Brian McAuley, my partner at Sitka Pacific Capital Management tells me that “things always happen when I am on the road“. They sure did last week while I was in Vancouver for an Agora sponsored wealth symposium called “Rim of Fire“.

The conference was about Crisis and Opportunity in the New Asian Era. It was a fantastic conference with speakers including Bill Bonner, Rick Rule, Nassim Taleb (author of The Black Swan) Frank Trotter (president of Everbank), Richard “Mogambo Guru” Daughty, James Kunstler, Paul Van Eden, Agora newsletter writers, and many more. A multitude of commodity oriented vendors were there (energy, base metals, gold, silver, nickel, uranium, copper, alternative energy). It was a fantastic conference and if you get a chance to go next year I think it would be worth your while to do so. Obviously my association with Agora makes my opinion somewhat biased but I am not getting anything per se for putting in this plug, nor was I asked to do it by Agora or anyone else.

With the conference going on, and not wanting to miss any sessions, it was a struggle trying to keep up with commenting on all the news about canceled IPOs, the falling stock market and other things. Saturday was a travel day and it was not until late Saturday evening that I saw what could be one of the stories of the year: a Liquidity Crunch at American Home Mortgage. This story had been brewing for a long time. And it worsened again this weekend, dramatically. Let’s recap.

Recap of American Home Mortgage Woes

2007-06-29

Roof Caves In For American Home Mortgage

American Home Mortgage announced missed payments on loans will lead to a big second quarter loss just as concerns escalate that defaulting mortgages could roil the economy. Shares of American Home Mortgage (AHM) plummeted 2.51, or 12.0%, to $18.40, after the company yanked its second quarter guidance. American Home said “substantial” charges will push the company to a second quarter loss. Analysts were expecting earnings per share of 75 cents.

2007-07-19

AHM Plunges On Rumor Credit Line Yanked

American Home Mortgage Investment shares plunged 21% Thursday on rumors that a large lender had withdrawn a credit line. Keefe, Bruyette & Woods analyst Bose George said that the rumor circulating was that Lehman Brothers had pulled the company’s credit line, however, George said American Home doesn’t receive a credit line from Lehman Brothers and that American Home’s chief financial officer had denied the rumor.

Nonetheless, shares of the Melville, N.Y.-based company plunged 20.8%, or $2.83, to $10.76 at the close on Thursday, although it gained 3.2% in after-hours trading.

2007-07-20
American Home Mortgage Back On Track?

Talk about a rebound! Although American Home Mortgage Investment hasn’t recovered all of the value it lost when the stock plunged on Thursday following a rumor that Lehman Brothers had yanked its credit line, it has certainly made up lost ground.

Another boost to American Homes shares may have been a research note put out by RBC Capital Markets analyst James Ackor saying the stock tumbled on Thursday well below its value. While investors fear the investment banks that lend the company money might withdraw their credit lines, Ackor said he doesn’t believe they will.

2007-07-20
American Home Mortgage Holdings “outperform,” target price raised

Analysts at RBC Capital Markets maintain their “outperform” rating on American Home Mortgage Holdings, while reducing their estimates for the company. The target price has been raised from $20 to $25.

2007-07-25
American Home Mortgage Plunge is Portfolio-Management Lesson

Thursday’s selloff was evidently triggered by speculation the company was being denied access to short-term lines of credit, the lifeblood of a mortgage lender. When I contacted AHM, a spokeswoman said no credit line had been pulled. Apart from the speculation, there’s little to explain why AHM stock has been punished so severely. Some bargain hunters stepped in Friday, and on the face of it, the stock screams “buy.” The dividend yield is 22%, and the P/E is 7.7.

In June, AHM forecast a second-quarter loss and withdrew guidance for the year, but reaffirmed its dividend of 70 cents a share. It attributed the shortfall to rising delinquencies on mortgages it issued, a reduced demand for the mortgages it packages and sells to investors, and losses on loans it had to buy back under warranties extended to buyers. But it said these trends were stabilizing and had shown some improvement.

