American Home Mortgage AHM
March 15, 2007 - 9:18am EST by
david101
2007 2008
Price: 24.28 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,220 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

American Home Mortgage Investment Corporation is the proverbial baby that got thrown out with the subprime bath water. AHM is a REIT that originates and invests in residential mortgages. Subprime loans are just 0.3% of the portfolio and Alt-A loans are 18.2%. Even so, the combined portfolio has a weighted average FICO score of 710 and 75% weighted average loan-to-value (LTV). Book value is $22.64 and tangible book is ~$20. It sports a forward dividend of $1.12/qtr for a 18.5% yield, trades at 1.07X book and the stock has potential price appreciate of 40% on top of the dividend.

 

The question of the moment is liquidity. Unlike its peers, less than 10% of AHM’s funding comes from warehouse credit facilities. They have been able to use purchase and sale agreements, collateralized commercial paper, and collateralized debt obligations (CDO). They also have 18 reverse purchase agreements to fund MBS purchases that account for half the assets on the balance sheet. The MBS help stabilize the balance sheet, as most are AAA-rated.

 

Here is a summary of their borrowings:

 

$3.3 billion SLN commercial paper program

$2.0 billion pre-purchase facility with UBS Real Estate Securities Inc.

$2.5 billion facility with Bear Stearns

$1.3 billion bank syndicated facility led by Bank of America, N.A. (committed) *

$125 million facility with J.P. Morgan Chase

$750 million facility with IXIS (committed)

$350 million facility with Credit Suisse First Boston Mortgage Capital LLC

$1.0 billion facility with Barclays

$1.5 billion syndicated facility led by Calyon (committed)

 

Additional comments from the 10-K

 

“In addition, we have gestation facilities with UBS, Greenwich Capital Financial Products, Inc. (“Greenwich”), Societe Generale, and Deutsche Bank (“Deutsche”). These facilities are secured by the mortgages owned by us and by certain of our other assets. Advances drawn under the facilities bear interest at rates that vary depending on the type of mortgages securing the advances. These loans are subject to sublimits, advance rates and terms that vary depending on the type of securing mortgages and the ratio of our liabilities to our tangible net worth. At February 22, 2007, the aggregate outstanding balance under the commercial paper program was $2.8 billion, the aggregate outstanding balance under the warehouse facilities was $3.3 billion, the aggregate outstanding balance in drafts payable was $4.0 million and the aggregate maximum amount available for additional borrowings was $5.3 billion.”

 

Note: * includes a $446.3 million term loan facility to finance MSRs.

 

AHM has better credit facilities, but more importantly, they have better loans. The market for prime loans is active and still profitable. The subprime lenders ran into problems when the price of selling subprime loans collapsed. The securitizers stopped paying a premium for these loans. That in turn caused the warehouse lenders, who were often the securitizers, to raise the margin requirement for the warehouse credit facilities. The result was an institutional version of a run on the bank, and the mortgage originators did not have the cash to ante up. If the market for prime loans collapses, there will be a lot of bad things happening.

 

AHM operates 550 retail and wholesale loan offices in 47 states, which originates 35% of their loan production, with 55% coming from mortgage brokers and 10% from correspondent/direct. By comparison, LEND and NEW only originated about 10% of their production through their retail operations. Their strategy is to retain the loans that they originate because they can ensure quality. Half of the loans they sell are to three customers, with 20% to Countrywide, 19% to Deutsche Bank and 11% to Wells Fargo.

 

The company recently released an 8-K that provides great information on the loans in their portfolio, broken out by loans held for investment, loans held for sale and securitized loans (which are off-balance sheet):

 

http://www.sec.gov/Archives/edgar/data/1256536/000119312507048199/dex991.htm

 

I like that they have relatively decent FICO scores, low LTV’s and use mortgage insurance when needed. I do have some concern that a large part of their loans are stated income, but I believe prime borrowers at 80% LTV have more incentive to be truthful than subprime borrowers at 100% LTV.

 

Management’s guidance for 2007 is loan production of $68 to $74 billion, fully diluted earnings per share of $5.40 to $5.70, and they upped the next quarterly dividend to $1.12/sh. This includes provisioning for more delinquencies.

 

CEO Michael Strauss owns 9.2% and the CFO has purchased 4,000 shares in the open market the past two weeks.

 

Pros:

- cheap at 1.07X book and 1.21X TBV

- nice dividend

- most of the loans and securities they hold are adjustable rate, and are matched to similar liabilities

 

 

Risks:

- while having more stable funding, they do depend upon the kindness of strangers in the capital markets

- mortgage origination business is volatile

- no guarantee that the margins on loan sales remains profitable

- a large part of the loans they hold have stated income

- they are a relatively new company and have only been a REIT since 2004

- 50% of loan portfolio is interest-only ARM and 25% option ARM

Catalyst

- market settles down
- AHM keeps doing what it has been doing
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