Fed Comment Undercuts Agency Investors

The Federal Reserve slashed its key fed funds rate by another 25 basis points Wednesday, but thoughts that the Fed may be done easing triggered a significant selloff among the agency RMBS investors.

"The committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth," the FOMC statement says. "The committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth."

That statement sparked selling in Annaly Capital (NLY), MFA Mortgage (MFA), Capstead Mortgage (CMO), and Anworth Mortgage (ANH). The agency investor group is all liability-sensitive, meaning that the impact of the change in its assets is smaller than the impact of the change in its liabilities after a change in prevailing interest rates. A liability sensitive entity’s economic value of equity decreases when prevailing rates rise or increase when prevailing rates fall. If the Fed stops lowering interest rates, these mREITs will have limited success investing long and borrowing short because the net interest spread available will not be as wide as they would like for it to be.

Dynex Delivers

Little-known mortgage REIT Dynex Capital (DX) was out with Q3 results this morning, swinging to net income of $2.7 million for the period. How did Dynex post a profit while other mREITs are struggling? "During the third quarter, we purchased $10.5 million of securities at attractive prices, including $3.2 million of common stock in publicly traded mortgage REITs and $2.3 million of publicly traded preferred stock in those and other mortgage REITs." Dynex is taking advantage of a loophole in the REIT tax code that allows REITs to treat investments in other REITs as qualified assets / income. Therefore, Dynex can bet on other mREITs, much like a hedge fund would, and still remain a mortgage REIT. The problem with this strategy is that Dynex's investments are all concentrated in this one sector, so another market dislocation like we had this summer could vaporize the value of Dynex's investments (see RAIT Financial Trust as an example).

Nonetheless, Dynex has waited patiently for opportunities to invest its available capital, and if the company is correct about a bottom being in on mortgage REIT equity prices, Dynex's big bet could reap serious rewards.

Annaly Posts In-Line Q3 Results

Annaly Capital Management (NLY) posted third quarter results that were largely in line with the Street's expectations. GAAP earnings were $0.33/share, which included $3.8 million in gains on sales of MBS and $2.0 million in gains on related swap terminations. After backing out those one-time gains, Annaly's adjusted GAAP EPS is roughly $0.31/share, two cents ahead of analyst estimates.

Although Annaly does not disclose taxable income, its operating earnings excluding FIDAC represent a reasonable proxy for REIT taxable income - about $0.28/share, leaving Annaly with a small amount of undistributed taxable income to roll into the fourth quarter. Look for a fourth quarter dividend of $0.30/share, assuming Annaly can fully deploy its early Q4 capital raise by year-end.

Annaly's book value rose to $12.11/share (excluding the liquidation preference effect of the preferred and the pro-forma effect of the accretive Q4 offering). At a closing price of $17.05/share, Annaly is trading at 1.4x book value, in-line with peer Capstead Mortgage. However, NLY has taken on significantly more interest-rate risk than Capstead by having 71% of its portfolio in fixed-rate securities. Annaly has hedged about half of that risk with swaps, clearly betting on a falling interest rate environment. We'll know as soon as Wednesday whether Annaly has made the correct bet.

From the "You Heard It Here First" Files - Bimini Going OTC

VERO BEACH, Fla.--(BUSINESS WIRE)--Bimini Capital Management, Inc. (NYSE:BMN - News) (“Bimini Capital” or the “Company”), a real estate investment trust (“REIT”), today announced that it has been notified by NYSE Regulation, Inc. that, because the Company’s average global market capitalization over a consecutive thirty trading day period has fallen below the NYSE’s minimum quantitative continued listing criteria for REITs of $25 million, trading in the Company’s Class A common stock on the NYSE will be suspended prior to the market opening on Monday, November 5, 2007, pending de-listing. The Company has applied to list its Class A common stock on another national securities market, however, no assurance can be given that the Company’s Class A common stock will be approved for listing on such national securities market. Until such time that the Company’s Class A common stock is approved for listing on another national securities market, the Company anticipates that the Company’s Class A common stock will trade on the OTC Bulletin Board. Details with respect to trading in the Company’s Class A common stock beginning Monday, November 5, 2007, are expected to be released on or before Friday, November 2, 2007.

Can Alesco Remain a REIT?

Last week, I blogged about the latest downgrades to affect Alesco Financial's (AFN) portfolio of CDOs. Both Kleros I and Kleros II, Alesco's MBS-related CDOs, contained tranches that were downgraded significantly.

Looking back to AFN's 2006 10-K, I noted the following ominous warnings:

Our investments in TruPS, RMBS and leveraged loans or in corporate entities, such as CDOs and CLOs, that hold TruPS, RMBS and leveraged loans, are subject to limitations because we conduct our business so as to qualify as a REIT and not be required to register as an investment company under the Investment Company Act of 1940. TruPS, leveraged loans and equity in corporate entities, such as CDO and CLO entities, created to hold TruPS, RMBS and leveraged loans, do not qualify as real estate assets for purposes of the REIT asset tests.

