The Company

The News

Another day, another housing lender in dire need of a loan.

American Home Mortgage became the latest victim of its namesake market, suspending dividends amid margin calls and asset write-downs late Friday. After plunging nearly 40% in Monday's premarket action, AHM shares remained frozen on the New York Stock Exchange for "news pending," spurring talk of a possible bankruptcy. By the end of the day, they still hadn't reopened.

As recently as six months ago, Melville, N.Y.-based AHM seemed to be precisely the sort of outfit that would weather the housing correction relatively well. After all, of the nearly 260,000 loans it originated last year only a negligible number were classified as subprime, the category that saw the biggest decline in underwriting standards and the sharpest subsequent spike in the rate of defaults.

The next-shakiest step in the credit ladder, the so-called Alt-A mortgages, accounted for less than 10% of American Home's total. Most of the borrowers had good or excellent credit ratings. The stock topped out in early February at $35.99, just 10% below the record high set at the housing market's peak 18 months earlier.

From there, it's been all downhill. The share price cracked first, but it would take some time for problems with AHM's loans to become apparent. Having earned $5 per share last year, the company warned a month ago of a second-quarter loss and withdrew earnings guidance for the year, as borrowers whose incomes it hadn't verified began to default on little-money-down loans at an accelerated pace. Investors who'd recently bought securities backed by such loans exercised out clauses to get their money back. AHM resorted to selling convertible securities on which it agreed to pay a subprime-worthy interest rate of 9.75%.

The other penny loafer dropped two weeks later, when Moody's and Standard & Poor's downgraded mortgage-backed securities worth billions, put more on negative credit watch and said they would be reviewing their very rating models in light of the unexpectedly high default rates.

In the aftermath of the downgrades, buyers of collateralized debt obligations backed by subprime, stated-income and excessively leveraged mortgage loans walked away, and they haven't been back. "The disruption in the credit markets in the past few weeks has been unprecedented in the company's experience and has caused major write-downs of its loan and security portfolios and consequently has caused significant margin calls with respect to its credit facilities," AHM explained in suspending dividend payments.

The Analysis

As a real estate investment trust, AHM was on a shorter financial leash than most mortgage originators, and was therefore more susceptible to the general liquidity squeeze quite apart from its own underwriting problems, says Paul J. Miller Jr., who follows the stock for Friedman Billings Ramsey. Early Monday, Miller was one of several analysts to effectively wash his hands of AHM, downgrading it to Underperform and slashing his share-price target to $3 from $15. Asked how much confidence he has in that new number, Miller offered another. "Zero," he said.

The warehouse debt dealers to whom AHM used to sell its loans the likes of Deutsche Bank, Wells Fargo and Countrywide Financial have fewer buyers for their "structured" products these days, and none at all interested in anything but the choicest cuts except at 50 cents on the dollar. Such dealers had extended $4 billion in credit to AHM, and with the securities stuck on the originator's books depreciating by the day, the warehouse crew demanded more collateral. Hence no dividends for AHM shareholders. Eight days earlier, AHM had denied a rumor that a Wall Street investment bank had revoked a credit facility.

The Bottom Line

Banking analyst Thomas Brown of Bankstocks.com likens the current crisis to the foreign debt disasters of 1998. "What happened then and what will happen now is people will return to their senses and the high level of fear that exists in the marketplace today will give way to some level of greed," he says. This faith has seen him through the dramatic market declines in the value of such holdings as mortgage lender

IndyMac

MGIC Investment

How long that might take is another question, and on that score nothing is guaranteed. Following the credit downgrades, Moody's and Standard & Poor's have faced accusations that they misjudged default rates and lending standards because they viewed the securities they were rating as a profit source. So despite the lost fees, they have every incentive now to be especially thorough in their re-evaluation of the industry. In the meantime, originators of less-than-ironclad mortgages will be on their own.

"I think this could drag out into the fall," says Miller of Friedman Billings Ramsey. "The issue is that the market is frozen. I don't know when it's going to get unfrozen. I think people will get comfortable with credit at some point, but we don't know how bad it's going to get. Liquidity crunches like these tend to work themselves out, but we've never seen one like this. What's going to happen is that there will be better mortgages originated, because that's the only stuff that's trading."