We've all heard of the problems with subprime mortgage lenders (i.e. nearly 50 such lenders catering to low income / high risk borrowers have now filed for bankruptcy due to mortgageholder delinquencies). However, the financial talking heads as well as the Fed have been claiming that these devastating losses were 'confined' to the subprime market with other banks / lenders catering to those with higher income / lower risk borrowers being relatively unaffected. Well, guess what ...
(snip)"This is very bad news kids.
"Market conditions are expected to reduce gain on sale revenues and necessitate write-downs of low investment grade and residual securities
The Company now sees first quarter earnings per diluted share of $0.40 to $0.60 and full year 2007 earnings per diluted share of $3.75 to $4.25
Common stock dividend policy is changed to $0.70 per share per quarter or $2.80 on an annualized basis (was $1.12 quarterly!)"
and
"Michael Strauss, American Home's Chairman and Chief Executive Officer, commented, "During March, conditions in the secondary mortgage and mortgage securities markets changed sharply.
In particular, these markets were characterized by far few buyers offering materially lower prices, both for loan pools and for "AA", "A", "BBB" and residual mortgage securities. These changes had a significant, adverse impact on our Company's first quarter results, reducing our gain on sale revenue and causing mark-to- market losses in our portfolio.
While the market may recover, and while we will attempt to restore our gain on sale margins by raising interest rates charged to consumers, our working assumption must be that current market conditions will persist and that our gain on sale margins will not recover through the balance of the year.
Consequently, I am disappointed to report that our Company is lowering its full year earnings guidance and its dividend policy.""
Can you say "I told you so?"
There are times I hate being right. This would be one of them.
Let's remember - these folks, along with many others in the space, had said "oh no, we didn't make any of those bad loans" and "ALT-A" is safe.
Well, guess what folks? AHM does not and never did write subprime business! They were an ALT-A lender, pure and simple! Yet this is what they said about the market environment for their mortgage-backed security offerings:
"The Company's first quarter results will be adversely affected by lower gain on sale margins. As March progressed, loan pools offered for sale by the Company received relatively few bids at lower than expected prices. As a result, those loans originated by the Company in late February and during March earned lower gain on sale revenues than were anticipated.
The Company's first quarter results will also be adversely affected by write-downs of its portfolio of low investment grade and residual securities. In particular, the Company's approximately $484 million of securities rated "AA", "A" or "BBB" will be written down to account for an unusually large widening in the first quarter of the spread over LIBOR at which these securities trade."
This is going to screw every mortgage lender - AHM has all along claimed to be "immune" to this, and what's even better, people have claimed that their insiders were buying their stock as "proof" they would be ok."(snip)
The serious bad news that is going to stem from this 'first of its kind' announcement goes well beyond AHM itself. It implies that the supposedly low risk mortgage backed securities that AHM and others have created by 'repackaging' Alt-A grade mortgages - securities that were eagerly snapped up by retirement funds / mutual funds / foreign investors etc. on the basis of their supposed 'safety' - are actually much more at risk of loss / default than everyone assumed. This could easily spill over into mainstream financial markets, and probably spells much tighter future lending standards for all levels of borrowers i.e. prime and Alt-A as well as subprime.
Also, as the big institutional investors as well as foreign investors in supposedly higher grade mortgage backed securities start to cut and run, higher interest rates for ALL forms of credit in the USA will quickly follow.
This really has the potential for an across the board 'snowball effect' in regard to institutional investors and foreign investors still choosing to invest in US dollar denominated securities, versus a decision to pull their US dollar denominated investments to avoid potential future defaults / losses and reinvesting in other countries. If that happens, it's very likely to lead to a nasty bout of US inflation via a tanking of the US dollar's foreign exchange rate causing the US dollar price of all imported products to skyrocket (like oil)
At the same time, flight of capital to 'safer' countries is very likely to precipitate a shortage of capital for US lenders to loan out (even at very high interest rates) to prime borrowers and businesses at the very time that they need extra US dollars the most ! As the US continues to run a huge trade deficit due to oil purchases, Chinese imports etc., if foreign investors decide not to reinvest those US dollar proceeds but plunk them in Europe or Asia instead, capital will start leaving the USA at a rate of about 3 billion dollars a day.
If the Fed wants to avoid a liquidity crisis, that would leave no choice but to print 3 billion new dollars every day to replace those dollars lost via one directional trade. Obviously this would only accelerate inflation and hasten the drop in US dollar exchange rate.
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