H&R Block's Option One sale in doubt

NEW YORK (Reuters) - H&R Block Inc (HRB.N) on Thursday said the sale of its Option One Mortgage Corp. subprime lending unit may fall apart, as credit markets deteriorate and after its quarterly loss more than doubled.

The largest U.S. tax preparer plans to stop offering home loans through Option One, and may sell only the loan servicing business to private equity firm Cerberus Capital Management LP, which had agreed in April to buy the entire unit.

H&R Block is negotiating with Cerberus to waive some closing requirements and close before a December 31 deadline, but said there is "no assurance" any transaction will occur.

Losses at Option One contributed to an overall loss of $302.6 million, or 93 cents per share, for the fiscal first quarter that ended July 31. That is up from a loss of $131.4 million, or 41 cents per share, a year earlier.

"The mortgage origination market is in the midst of the most severe dislocation that it has seen in years, maybe the most severe since the 1930s," Chief Executive Mark Ernst said on a conference call, referring to the decade that included the Great Depression.

Ernst said Option One will stop mortgage lending regardless of talks with New York-based Cerberus, but the exit date was "fluid." He added the servicing business remains "quite valuable."

A Cerberus spokeswoman declined to comment. H&R Block spokesman Nick Iammartino said H&R Block's banking unit will continue to offer higher-quality, prime mortgages.

Subprime lenders make loans to people with poor credit. Dozens of mortgage lenders have closed this year as rising borrowing costs and stagnant home prices led to more defaults, while tight capital markets deprived lenders of needed cash.

Another private equity firm, Lone Star Funds, is trying to cancel its $400 million purchase of San Diego subprime lender Accredited Home Lenders Holding Co LEND.O.

CLOUDS

Excluding $192.8 million of losses at Option One and two discontinued businesses, H&R Block's quarterly loss was $109.8 million, or 34 cents per share, compared with a loss of $117.8 million, or 36 cents, a year earlier.

On that basis, analysts expected a loss of 35 cents per share, according to Reuters Estimates. Revenue rose 11 percent to $381.2 million.

H&R Block often loses money in quarters outside the main U.S. tax filing season, which ends in April. Tax services generated a $172.3 million pretax loss, while consumer financial services posted a $6.2 million pretax profit.

"It was a reasonably good quarter excluding the 800-pound gorilla, Option One," said David Roberts, a principal at Harvest Investment Advisors LLC in Tallahassee, Florida. "Expectations are so low that even marginal good news can support the stock."

H&R Block shares rose 50 cents to $20 in afternoon trading on the New York Stock Exchange.

Concern about Option One have helped push H&R Block shares down 15 percent this year through Wednesday. Some investors want H&R Block to narrow its focus to tax preparation.

"Until the clouds lift, there's continued investor concern that these distractions keep the company from optimizing results in its core tax business," said Thomas Russo, a partner at Gardner, Russo & Gardner in Lancaster, Pennsylvania. The firm invests more than $3 billion and owns H&R Block shares.

H&R Block is seeking to waive requirements that Option One fund $2 billion of loans within 60 days of closing and have at least $8 billion of warehouse credit lines.

Ernst said Option One will now make only loans eligible for purchase and guarantee by mortgage companies Fannie Mae (FNM.N) and Freddie Mac (FRE.N). Investors view these loans as safer.

Following deep job cuts this year, only 400 workers now make loans at Option One. The unit made $29.8 billion of subprime loans in 2006, according to National Mortgage News.

BREEDEN SHOWDOWN

H&R Block is expected at its September 6 annual meeting to face a showdown with activist shareholder Richard Breeden, a former U.S. Securities and Exchange Commission chairman seeking three board seats.

Breeden has won backing from the three largest proxy advisory firms and at least three big H&R Block shareholders.

"This is a company with an ill-conceived strategy and failed execution," Breeden said in an interview. "The net result has been the loss of enormous shareholder value." He declined to comment on results or the Cerberus talks.

H&R Block narrowed its forecast for fiscal 2008 profit per share from continuing operations to a range of $1.30 to $1.45 from $1.25 to $1.45. Analysts on average expected $1.33. The company does not expect to buy back stock before next May.

(Additional reporting by Dan Wilchins)