Morgan Stanley's Fremont Faction

The big bank has ties to a lender shopping its subprime arm.
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Morgan Stanley

(MS) - Get Report

seems like a natural match for

Fremont General's

(FMT)

subprime mortgage business, which the Santa Monica, Calif.-based distressed lender has been looking to offload.

Hedge funds and other players have been circling with an eye toward either bagging subprime paper on the cheap or scooping up experienced staff. On Tuesday, shares of

Accredited Home Lenders

(LEND) - Get Report

surged 20% on news the company scored a loan commitment from a big West Coast hedge fund.

Fremont General recently said it would sell its subprime lending business after the company consented to a cease-and-desist order from the Federal Deposit Insurance Corporation. Regulators alleged the company was operating without effective risk-management policies. Shares, after plunging on that news, surged after Fremont said it was in talks with unnamed possible buyers of the unit.

In Morgan Stanley's case, an acquisition of Fremont could be a logical move, given the big investment bank's recent moves in the sector. Back in June, Morgan hired mortgage lending pros Wes Iseley and Arvin Wijay from Fremont General in an effort to bolster its loan origination practice.

That suggests that Morgan Stanley has intimate knowledge of Fremont's loan book, which could help it assess the portfolio's value. A person familiar with Morgan's thinking says the investment firm probably would be more inclined to look at Fremont's loans, if it were interested in picking at the mortgage lender, rather than its entire business.

Calls to officials at Morgan were directed to a spokesman who declined to comment. A spokesman for Fremont at Abernathy MacGregor Group in Los Angeles declined to comment.

Morgan Stanley is expected to provide some insight as to how big of an impact subprime has had on its finance business Wednesday morning, when it reports its first-quarter earnings.

Shares across the mortgage sector have been hammered this quarter by steep losses at lenders to homebuyers with questionable credit histories.

New Century

(NEWC)

lost its New York Stock Exchange listing after the company lost funding and disclosed a criminal investigation of its accounting.

But big investors, including banks such

Lehman Brothers

(LEH)

and

Bear Stearns

(BSC)

, have indicated they intend to be buyers of distressed subprime assets. They are basically betting that even with the recent unrest in the industry, which has seen a number of smaller players file for bankruptcy, the subprime business will continue to be a significant and profitable part of the loan business.

On Monday, San Francisco-based hedge fund

Farallon Capital Management

said it is offering a $200 million five-year secured term loan at a steep 13% interest rate to Accredited. Calls to an executive at Farallon were directed to an external spokeswoman, who declined to comment.

Last week, San Diego-based Accredited agreed to sell substantially all of its $2.7 billion worth of loans held for sale to an unnamed buyer to meet margin calls. Calls to Accredited spokesman Rick Howe were not immediately returned.

Morgan gained traction in the mortgage arena six months ago when it acquired Glen Allen, Va.-based mortgage lender Saxon Capital for $706 million. At the time, Morgan acquired the firm for its subprime mortgage servicing ability. Saxon's servicing ability could come in handy if troubled loans need to be remedied.

Morgan's mortgage business also includes Morgan Stanley Credit Corp., which services prime retail loans.