A substantial portion of our borrowings are in the form of collateralized borrowings. If the value of the assets pledged to secure our borrowings were to decline, we would be required to post additional collateral, reduce the amount borrowed or suffer forced sales of the collateral. If sales were made at prices lower than the carrying value of the collateral, we would experience additional losses. If we are forced to liquidate qualified REIT real estate assets to repay borrowings, we may not be able to maintain compliance with the REIT provisions of the Internal Revenue Code regarding asset and source of income requirements. If we are unable to maintain our qualification as a REIT, our distributions will not be deductible by us, and our income will be subject to U.S. federal income taxation, reducing our earnings available for distribution.

Alesco has acknowledged that it is evaluating the risks and benefits of converting its structure from a publicly-traded corporation, that has elected to qualify as a REIT, to a publicly-traded limited liability company, or LLC, that intends to qualify as a partnership for U.S. federal income tax purposes. Such a move would be similar to the conversion undertaken by KKR Financial Holdings (KFN) earlier this year and would allow Alesco to add higher-yielding leveraged loan and equity tranches to its portfolio. Conversely, the conversion may also allow Alesco to retain more mezzanine and equity paper, which it cannot sell in the current credit environment anyway. In any case, Alesco needs to make the decision quickly, or continued downgrades of Kleros CDOs may make the decision for them.

Offering Documents Offer Earnings Clues

After discovering the losses associated with Capstead's third-quarter portfolio restructuring in an earlier prospectus document (and only in that document), I did a search of recent mREIT registration statements to discover similar news hiding in offering documents.

Interestingly, one of Capstead's peers also undertook a third-quarter restructuring charge. MFA Mortgage (MFA) sold approximately $650 million of Agency and AAA rated MBS at a loss of approximately $22 million during the quarter. MFA, which has had a run rate of $10 million in quarterly earnings, will likely report a GAAP loss of $0.15/share. The asset sales will result in capital losses for tax purposes, which will not impact the ordinary taxable income used to set dividend policy.

Book value, adjusted for MFA's accretive post-quarter offering and third-quarter dividend is estimated to be about $8.27/share. At recent share prices of $8.68/share, MFA is trading at just 1.05x book value.

Given the relatively low portfolio restructuring charge and continued improvement in the dividend, MFA appears to be one of the more attractive opportunities in the agency RMBS sector.

Hanover's Mark-to-Mess

Hanover Capital (HCM) tried to slide in this 8-K where they admit to obtaining a waiver from lender Greenwich Capital of their "Tangible Net Worth" covenant. Hanover has agreed to maintain Tangible Net Worth of not less than $56,000,000, of which a minimum of $38,000,000 shall be comprised of stockholder’s equity. Hanover had $42.8 million in equity at June 30, so they easily lost well over $5 million in the current quarter -- after already taking a $14 million mark-to-market hit during the second quarter.

The losses are not surprising, given Hanover's investments in subordinate RMBS (i.e. BB+ and below rated tranches). Despite Hanover's claims that realized losses have been minimal, that brand of toxic paper will barely catch a bid these days.

Hanover, which suspended its return-of-capital dividend last quarter, closed at $1.35/share in regular trading.

The Countrywide Conundrum

I was initially going to refrain from even touching on Countrywide's (CFC) earnings (and planned three-hour conference call -- really, Angelo, is that necessary?), but I had to get a perverse laugh out of the fact that CFC posted a $1.2 BILLION loss for the quarter and the stock soared 30%.

More CDO Woe for Alesco

Two of Alesco Financial's (AFN) CDOs, Kleros Real Estate CDO I and Kleros Real Estate CDO II, were gouged by Moody's today. The downgrade affected $64.7 million of Kleros I tranches and $219.7 million of Kleros II tranches.

Alesco had previously warned in a September 4, 2007 8-K that these two CDOs had failed overcollateralization tests, thus AFN would no longer receive cash flow from the retained mezzanine and equity tranches. Nonetheless, Moody's cut previously AAA-rated tranches in both CDOs, damaging Alesco's reputation in the collateralized debt obligation market and making potential buyers think twice about purchasing from Alesco.

Shares of Alesco were under pressure today, down over 3% at last glance.

Capstead Comes Clean

Update: Just finished listening to Capstead's conference call. My biggest takeaway was that Capstead is lengthening the duration of their portfolio to approximately four months and they are more concerned about being overhedged versus underhedged. The market cost of swaps remains high. Also, despite the attractive yield currently offered by fixed-rate passthroughs, Capstead doesn't anticipate changing its investment strategy of investing in ARMs only. Additionally, prepayment speeds continue falling on ARMs despite recent Fed cuts. Despite the large operating loss sustained in the third quarter, Capstead intends to pay out 100% of its fourth quarter operating earnings.

Capstead released third-quarter results this afternoon, posting a shocking loss of $0.43/share versus earnings of $0.04/share in the second quarter of 2007. Driving the loss was the sale of $809 million of its lower-yielding, faster prepaying agency-guaranteed securities incurring a loss on sale of $5.9 million and a loss of $2.3 million from terminating related longer-dated repurchase arrangements. Net interest spread improvement was a disappointing six basis points.

Most notably, Capstead admitted that

With asset values falling and lenders becoming more cautious, many investors in non-agency securities were forced to liquidate substantial amounts of their holdings. These distressed sales placed downward pressure on market values of all residential mortgage securities, including agency issued and guaranteed securities...

