American Home's Credit Crisis

As it faces an "unprecedented" disruption in the credit markets, the mortgage lender delays dividends in a bid to keep itself afloat

American Home Mortgage (AHM) is hoarding cash, trying to keep the company afloat as borrowers flee from riskier debt.

The company said on July 30 it will delay paying its quarterly dividends to keep the cash on its balance sheet. "The disruption in the credit markets in the past few weeks has been unprecedented in the company's experience," the firm said in a statement.

As a credit crunch calls into question the value of American Home's mortgage holdings, creditors are panicking, issuing margin calls.

The shares plunged 42% in pre-market activity on July 30 but did not open for trading on thje New York Stock Exchange that day. Trading in the stock remained halted as of mid-morning July 31 as the NYSE said it still expects the company to report important news, according to an Associated Press report.

"The problem is the mortgage market has frozen up," says Friedman Billings Ramsey analyst Paul J. Miller Jr. It started a couple weeks ago when the major rating agencies downgraded various kinds of mortage-backed debt. (Those agencies include Standard & Poor's, which, like BusinessWeek, is a unit of the McGraw-Hill Companies.)

American Home makes money originating and then re-packaging mortgages into securities that are sold on secondary markets. It originated almost $60 billion in loans in 2006.

Many buyers are simply refusing to bid on riskier debt, especially mortgage-backed debt. Thus, lenders like American Home are stuck with debt in their pipelines that they can't sell. The biggest issue may be uncertainty. Since parts of the credit market aren't really operating properly, it's hard to tell what American Homes' assets are really worth, says Jason Willey, a Standard & Poor's equity analyst.

"The company has provided fairly limited information" on its troubles, Willey says. American Home's statement says the credit market disruptions "has caused major write-downs of its loan and security portfolios" and "significant margin calls." It's not clear which sort of debt is causing the biggest write-downs. American Home has steered clear of subprime loans, the riskiest class of mortgage debt.

The dividends had been declared last month and were to be paid on July 27 and July 31. It's highly unusual to delay a dividend after it's already been declared. As a real estate investment trust, or REIT, American Home is required to distribute a large amount of its income to investors. The dividend delay might violate some REIT rules, but that's the least of American Home's concerns, says Fox-Pitt Kelton analyst Matthew Howlett.

"Right now, it's about survival," he says.

"It's very hard to quantify how bad this could get," FBR's Miller says. Bankruptcy this week is not out of the question, he says.

To survive, American Home needs the secondary credit markets to stabilize, so the company can re-sell its loans for a profit. "They need it to happen very, very quickly," Miller says. (American Home is an investment banking client of FBR.)

RBC Capital Markets analyst James Ackor has a more optimistic view. At the end of the first quarter, American Home had $837 million in cash, he wrote Monday, and should be able "to weather a margin call-related storm." (RBC does business with American Home.)

Many analysts believe other mortgage companies are now under the same pressure as American Home. Some, without a REIT structure, may have enough cash or other capital to ride out problems until credit markets stabilize.

"The amount of uncertainty in the market makes it difficult to forecast," S&P's Willey says. "Thing have taken a turn that a lot of people did not expect."

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