My initial recommendation was based on the good reputation of the company’s management, its excellent liquidity and its lack of exposure to the subprime crisis. None of that has changed. But what started as a subprime-mortgage crisis is working its way through the financial system in some unexpected and unpredictable ways.

2007-07-26

AHM Infected By Subprime Problems.

The tentacles of the subprime mortgage debacle have now reached even further. American Home Mortgage Investment, which specializes in both prime and “Alt-A” loans, which are riskier than prime loans but safer than subprime loans, is laying off 500 employees nationwide Thursday.

A senior staffer at AHM, who only agreed to speak anonymously, told Forbes.com that in their office, which only has 100 employees, 25 positions are being cut. “The company is calling this ‘the largest lay-off in AHM company history’ and a necessary reaction to market trends,” the employee said. “Unless volume increases in the next 60 to 90 days, most feel these lay-offs are only the beginning and additional lay-offs seem inevitable.”

2007-07-26
American Home Mortgage cuts more jobs

American Home Mortgage Investment Corp., the beleaguered Melville-based mortgage bank, has laid off another 228 employees, bringing to 428 the number of job cuts this month, a company spokeswoman said yesterday.

Several current and former employees numbered the total planned layoffs at 1,200, including the 448 already announced. The company would not respond to questions about future layoffs.

Another cause for concern is the company’s delay in scheduling the release of second-quarter earnings. The earnings are due by early August and historically American Home has set a date two weeks in advance. But no such announcement has been made.

One possible reason for this, analysts said, is that market turbulence makes it more difficult for the company to determine the value of the $10.7 billion in loans it was carrying as “Off-balance sheet securities” at the end of fiscal 2006. Many of these loans carry higher credit risk than those the company bundles and sells to investors, and if market conditions cause their value to drop, the company will be required to take an earnings mark-down.

2007-07-27
American Home Mortgage Investment Corp. Delays Payment of Dividends

The quarterly cash dividend of $0.70 per share on the Company’s common stock had been declared on June 15, 2007 and was to be paid on July 27, 2007 to all shareholders of record as of July 9, 2007. The Series A Preferred Stock dividend and Series B Preferred Stock dividend had been declared on June 15, 2007 and are payable on July 31, 2007, to shareholders of record as of July 9, 2007.

American Home Mortgage Investment Corp. is a mortgage real estate investment trust (REIT) focused on earning net interest income from self-originated loans and mortgage-backed securities, and, through its taxable subsidiaries, from originating and selling mortgage loans and servicing mortgage loans for institutional investors.

2007-07-28
American Home Mortgage yanks dividend at last minute

In a sign of continuing tumult at American Home Mortgage Investment Corp., the troubled Melville-based mortgage bank announced at 10:19 p.m. Friday that it would not deliver the 70 cent per share dividend that was to be paid out that day of major write-downs in its loan portfolios.

Company officials made the move, which they called a delay, because, “The disruption in the credit markets in the past few weeks … has caused major write-downs of its loan and security portfolios and consequently has caused significant margin calls with respect to its credit facilities,” according to a release.

Dividends were pulled “in order to preserve liquidity until it obtains a better understanding of the impact that current market conditions in the mortgage industry and the broader credit market will have on the Company’s balance sheet and overall liquidity,” the company said.

The deadline for American Home’s second-quarter earnings release is August 8, but the company has yet to set a date for that announcement.

2007-07-29
American Home Mortgage says faces margin calls

American Home Mortgage Investment Corp. said its lenders are demanding it put up more cash after the mortgage lender wrote down the value of its loan and security portfolios significantly.

The company said in a statement released late Friday that as a result of the margin calls from lenders, it has delayed paying dividends on its common stock, and plans to delay payments on its preferred shares.

Margin calls can create severe difficulty for a company that depends on funds from its lenders to finance loans, and can force the company to sell assets or seek other financing. If the company cannot generate enough money to satisfy its lenders, in the worst case scenario it can be forced to reorganize its debt or file for bankruptcy.