This statement leads me to believe that agency RMBS may be facing more serious mark-to-market adjustments for the third quarter than first thought. If even agency securities lost some pricing visibility and liquidity, competitors like MFA Mortgage and Annaly Capital may post results that are considerably short of expectations. While these downward valuation adjustments will not affect taxable income, they will push down book value, which is typically the metric off which passive REITs trade.

Capstead's book value fell to just $7.57/share as of September 30, which excludes the $0.60/share accretion to book value from the recent common offering.

Capstead's failure to disclose the impact of portfolio sales during the quarter via a press release or even in a separate 8-K is troubling given the timing of the common offering. The information was disclosed in the offering prospectus; however, existing Capstead shareholders may have easily missed this information.

Based on the pro-forma book value of $8.17/share (including the accretive offering), Capstead is trading at a lofty 1.4x book value.

Shorts Stay in Control of These Ten Stocks

I believe these stocks are firmly in the short-sellers' crosshairs. Buyers beware.

1. Redwood Trust (RWT)
2. Alesco Financial (AFN)
3. Crystal River Capital (CRZ)
4. Deerfield Triarc Capital (DFR)
5. Newcastle Investment Trust (NCT)
6. iStar Financial (SFI)
7. RAIT Financial Trust (RAS)
8. Anthracite Capital (AHR)
9. CapitalSource (CSE)
10. Thornburg Mortgage (TMA)

FBR Takes Big Third Quarter Bath

FBR Group reported third-quarter results earlier today, posting a quarterly loss of $1.28/share. The results were significantly weighed down by a number of hefty charges, including:

The four principal components of the third quarter results are:

• $90 million of write downs and losses relating to the company's on-balance sheet securitized loan portfolio ("residual interests") that reduce the company's economic risk in this portfolio to zero,
• a net loss of $67 million from the company's mortgage-backed securities portfolio and operations, including the previously announced $57 million loss on the sale of approximately $4.95 billion of agency mortgage-backed securities,
• an economic loss of $17.2 million(2) associated with restructuring and operating costs at First NLC Financial Services (FNLC), of which $15 million was incurred prior to the agreement announced in July to sell FNLC to an affiliate of Sun Capital Partners (Sun Capital), and
• a $27 million valuation loss relating to the portfolio of conforming and non-conforming loans originated by FNLC and for which FBR Group took ownership under the Sun Capital sale agreement, reducing the value of those loans to $203 million.

Consolidated book value fell to $4.36/share. "Economic exposure to our securitized, non-recourse mortgage loan portfolio has been eliminated, and our remaining exposure to FNLC is $12 million," said Eric F. Billings, Chairman and Chief Executive Officer of FBR Group.

Friedman Billings was sinking 5% in light pre-market trade.

Did Merrill's CDO Contagion Spread to Cohen?

An interesting (and free) article from the Wall Street Journal reveals that Merrill's whopping $7.9 billion write-down might have had its seeds sown as early as 2003 -- and a familiar name in the mortgage REIT world, Cohen & Company, might have been its victim.

The article reveals that:

In the 18 months after his [Chris Ricciardi's] early 2006 arrival [from Merrill], Cohen's assets under management swelled to more than $40 billion from $10 billion. Mostly in conjunction with Merrill as underwriter, Cohen formed 25 new CDOs valued at $23 billion, most of which contained subprime mortgages.

Many of these CDOs were issued through Cohen & Company's managed REIT - Alesco Financial (AFN). In addition, a large number of CDOs were also issued through another Cohen-controlled entity, Taberna Realty Finance. Late in 2006, however, as the cracks in the mortgage finance indsutry became much more visible, Cohen & Co. transferred its Taberna investment to another publicly-traded entity, RAIT Financial Trust (RAS) - a company that conveniently happens to be run by Betsy Cohen.

The Cohen CDO machine hit a wall earlier in the summer. The Taberna CDOs acquired by RAIT have been downgraded and produced at least one default -- when American Home Mortgage's (AHMIQ.PK) bankruptcy wiped away the value of RAIT's investment in American Home's trust preferred securities. The default amounted to net equity exposure approximately $95 million, or $1.56 per share of book value. Meanwhile, Alesco admitted in September that two of its CDO issuances were failing overcollateralization tests, which meant that cash flow to the subordinated tranches held by Alesco would be cut off.

Shares of RAIT Financial Trust have fallen 76% since hitting a high of $38.25 in February. Shares of Alesco Financial have fallen 62.5% in the same time frame.

Disclosure: I have a small long position in shares of RAIT Financial Trust.

Is Impac's Listing In Trouble?

A double-digit percentage drop in shares of Impac Mortgage Holdings (IMH) has put the one-time Alt-A giant at risk of being delisted from the NYSE. Shares of Impac dipped below the NYSE's $1.00/share minimum bid price for the second straight day, although Impac still has twenty-eight more days for share prices to recover before they are technically out of compliance with NYSE Listing Standard 802.01C. However, the depressed share price does limit the ability of institutional investors to remain in Impac shares, so I would look for IMH to do a reverse split in the near future - a first in the Company's 12-year public history.

As a side note, the situation at Impac is different from that at Bimini. Impac is only at risk of being out of compliance with the $1/share minimum bid price rule, but has sufficient capitalization otherwise. Bimini has been below the $25 million market capitalization threshold for thirteen days now.

