Mortgage Market Woes: American Home Mortgage Implodes

by Amy Lillard

This year has been a year of ups and downs for the housing market. In our continuing series, we chronicle news affecting the housing market and its major players.

An increasing roster of companies succumbing to serious financial problems has dominated much of the news this year. Recently added to this group, in a surprisingly spectacular fashion: American Home Mortgage.

On July 27th, the first signs of trouble emerged when the company postponed paying a scheduled dividend. Then, the company's lenders cut off access to credit. Last Friday, August 3, the company announced a decision to cut its workforce. From a robust 7,400 employees, the company slashed the payrolls to a shocking 750 employees.

Finally, on Monday, August 6, the company filed Chapter 11 bankruptcy. The company intends to use bankruptcy to maximize any remaining value of its assets, and wind down operations. They hope to sell their portfolio of loans and mortgage-related securities at auction. Analysts predict lenders and other investors might pick up the loans for pennies on the dollar. After the news, the New York Stock Exchange began delisting all American Home's common and preferred shares. The stock ended its trading at 44 cents, a huge drop from December values of $36.

What's most striking about American Home Mortgage's failure is their status as the first major lender serving high-credit and near-prime borrowers to see this severity of problems.

Most of the cause of mortgage industry problems thus far, and the focus of the media, has been the subprime mortgage market. These loans are made to people with less attractive credit scores, and are the biggest risk to default. That's exactly what's been happening, in big enough numbers to bring down many companies predicating their success on the strength of debt obtained from the subprime market. In fact, over 50 lenders focused in the subprime market have been forced into bankruptcy this year.

But the case of American Home Mortgage is different. Their focus was on lending to people considered better credit risks. Their products were "Alt-A" mortgages, loans that weren't quite prime but not yet subprime. The problem with these loans was sometimes unfavorably changing interest rates that become hard for borrowers to handle. These loans have defaulted in growing numbers, putting companies like American Home at risk. These loans represent 20 percent of the mortgage market (the subprime market represented 20 percent as well).

Mortgage-backed securities are directly affected by the subprime, and now the Alt-A market, fall. These packages of loans that are securitized and sold to investors are increasingly become devalued, making investors and sellers leery. In addition, we could be in the middle of a credit crunch that increases with each major company downfall. Lenders are afraid to make loans, don't have the funds for loans, or charge much higher interest rates on loans to break even.

For these reasons, and more, many industry experts and watchers see American Home's fate as a sign of what's to come in the wider mortgage industry. In the meantime, borrowers can expect to find slowly increasing mortgage rates and slightly less favorable lending environments.