So who's next?

Yesterday I agreed with a comment by Michael Shedlock that it's not a matter 'if' a US homebuilder will go under but a matter of "Who's first?"

With mortgage providers it's a matter of "Who's next?" American Home Mortgage (AHM) succumbed to the inevitable and officially filed for bankruptcy yesterday. That comes as no surprise.

However the passing of AHM into chapter 11 shouldn't be dismissed lightly. The company was once ranked as the No. 10 mortgage lender in the US. Moreover, the company specialized in Alt-A mortgages not the riskier sub-prime variety.

How does the 10th largest mortgage lender in America suddenly implode?

Well, when your business is based entirely on the assumption that you can go on lending money to an increasing number of people who can't pay it back you can bet you're going to run into a problem or two.

On top of that you have the fact that the money you lend is not actually yours to begin with - the liquidity gravy train suddenly dries up because investors finally realize that you're selling them junk and you're left holding that junk.

Then to top it all off your creditors now want their money. But you can't sell that junk to cover your creditors calls so what to do? File for chapter 11.

You might conclude that the people running theses businesses are not very bright, that they have no concept of risk, that they naievely believe market cycles don't exist and that the good times will go on forever. If you did come to that conclusion you would be correct.

Unlike gullible fools piling in at the top of the dotcom bubble the people running these mortgage lending outfits cannot claim the cloak of ignorance. They are supposed to understand risk, leverage and market cycles. So when the CEO of American Home Mortgage says this:

"It is unfortunate that American Home Mortgage, a company that we built into a highly successful business, experienced this sudden reversal of its fortunes due to the unanticipated and rather sudden deteriorations in the secondary and national real-estate markets,"

you know it is disingenuous. "Sudden reversal of fortunes" makes it sound like an act of God. Interesting how CEO's are first to take credit for success but then take no responsibility for failure.


Who's next?

Anyway now that the books have been closed on AHM the question is "who's next?" As you may have guessed there are a number of candidates:

American Home Lenders (LEND) is the top contender but not by much. Last week the company said in a regulatory filing that if it's unsuccessful in amending covenants with its lenders, that could lead to defaults which:

"would have a material adverse impact on our ability to fund mortgage loans and continue as a going concern."

That doesn't sound good. Like others, Accredited made a large portion of their money from gains it made selling mortgages in the secondary market. However, buyers have all but disappeared.

HSBC (HBC) bought 30% of Accredited's mortgages in 2006, while CIT Group (CIT) purchased more than 12%.

But in April, HSBC stopped buying subprime loans and CIT stopped in July, Accredited said on Thursday. Management failed to inspire confidence with this comment:

"We cannot assure you that we will continue to have any purchasers for our mortgage loans on terms and conditions that will be profitable,"


Next up we have Novastar Financial, with the very fitting stock code of (NFI). Last Friday NovaStar's wholesale unit, stopped issuing commitments for new loans. A sensible move given the current environment.

However that pushed NovaStar's shares down more than 30% on Monday. So what do they do? A complete about face and say they will start committing to and funding new loans in its wholesale channel on Tuesday.

You might be inclined to think that doesn't make much sense. That's because it doesn't. The only way it does is by understanding it as a panicked reaction to a plunging share price.

NovaStar is not getting any joy from the broking community either. Scott Valentin, an analyst at Friedman, Billings, Ramsey, cut his price target on the company's shares to $0. He also reiterated his underperform rating. No need to reiterate Scott with a $0 price target.

Even after After NovaStar announced the resumption of wholesale origination, Valentin said he was sticking to his call.

"Subprime mortgage conditions have deteriorated in recent weeks, as whole loan and securitization markets have ground to a halt, forcing NovaStar to retain assets,"

"Asset prices have declined further, subjecting NovaStar to potential margin calls, which we believe it will be unable to meet given its highly levered balance sheet."

"The likelihood of subprime mortgage market conditions improving in the near term (is) very low," he added, noting that "there is a high likelihood NovaStar will be unable to continue operations."

That's it son, tell it like it is.


Then we have Aegis Mortgage Corp., a mortgage lender that's part-owned by private-equity firm Cerberus. According to an industry publication Aegis was the 13th largest subprime mortgage originator in 2006.

Currently Aegis is not faring so well, suspending all loan originations as of Monday. According to spokeswoman Pat Wente, they are unable to fund home loans that are already in its pipeline.


Also yesterday National City's (NCC) Home Equity unit has suspended approvals of addition loans or lines of credit. National City Home Equity is just one part of National City's mortgage business which saw them rated as the 13th largest originator of all types of mortgages during the first half of 2007.

Personally I think it will be a close call between NFI and LEND. But does it really matter? They'll both probably be out of business by the end of the year.


Insider comments:

So just how hard is it to sell mortgages on the secondary market? Mark Lachtman, president of mortgage brokerage firm First Capital Group Inc. says that institutional investors:

They've had it with mortgages. They don't care how good the underwriting standards are right now or how much higher the interest rates are."

He added that the market for Jumbo loans is particularly problematic at the moment. The difference between interest rates on conforming mortgages and jumbo loans is usually about 25 basis points. But now it's 100 basis points higher,

"if you can get it done at all,"

According to an unnamed source on MGETA subrpime rates have risen by as much as 190 basis points at a certain organization in just the last 2 weeks. Click here for the full article.