Rise of the Mortgage REITs

Barron's is out with an article today entitled "Rise of the Mortgage REITs" touting the near-term positive outlook for agency-backed RMBS investors. See the article here.

Redwood Shorts are Simply Short-Sighted

Another day, another round of selling at Redwood Trust (RWT). The pattern has become fairly entrenched since Redwood briefly bounced to $40/share in mid-September. Since then, the stock has steadily dropped, lately trading as low as $26.50/share.

Redwood is in one of the most-hated sectors in the market right now: residential-focused mortgage REITs. One of the few residential mREITs to have yet to announce bad news, short-sellers have targeted the stock, figuring it must eventually suffer the fate of its peers like Luminent Mortgage Capital (LUM) and Thornburg Mortgage (TMA). However, Redwood has a strategic advantage that other mREITs don’t possess – its funding structure.

Redwood currently match-funds about 88% of its mortgage investments with CDOs, which enables the company to largely avoid the use of repurchase agreements and commercial paper as a source of funds. Redwood’s CDOs have a strong reputation and have performed well over time, making them desirable even in the current credit environment. This is evidenced by the Company’s ability to complete a securitization deal in July, even as the CDO market was growing cold.

Although Redwood’s portfolio of mortgage securities is exposed to significant downward valuation adjustments, the GAAP impact of mark-to-market adjustments has relatively limited economic exposure for the Company. Because of Redwood’s extensive securitization programs, the mortgage securities are permanently funded and not subject to cash-draining margin calls. The GAAP losses are not deductible for tax purposes, so there is no hit to taxable income (which drives the dividend).

On a valuation standpoint alone, Redwood Trust is a screaming buy. Shares have recently traded at just 0.84x June 30 book value, and the yield considering just the regular dividend alone has climbed to 11%. Redwood’s dividend appears very stable for several quarters ahead, as the company has $2.11/share of taxable income remaining to distribute – enough to support the dividend at current levels through the second quarter of 2008. If Redwood continues to earn taxable income at the current run rate through the second half of 2007, they will finish the year with approximately $5.25/share of undistributed taxable income. Based on Redwood’s past distribution policies, that level of taxable income would support a special dividend of $3.00/share.

Short-sighted shorts, beware of the special.

NorthStar Dividend: No Change

NorthStar Realty Finance (NRF), a commercial-focused investor dealing in CRE debt, announced today that it was maintaining its $0.36/share dividend for the third-quarter. NRF shares ticked up 2.5% after the bell on the news. NorthStar's dividend yield is currently 15.5%.

Deerfield's Dividend Stays Intact

Deerfield Triarc (DFR), a diversified portfolio investor, recently announced that its third-quarter dividend would continue at a rate of $0.42/share, confirming the stock's astronomical yield of over 18%.

Deerfield has been plagued recently by concerns that it will be unable to purchase its external manager, Deerfield & Company LLC, from Nelson Peltz-controlled Triarc Companies (TRY). The two companies terminated their original arrangement on October 19, and DFR shares have remained under pressure since the credit crunch escalated in August.

Nonetheless, Deerfield continues to generate taxable income from its diversified portfolio of largely-unencumbered loans. Shares of Deerfield were recently rising 4% on the news.

JMP’s Upgrade of Anworth Was Right On the Money

Anworth Mortgage (ANH), an agency RMBS investor, popped higher last week after JMP upgraded the stock to “Strong Buy”. The swift upward movement in the shares prompted some market participants to consider shorting Anworth on valuation.

Prior to the JMP upgrade, Anworth shares were trading at about 90% of September 30 book value of $6.25/share. Now the shares are trading as high as 106% of book value…and they’re still cheap. Consider the valuations of competitors such as Annaly, Capstead, and MFA Mortgage, which are trading anywhere from 130% to 160% of second-quarter book value, as they have yet to report third-quarter numbers. Right there, Anworth has a visibility advantage over its peers. Its third-quarter book value estimate includes all losses on sales of securities and the impairment charge for subsidiary Belvedere Trust.

Short-sellers point to the remaining credit risk of Anworth’s non-agency MBS, but the Company's remaining Non-Agency MBS holdings currently consist of AAA-rated MBS with a current face amount of approximately $52 million, and there are currently no repurchase agreement borrowings related to these holdings. Anworth’s remaining exposure to Belvedere is also limited in that Belvedere’s entire residential loan portfolio has been securitized. Thus the only losses in the near-term relate to the valuation of residual interests, which would be a mark-to-market adjustment that does not impact Anworth’s taxable income.

Another positive for Anworth is the increased rates of prepayments on its portfolio, which will cause the portfolio yield to continue to increase as lower yielding assets pay down and are replaced with higher yielding assets. Coupled with the impact of a lowered cost of funds thanks to the Federal Reserve, Anworth will almost certainly see an expansion in its net interest margin and be able to raise the dividend in 2008.

Capstead Continues Climb

Another day, another uptick for Capstead Mortgage (CMO). As the macroeconomic news gets worse, this agency RMBS investor gets a boost from speculation that another federal funds rate cut is forthcoming. But has Capstead gotten ahead of itself?