One has to laugh at the staunch belief that that American Home Mortgage could maintain a 22% dividend while the share price and spreading credit risks said otherwise. That 22% dividend is now 0%. About that PE… Well there are no earnings.

James B. Stewart at the WSJ put out a buy recommendation apparently based on the following ideas.

  • The carnage in the subprime-mortgage market should be reflected in its share price
  • The good reputation of the company’s management
  • Its excellent liquidity
  • Its lack of exposure to the subprime crisis

Excellent liquidity?! In the face of the debacle at Bear Stearns how can anyone think there is (or recently was) excellent liquidity in ANY mortgage related stocks?

Or are Mortgage “REITs” supposedly different? Did Stewart not see the debacle at New Century Financial Corporation? Was there any doubt that things were spreading from subprime to Alt-A to Prime?

If American Home Mortgage is facing margin calls what does that say about its use of leverage? The next question then must be: what does that say about the company’s management?

I happened to talk to a commercial real estate developer going back some 30 years at the Agora symposium late Friday. He was not a reader of my blog and had no idea I had written about Sam Zell in a Vital Lesson From Blackstone. But somehow we got to discussing the Florida condo situation and other real estate woes when all of a sudden he exclaimed, “Commercial real estate is through”. I asked him why and he told me about cycles: Residential followed by commercial followed by industrial, and how they peak in that order. He went on to tell me about how Sam Zell marked the top in commercial and there was at most one year left or so in industrial. The developer I was speaking to “cashed out” over the past few years.

Perhaps it’s time to review Debating the Flat Earth Society (Part 1) and Debating the Flat Earth Society (Part 2). In particular, let’s take a look at the addendum of part 2 written December 28, 2006. Here goes:

I want to include a few comments from Professor John Succo on Minyanville:

As central banks rain liquidity (credit) down on markets, its long range effects eventually cause the very thing central banks are trying to avoid: deflation. The reason people don’t understand this is that it is cumulative: the accumulation of debt is in itself inflationary, but at a certain point it becomes unmanageable. Why is this?

Easy or free money (when central banks drive real interest rates below inflation rates) is irresistible. It wouldn’t be if people managed risk properly but they do not. Easy money causes competition for “projects” to increase: companies with free money take risk with it for less and less return. We are seeing deals getting done in LBO land and commercial real estate being built using very aggressive assumptions and low cap rates. With all that “money” out there rates of return drops dramatically. Everyone is starved for income.

At the very time that income and returns are dropping debt is increasing. Less income with more debt means that eventually it gets impossible to service that debt.

That was an on time, real time, warning from Professor Succo much along the lines of what I have been writing about in my deflation themes. The warning was virtually ignored by everyone. The arrogance in which it was ignored caused a total 100% wipeout of Bear Stearns’ High-Grade Structured Credit Strategies Enhanced Leverage Fund. Sadly, some Bear Stearns investors wanted out as early as January but Bear Stearns would not let them out. I am sure those assets were worth something (perhaps even 60% or more) in January or even March, but Bear Stearns halted redemptions and held on until the fund went to zero. Lawsuits will fly over this.

If the market dips a bit more, the buy the dip mantra will be sung loud and clear. I have no doubt it will be based on an absurd Fed Model and/or expected interest rate cuts by the Fed (see Rate Hike Odds Plunge – Gold Should Benefit). Of course the same people were singing the tune: The Fed hiking shows the economy is strong.

The Fed Model was thoroughly trashed by Hussman (see Tightening Cycle) but that will not slow down the number of comments on it one bit. Earnings?! forget about it. Where are earning headed in a slowing economy? What are the forward earnings of Merrill Lynch (MER) , Lehman (LEH), Goldman Sachs (GS), and Morgan Stanley (MS) going to look like when it becomes harder and harder to get pools of CDOs out the door and demand for leveraged buyouts dries up? The earnings of American Home Mortgage (AHM) effectively went negative. There is only one reason to buy major market indices here (a belief that he greater FOOL theory will be revived) because the case sure can’t be made on fundamentals.

Mike Shedlock / Mish/