 540 employees jobless, and creditors scrambling to collect more than $1 billion in debt.

The result likely will be tougher times for borrowers with weak credit histories and the housing industry in general.

According to evidence cited by the Federal Deposit Insurance Corp., so-called ``subprime″ borrowers may have accounted for as much as 10 percent to 15 percent of the nearly $1 trillion worth of home mortgage loans made in 1996.

These high-risk borrowers were the target group for Southern Pacific Funding and companies like it.

Howard insists the company he co-founded fell victim to the economy.

Events as far removed as the devaluation of the Russian ruble and last month’s bailout of Connecticut-based hedge fund Long-Term Capital Management LP created an atmosphere of near-panic in the financial community that crippled Southern Pacific Funding.

It’s not a coincidence, Howard said, that longtime lender Morgan Stanley Dean Witter & Co. cut Southern Pacific Funding off about the same time the New York-based company pledged $300 million to the bailout of Long-Term Capital.

But others feel internal problems at Southern Pacific Funding also contributed to its demise.

Six former employees interviewed by The Oregonian criticized management for not cutting costs earlier. They said they felt the company’s swift expansion left it ill-equipped to adequately monitor operations.

``It’s true that the people at the top of the company were grounded in marketing and they were able to grow the company spectacularly,″ said an executive at Imperial Credit Industries Inc., a key Southern Pacific Funding lender and single largest shareholder.

In that environment ``internal controls sometime tend to get second-class treatment″ in favor of continued rapid expansion, said the executive, who was not identified by the newspaper.

The FBI confirmed Thursday it is investigating the disappearance of $3 million that Southern Pacific Funding sent a Colorado mortgage production partner.

The Colorado company told Southern Pacific Funding that it needed the money for home loans. The partner never made those loans but also never returned the $3 million, said James Hedemark, who replaced Howard as Southern Pacific Funding’s chief executive officer last month.

Now the question is not if more companies like Southern Pacific Funding fail, but when.

``I think the verdict is in,″ said E. Reilly Tierney, an analyst with Fox-Pitt Kelton, Inc. in New York. ``I think it is going to be very difficult″ for this industry to survive.

Unlike a bank, Southern Pacific Funding did not hold its loans and live with the consequences of its lending decisions. It was in essence a middleman.

In the words of one industry analyst, ``it played an arbitrage game,″ acquiring large volumes of loans from independent mortgage brokers, reselling them to Wall Street and pocketing a relatively slim cut for itself.

But the slim cut came from eye-popping sums of money. Southern Pacific Funding originated or acquired $1.9 billion in mortgage loans in 1997 and sold more than $1.8 billion in securitized loans to investors.

Southern Pacific Funding’s revenue for the year totaled $189.3 million, about 10 percent of the volume it handled. The company earned $53.8 million in 1997, up from $27.6 million the year before.

But due to insurance coverage and collateral requirements of Southern Pacific Funding’s Wall Street customers, the company saw little if any actual cash in the near term from its mortgage-backed security sales.

The cash-flow problem put Southern Pacific Funding on a never-ending quest for new capital, either from lenders or the capital markets.

More than one industry observer said Wall Street investment banks deserve a share of the blame.

``Look at it, what a gravy train,″ said one analyst. ``These guys were going to the debt and equity markets twice a year.″

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