The Company hasn't paid a double digit quarterly dividend since 2005, and even in the most recent quarter, Capstead only managed to earn net income available to common shareholders of $0.04/share, equal to its common stock dividend. Capstead doesn't release taxable income information, but agency RMBS investors tend to have fewer GAAP/tax adjustments than other mortgage REITs, so Capstead is probably paying out close to 100% of its taxable income. At June 30, 2007, book value was just $8.32/share, yet CMO was recently trading up at 4% to $11.40/share, a premium of 1.37x book value.

Capstead's dividend yield is significantly lagging its peers, and its investments are primarily floating-rate securities -- meaning that the upside from falling interest rates is effectively capped.

Capstead reports third quarter results on Friday and plans to declare the fourth quarter dividend in early December. We'll see if Capstead was able to effectively deploy its recent capital raise and improve net interest margins.

Big Bet on Thornburg's Recovery

In a Form 4 filing early this morning, Garrett Thornburg, Chairman of Thornburg Mortgage (TMA), disclosed that he bought a million shares of TMA in an open market purchase - an investment in the Company of nearly $10 million. While TMA has been thrashed by the turmoil in the credit markets, insider buying has remained steady, indicating that things may be improving for Thornburg Mortgage by the end of the year. Although there was no dividend declared for Q3, look for TMA to resume dividend payments next quarter at a rate of $0.25/share.

Is Bimini About to Get the Boot?

Bimini Capital Management (BMN), formerly known as Opteum (OPX), is but a shell of its former self after a distastrous twenty-month foray into the origination business. Since April, the Company has exited the mortgage origination business and sold all of its mortgage servicing rights portfolio. Bimini has now completed its transformation back into an agency RMBS investor, but it is too late to save the Company? Bimini shares have been on a steady slide since April, and they no longer meet NYSE listing requirements after falling below the $25 million market cap threshold on October 8. With the 20% slide in the shares today, it looks as though Bimini will not regain a minimum $1.00/share price before their 30-day window is up unless management can positively surprise the market with third-quarter earnings.

Gramercy Gains Momentum

Gramercy Capital (GKK) is a mortgage REIT focused on originating and investing in various pieces of commercial loans. The company came public in August 2004 and has delivered solid performance ever since. In stark contrast to the troubles in the residential mREIT universe, Gramercy has thrived on its investments in New York City and surrounding areas.

GKK reported third-quarter results after the bell on Wednesday, and the results were impressive. The company posts funds from operations (FFO) of $0.83/share and raised full-year FFO guidance to $3.00 - $3.05/share. Interestingly, Gramercy is one of the few mREITs to use FFO as a key metric -- likely attributable to its sponsor, equity REIT giant SL Green Corp (SLG).

Much of Gramercy's earnings power this quarter, however, was due to a $92.2 million realized gain on sale of the Company's 45% interest in One Madison Avenue in Manhattan. Nonetheless, Gramercy continues to deliver quarter after quarter, and until the CRE market begins to show signs of stress, the Company is attractively valued at just over 1x book value and a yield of 9.8%. Moreover, GKK expects to declare a special dividend in the fourth quarter of 2007, as it has earned FFO of $2.36/share through the first nine months of 2007 but paid out dividends of just $1.82/share -- a payout ratio of just 77%.

Anworth Mortgage Pre-Announces

Anworth Mortgage (ANH) pre-announced a miss on third-quarter earnings but maintained its $0.05/share quarterly dividend.

Anworth will write-off its $143 million investment in Belvedere Trust, as BT has been unable to obtain alternative financing for its remaining repurchase agreement borrowings. The related collateral is too small to complete a CDO deal, even until normalized market conditions.

Anworth also sold approximately $904 million of agency and non-agency MBS at a loss of $23.4 million.

Anworth expects net income to be positive, but much less than the $0.05/share it earned in the second quarter.

Including the expected write-off of our investment in Belvedere Trust and the sale of other securities, the preliminary estimate of Anworth’s book value per common share as of September 30, 2007 is approximately $6.25, a 13.6% premium to recent Anworth share prices.

It's difficult to get much visibility on Anworth's taxable income situation, though Anworth has a history of periodically declaring dividends that represent returns of capital. Given Anworth's outlook of improvement in costs of funds, I believe Anworth will be able to pay future dividends out of ordinary taxable income.

NYSE Moves to Delist NovaStar

Well, we knew it was coming based on NovaStar's September 17, 2007 8-K -- the NYSE has moved to delist NovaStar's common and preferred shares from the Big Board. Due to the termination of its REIT status, NovaStar no longer meets the market capitalization requirements for listing on the NYSE. (The NYSE allows REITs to list under lower threshold requirements.)

NovaStar, for its part, put out a press release stating that it "intends to request a review of this determination and will explore alternative arrangements for the listing or quoting of its common and preferred stock."

The company's securities are expected to continue to trade on the NYSE pending review of the NYSE's determination.

The delisting was part of a one-two punch hitting the ailing subprime lender. Earlier in the day, S&P downgraded $306.6 million of RMBS in NovaStar's 2007 securitizations, which will require downward mark-to-market adjustments to the residual securities and possible additional margin calls.

NovaStar shares tanked 12% in after-hours trading.

Thornburg Thrashed By Credit Market

Thornburg (TMA) finally posted Q3 earnings late yesterday, and once they did, it wasn't pretty. The company posted a GAAP loss of $8.83/share and worse, a taxable loss of $0.08/share. Since the taxable loss wiped out any remaining undistributed taxable income, Thornburg wisely suspended its dividend for the third quarter.

