Lehman has yet another update on AHM. The report is titled "Liquid Balance Sheet Limits Risks" and is dated 3/14/2007. They reiterate 1-Overweight. The following is the Investment Conclusion section :
"Liquid Balance Sheet Limits Risks
Investment Conclusion
Liquidity crises among the subprime lenders have touched off concerns that other lenders like AHM could experience similar problems. After examining the issues that are draining liquidity from the subprime sector and examining AHM's balance sheet, we have concluded AHM is in a much better position to manage through this challenging operating environment, so we reiterate our 1-Overweight rating.
Summary
?? AHM is now trading below book value and just above tangible book. To justify a valuation below book, earnings would have to swing to a negative, which seems unlikely to us given the high credit costs already embedded in our estimates.
?? The drain on subprime liquidity was largely
attributable to a precipitous drop in the value of subprime mortgages that prompted warehouse margin calls. AHM's prime mortgages are still getting a strong bid, so as long as those values hold in, margin calls should be minimal.
?? AHM could expand its liquidity provided through warehouse, repo and commercial paper facilities, if need be, by drawing on FHLB advances.
?? AHM has $9.1B of MBS ($8.1B are AAA) that it could sell, releasing $400MM-$500MM of capital."
1) AHM has a book value per share of $22.64 and tangible book value per share of $19.98. To the degree the stock is falling below that
level implies that investors are discounting the value of assets on the balance sheet by the amount of the discount in the stock, in our
opinion.
2) In order for the assets to be worth less than book value, losses on assets, or loans, would have to exceed current year earnings and wipe
out current earnings and create a loss equal to $51MM for each dollar of book value. Currently we estimate earnings at $4.90 per share in‘07, or $295MM in total dollars. We estimate provision for loss this year of $47MM and total credit costs of roughly $150MM (inclusive of
repurchase credit costs reflected in our assumption for 25 bps of y-o-y gain on sale margin contraction), thus, in order for earnings to go to
zero credit costs would have to increase $295MM above our estimate.
3) The "run on the bank" so to speak at the subprime lenders was caused by a chain of events that resulted in their funding sources going
away. Most notable was the fact that the subprime lenders had no unsecured financing such as FDIC insured deposits and were reliant on
securitization funding and "warehouse lines of credit" that were backed by collateral. As the value of subprime loans decreased, the value of
the collateral backing their funding decreased, causing margin calls to increase the amount of collateral used to keep the warehouse lines in
place. When the companies could not supply more quality collateral, the subprime companies went into default on their financing
agreements and the warehouse lines were withdrawn. In the case of AHM, its collateral is higher quality, mostly Alt-A, ARMs and FNM/FRE
conforming fixed rate loans (not subprime by definition). The secondary market for its loans continues to pay premiums in the 101-102
range relative to par. This pricing is barely profitable net of origination costs, but it is still netting a gain on sale. At year end 2006, AHM had
liabilities of $17.6 billion and $1.3 billion of equity. Warehouse lines of credit were $1.3 billion, commercial paper was $1.2 billion, and
CDOs, or collateralized debt obligations were $4.8 billion. As far as we know, the collateral underlying the warehouse lines and repos
continue to perform well, and thus the liability side of AHM’s balance sheet is still in stable condition, with no funding problems that we are
aware of.
4) In our opinion, with a 20% dividend yield, the market no longer believes the dividend is secure. Under REIT rules, the company must
continue to pay out 90 percent of earnings in the part of the company that is the qualified REIT subsidiary (QRS), and this part of the
business has been generating about 85% of the dividend. In our discussions with management, and in analyzing the company, we believe
this dividend is secure. For the sake of creating more conservative expectations, it might add confidence to the market if the company
lowered the dividend contributed by the TRS, or taxable REIT subsidiary just to build capital, even if management believes it is not
necessary to do so. If this were to happen, the yield would still be in the mid-teens at the current price. Of course, that is a tough call
because given the apparent current state of fear in the market, a reduction in the dividend would be likely PERCEIVED negatively at first.
5) Of assets on balance sheet, there are about $8 billion of AAA securities, which could be sold even in a tough market and free up about
$500 million of capital if so needed. |
