BOSTON (MarketWatch) -- American Home Mortgage Investment Corp.'s rapid slide into Chapter 11 is a stark reminder that instability in the subprime-mortgage market is rippling into higher-quality loans, an attorney specializing in bankruptcy restructuring said Tuesday.
"American Home Mortgage is going down and it's not a subprime originator, so it looks like it's a step up the ladder in terms of turmoil in the mortgage market," said Vincent Slusher, a partner at Beirne, Maynard & Parsons LLC in a telephone interview.
"If it continues up the chain, it's tough to say what might happen," he said.
American Home Mortgage's demise sounded alarm bells because the real estate investment trust dealt in so-called Alt-A mortgages, which are offered to more creditworthy borrowers than subprime loans, but they often have adjustable rates and sometimes require little or no documentation.
Highlighting the spreading damage in the mortgage market, Standard & Poor's said on Tuesday that it may downgrade 207 classes of Alt-A residential mortgage-backed securities because of rising delinquencies on the underlying home loans. The underlying loans were offered from the beginning of October 2005 through the end of December 2006, the ratings agency noted.
"The collateral underlying the Alt-A transactions has been experiencing high levels of severe delinquencies that have not abated," S&P said. Alt-A loans represented 20% of the mortgage market in 2006 by estimated purchase dollar originations, while subprime also accounted for 20%, according to Credit Suisse.
Meanwhile, Slusher also pointed to substantial doubt in the market for mortgage-backed securities, which are packages of loans that are securitized and sold to investors.
Large financial institutions holding these securities are feeling the pinch as their values are being marked down with delinquencies up and the housing market on ice. If pessimism in the MBS market continues or worsens, "there could be a severe liquidity crisis," Slusher observed.
The recent decline in shares of Bear Stearns Cos. (BSC : The Bear Stearns Companies Inc
News , chart , profile , more and the departure of a key executive are more signs that investors are uncertain how deep into credit markets the pain could spread. S&P last week lowered its outlook on the company due to exposure to mortgage-backed securities and leveraged buyouts, another market that is slowing.
"Staid, solid investment houses and investment banks getting caught up in some of the mess is an indication that there's some exposure that could be pretty widespread," Slusher said.
He compared the situation to the run of bank failures in the late 1980s.
"There was a lot of money in the marketplace that needed someplace to land," the lawyer said.
"Whenever more dollars are chasing a limited number of outlets, lending requirements are lessened and riskier loans are made, which results in higher default rates eventually."
The mortgage market has almost ground to a halt on the subprime fears, and all lenders "are caught up in the crunch because they don't have funds to make mortgage loans."
Additionally, Slusher said he's seeing a "minor" increase in bankruptcy filings in the real estate sector in both Florida residential and commercial companies, which are holding land for development longer than anticipated, which creates "liquidity problems."
Home buyers should expect mortgage rates to rise more, the lawyer said.
"There will be tougher underwriting requirements in terms of down payments and required equity to lessen lender risk," said Slusher. And as rates jump and monthly payments on adjustable-rate mortgages reset higher and bump up monthly payments, default rates should increase even more, he said.
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