Some headlines from the earnings release:

• The company finally realized a small amount of loan losses during the quarter for the first time in five years.
• Book value fell to $10.14/share.
• The company now believes its REIT status will remain unaffected.
• The company is no longer acquiring pay option ARM assets from third parties, and stopped doing so in January 2007.
• Given the current mortgage rates offered by the company and its estimate of these financing costs, the company believes that it can achieve a 6.25% yield on its mortgage loans and a 30 to 40 basis point net spread leveraged approximately 27 times. This would translate into a return on equity before corporate operating expenses of approximately 14% to 17% on these originated and securitized mortgage loans. The company's goal is to acquire and securitize 70% of all new assets using this structure. Over time, this strategy will likely result in increased balance sheet leverage and continue to reduce the company's dependence on short-term financing sources.

Larry Goldstone, Thornburg's President and COO, noted that

Additionally, we still see credit availability and liquidity problems impacting financing for below AAA-rated asset classes. As of September 30, 2007, the company's portfolio consisted of 94.8% AAA-rated assets and 5.2% below AAA-rated assets. And while those portfolio assets continue to perform extremely well from a credit performance perspective, we have yet to see financing terms materially improve for these asset classes. Margin requirements remain high, financing spreads to LIBOR remain high and the number of finance counterparties for these asset classes remain limited. To date, the company has been successful in securing financing for its below AAA-rated assets, but it continues to pursue more permanent or predictable forms of financing, so as not to be subject to any further deterioration in future mortgage financing markets. Also, while the company has successfully obtained waivers of financial covenants from its warehouse lenders to be able to continue to fund its mortgage loans, the commercial paper market for financing AAA-rated securities remains closed to the company and the company remains concerned about the impact of 'structured investment vehicles' for which financing remains uncertain.

It was a horrible quarter for Thornburg, but a true testament to the acumen and ability of Thornburg management to survive an unprecedented dislocation in the the credit markets.

NovaStar to Sell MSRs and Advances

In a press release this afternoon, NovaStar (NFI) revealed that it was selling its existing portfolio of servicing rights and servicing-related advances to Saxon Mortgage for $175 million, about a $70 million premium to their recorded value at June 30, 2007. NovaStar expects to subsequently exit the servicing business. The sale will enable NovaStar to repay its existing $100 million Servicing Rights Facility with Wachovia and its existing $80 million Servicing Advances Facility with Deutsche Bank.

The big winner on the deal was Deutsche Bank, which will fully recover its credit line extension to NovaStar in the form of the Servicing Advances Facility and DB will also earn deal fees for advising NovaStar in the transaction.

NovaStar, for its part, will "focus on managing [its] portfolio of mortgage securities, along with brokering loans with a retail team that continues to serve homeowners." Perhaps NovaStar should also focus on maintaining a strong relationship with its remaining creditor, Wachovia Bank.

Astute readers may have guessed this was coming, as late Friday, NovaStar disclosed that it had entered into a forbearance agreement with DB over the Servicing Advances Facility and it was paying a hefty fee for two weeks of grace.

Countrywide's Colossal Writeoff

Countrywide (CFC) finally confessed the amount of its expected restructuring from layoffs and consolidations. In an amended 8-K filed this afternoon, Countrywide said that

The Company...estimates that it will incur a pre-tax restructuring charge of approximately $125 million to $150 million, consisting of approximately $30 million to $35 million in one-time termination benefits, $73 million to $89 million in lease termination costs and $22 million to $26 million in fixed asset disposals and other miscellaneous costs. Of the total amount of the pre-tax restructuring charge, approximately $57 million is expected to be recognized in the quarter ending September 30, 2007, with the remaining amount expected to be recognized primarily in the following quarter. Additionally, the Company estimates that of the total amount of the pre-tax restructuring charge approximately $65 million to $90 million will result in future cash outlays.

The $57 million hit represents about 12% of Countrywide's second-quarter earnings and will likely push CFC well into the red for the third quarter. Countrywide reports Q3 earnings on October 26.

Origen Completes 2007-B deal

Origen Financial (ORGN) announced today that it was able to complete a small securitization of its manufactured housing loans. The $127 million deal, Origen Manufactured Housing Contract Trust 2007-B, was structured as an Ambac-wrapped, floating rate bond structure with a 9.5% target over-collateralization amount. The ABS issued by the trust all received an AAA rating and were privately placed.

The execution was not quite as good as 2007-A, which only needed O/C of 8%. Nonetheless, getting any deal done in this environment is quite an accomplishment. Origen's deals have been performing quite well, with delinquency rates at or below that of many Alt-A securitizations. I'll have an update on more of the deal details when Origen files the requisite Reg. AB information with the SEC.

S&P Dings 2005 Subprime Vintage

Standard & Poor’s announced yesterday that it had downgraded 402 classes of U.S. residential mortgage-backed securities backed by first-lien subprime mortgage loans that were issued in the first three quarters of 2005. The downgrades hit a total of $4.6 billion in original par, or 1.45% of the $320 billion in first-lien US RMBS rated by the agency. S&P also affirmed its ratings on securities representing $252.4 billion original par value of U.S. RMBS backed by first-lien subprime mortgage loans from this same period.

Approximately 86% of the downgrades affected securities rated in the ‘BBB’ category and below, Standard and Poor’s said. No ‘AAA’ rated first-lien RMBS securities rated during this period were downgraded.

Perusing the list of downgrades, only mortgage REITs that appear to be affected were Friedman Billings (FBR), New Century (NEWCQ.PK), and Fieldstone (FICC). It would be very interesting to know why the mREIT deals held up better than the investment bank deals. Are mortgage REIT deals collateralized by more soundly underwritten loans, or are they simply better-structured securitizations? Difficult to say, but at least on an empirical basis, hindsight is showing that the mortgage REITs tend to bring strong deals to the market.

Thoughts on Thornburg, Earnings Season

Update (2:45 pm): Thornburg is still expected to release earnings later this afternoon. Options activity has been heavy, with October put volume outpacing call volume 13 to 5. The $10 puts have been especially active as traders continue to bet against a bright outlook for TMA.

The mortgage REIT earnings season kicks off in earnest tomorrow when Thornburg (TMA) is scheduled to report third quarter earnings after the bell. Normally Thornburg is a relatively benign start to the season, but this quarter has been anything but normal. Many investors are anxiously awaiting Thornburg's dividend declaration for the third quarter, and speculation has ranged from no change to the $0.68/share quarterly payout to a complete suspension of the common dividend.

I believe Thornburg will cut the dividend significantly. The company sold $22 billion in assets during the third quarter, or about 35% of its existing mortgage portfolio. The reduction in assets will reduce future interest income (and consequently REIT taxable income) going forward. Thornburg only had $0.05/share of undistributed taxable income remaining at 6/30/07. In addition, Thornburg's Series F Preferred pays a dividend at the higher of 10% or the going rate on the common shares. At the current annual rate of $2.72/share, that's a yield over 23%. To limit its obligations and preserve cash, I believe Thornburg will cut the common dividend to bring the yield down to 10%, which would be a rate of $1.16. As the share price recovers, Thornburg may raise the dividend accordingly, but may keep it around a yield of 10% due to the provisions on the Series F Preferred.

An interesting wrinkle in the picture is the dependence of the price of the common stock on the common stock dividend. If Thornburg doesn't cut the dividend severely, will it induce a rise in the stock price that will bring the dividend yield down? And will Thornburg management make that gamble?

Accredited Hits Up Its Daddy For $100M

The ink is barely dry on the merger papers, and already Accredited (AHH-PA) is announcing that it's hitting up new daddy Lone Star for $100 million. Presumably the cash will be used to payoff the Farallon loan, and in a bright piece of news (quite rare these days), Accredited expects to resume funding loans today. As of this morning, the Accredited website hasn't been updated to reflect this news, so their lending guidelines remain to be seen. We'll see how much they tighten up their lending standards and how much their production falls off from historical levels.

NovaStar's Pier Securitization

Update: Five posts in, and already I've got a factual black eye. Thanks to my buddy Run50k at Investor Village for catching my mistakes. I've updated the post to correct the securitization details.

It's been almost two months since NovaStar Financial (NFI) filed a prospectus for its third securitization of 2007, NovaStar Mortgage Funding Trust 2007-3, but in that time frame, it seems that little progress has been made towards closing the $548 million deal.

It's not as if NovaStar couldn't use the cash; they are required to repay $30 million in advances on a Servicing Rights Facility with Wachovia (WB) by October 18th. The securitization market for RMBS remains absolutely frozen, as only Thornburg (TMA) has completed a deal since August. Even then, Thornburg admitted that most of the MBS went to one buyer.

Looking at the underlying collateral of NovaStar's NMFT 2007-3 deal, however, there seems to be no reason why this deal can't get done. 92.4% of the loans are conforming, 62.8% of them have private mortgage insurance, and the collateral is geographically diverse, with the only concentrations being in Florida (20%), California (11%), and Texas (8%). The weighted average coupon in the aggregate is an impressive 8.86%.

Let's hope NovaStar can close this deal soon and raise some much-needed cash. Otherwise, we might be looking at another victim of the credit crunch.

Annaly's Secondary Is Not That Exciting

Here's a classic example of a misunderstanding in mortgage REIT land. I came across this article on Seeking Alpha. I don't mean to pick on the author, as his misunderstanding is fairly common.

In the article, the author discusses Annaly's recent secondary offering that should close this week. He's particularly excited because "Annaly’s capital raise is a brilliant move here, as it gives the company a huge chunk of cash to buy distressed mortgage backed securities."

Right, except that Annaly's entire portfolio consists of GSE-sponsored MBS, which have remained relatively liquid and maintained their pricing visibility throughout the current credit crunch. These securities aren't distressed at all. Annaly is simply taking advantage of the fact that they are trading at about 1.5x book value right now, so any offering they complete is immediately accretive to book value.

It's probably a good time for Annaly to raise additional capital, but it's not the opportunity of a lifetime that so many market participants are thinking. Annaly will simply take the proceeds, plow it into fixed-rate agency RMBS, and keep on hoping for more interest rate cuts to improve their liability-sensitive position.

Mortgage REITs - A Primer

Peter Ritter, a tax partner with O'Melveny & Myers LLP, wrote an excellent treatise on mortgage REITs back in spring of 2004. It still remains one of the most insightful articles I've ever come across regarding the challenges of being an "active" mortgage REIT.

Ritter vary aptly explains the difference between active and passive mortgage REITs:

Mortgage REITs, on the other hand, generally do not own or operate such assets or properties, but rather lend money to real estate owners and operators, either directly or indirectly through secondary market purchases of real estate loans or mortgage-backed securities. Mortgage REITs, in turn, generally fall within two categories: those that act like arbitrageurs by investing in mortgages and mortgage-backed securities, often with significant leverage, and trying to profit from the “spread” between the yields produced by assets they hold and their costs, including interest costs from leverage, and those that act like banks by originating, holding and securitizing mortgages and mortgage-backed securities.

REITs in general, and mortgage REITs in particular, are complicated creatures of the Code. Given all of the requirements that must be satisfied on a continuing basis to maintain REIT status, it is clear that mortgage REITs are not the optimal structure for all circumstances. Compliance with these requirements clearly prevents an entity from operating solely with the goal of maximizing profits and given the nature of the REIT gross income and asset tests generally, REIT status may be incompatible for “active” mortgage related companies. However, in circumstances where the REIT requirements are consistent with the proposed or existing operations of the entity desiring REIT status, the tax and other benefits achieved by REIT status are warranted.

It appears that Ritter may have been particularly prescient, as the recent credit crunch has reduced the active residential mREITs to Thornburg, Impac, and Origen. Origen is something of an anomaly, as it focuses on manufactured housing lending. Impac is fighting for its life, and even jumbo giant Thornburg has faced serious challenges despite the minimal credit risk in its portfolio.

REIT structure proved to be the downfall of American Home, HomeBanc, and New Century Financial. It also severely damaged NovaStar Financial, the only true subprime mREIT to stay alive so far in 2007.

Mortgage REIT Companies I'm Covering

Here are the companies that I’ll be covering on the blog (by category). Companies in red are now bankrupt and companies in blue have not elected REIT status. I include them for a comparison of business models and because some of them have previously used the REIT structure.

Residential-Focused Investors, Prime
Annaly Capital Management, Inc. (NLY)
MFA Mortgage Investments, Inc. (MFA)
Capstead Mortgage Corporation (CMO)
Anworth Mortgage Asset Corporation (ANH)
Bimini Capital Management, Inc. (BMN)
New York Mortgage Trust, Inc. (NMTR.OB)

Residential-Focused Investors, Alt-A, Subprime, and Subordinate RMBS
Redwood Trust, Inc. (RWT)
Luminent Capital Mortgage, Inc. (LUM)
Hanover Capital Mortgage, Inc. (HCM)
Friedman Billings Ramsey Group (FBR)
ECC Capital, Inc. (ECRO.PK)
Capital Alliance Income Trust, Inc. (CAA)

Residential-Focused Originators, Prime and Alt-A
Thornburg Mortgage, Inc. (TMA)
Impac Mortgage Holdings, Inc. (IMH)
Countrywide Financial Corporation (CFC)
American Home Mortgage Investment Corporation (AHMIQ.PK)
HomeBanc, Inc. (HMBN.PK)

Residential-Focused Originators, Subprime
Origen Financial, Inc. (ORGN)
NovaStar Financial, Inc. (NFI)
Delta Funding Corporation (DFC)
Accredited Home Lenders (AHH-PA)
New Century Financial, Inc. (NEWCQ.PK)

Commercial-Focused Investors
American Mortgage Acceptance Corporation (AMC)
Anthracite Capital, Inc. (AHR)
JRT Investors Trust, Inc. (JRT)

Commercial-Focused Originators
Arbor Realty Trust, Inc. (ABR)
BRT Realty Trust, Inc. (BRT)
Capital Trust, Inc. (CT)
Gramercy Capital Corporation (GKK)
PMC Commercial Trust, Inc. (PCC)
iStar Financial, Inc. (SFI)
NorthStar Realty Finance, Inc. (NRF)
CBRE Realty Finance, Inc. (CBF)
Quadra Realty Trust, Inc. (QRR)

Diversified Investors
Alesco Financial, Inc. (AFN)
Crystal River Capital, Inc. (CRZ)
Deerfield Triarc Capital, Inc. (DFR)
Dynex Capital, Inc. (DX)
KKR Financial Holdings LLC (KFN)
Newcastle Investment Trust, Inc. (NCT)
RAIT Financial Trust, Inc. (RAS)
Resource Capital Corporation (RSO)
Vestin Realty Mortgage I, Inc. (VRTA)
Vestin Realty Mortgage II, Inc. (VRTB)

Welcome!

The mortgage REIT landscape has changed dramatically over the past three years. From its peak in 2004 to its (hopeful) bottom in August 2007, mortgage trusts have endured a wild ride from riches to rags. Many of the companies I have followed in that time frame are no longer with us due to acquisitions or bankruptcy. Some companies are still with us, but they have had to drastically change their business models to survive.

This blog aims to cover what I hope to be a new boom cycle for mortgage REITs and specialty finance lenders. Valuations have become extremely attractive for many names in the sector, and I strongly believe that patient investors will be handsomely rewarded.

I hope to bring you comprehensive coverage of news and events that will drive the stocks of mortgage REITs and help you make an informed decision about when and where to invest your hard-earned cash in this potentially lucrative sector.