PMC Plans Ahead

Update: PMC seems committed to trying to do a securitization deal. It's the only mREIT presenting at the American Securitization Forum 2008 Conference this weekend.

As a bit of a follow-up to yesterday's post about Quadra Realty's (QRR) lack of a back-up plan regarding the use of securitization funding to support its portfolio, I'd like to contrast that with one of the most forthright 8-K filings I have read in a while, courtesy of PMC Commercial Trust (PCC) late yesterday. PMC, a Dallas-based small business lender and REIT had the following to say:

On January 28, 2008, PMC Commercial Trust amended its (i) revolving credit facility to increase the amount available under the facility from $20 million to $45 million and (ii) warehouse facility (the "Conduit Facility") which, among other things, extended the Conduit Facility’s maturity date from February 2008 to May 2, 2008.

The interest rate spread on our Conduit Facility will remain the same during the extended period. The Conduit Facility cost of funds is the pass-through rate as defined in the facility documents plus 0.85%. The "pass-through" rate is the rate that the Conduit Facility pays for its commercial paper and historically has approximated LIBOR.

The Conduit Facility allows for advances based on the amount of eligible collateral sold and has minimum collateral requirements. In addition to the extension, the amendment increased the amount of collateral required under the Conduit Facility. Due to PMC Commercial Trust having excess collateral that meets eligibility requirements of the Conduit Facility, we do not expect this change in collateral requirements to have a material impact on us.

The funds to repay principal under our Conduit Facility are typically obtained through securitizations of the loans collateralizing advances under the Conduit Facility. As a result of current market conditions, we expect that the interest rate spread would be at or above the spread on our prior variable-rate structured transaction of LIBOR plus 1.25%. Therefore, we may delay completion of a securitization until market conditions are more favorable.

While we can give no assurances, prior to May 2, 2008, we anticipate that we will either extend the maturity date of the Conduit Facility by as much as a year and/or complete a securitization. Accordingly, to allow us to continue our loan origination platform without disruption, we have increased the amount available under our revolving credit facility, hich matures December 31, 2009, from $20 million to $45 million. We currently have approximately $24 million of Conduit Facility borrowings outstanding and have no borrowings outstanding under our revolving credit facility.

PMC is honestly acknowledging that securitization is not an economically viable option right now and it stating its plans to increase its warehouse facilities on reasonably favorable terms in order to continue growing the portfolio going forward. It's all subject to the usual boilerplate risk, but it beats the evasive (and annoying) "we're reviewing all available financing options". Review time is over. Test time is here. On the funding question, PMC seems to be passing.

Quadra's Failure Raises More Questions for mREITs

The boom in launching diversified mortgage REITs during the mid-2000s has officially busted. Hypo Real Estate Bank International AG is folding its US commercial mREIT, Quadra Realty Trust (QRR), back into its portfolio less than 12 months after Quadra's February 2007 IPO.

There was no commentary in the press release announcing the acquisition other than the terms and the price of the tender offer. Quadra shareholders will get a total of $11/share in cash and a special dividend. Shareholders who bought into the IPO at $15/share last year have seen a 30% capital loss (not considering the dividends Quadra has paid of $0.42/share).

The offering was pretty much a bust from the outset, as Quadra barely traded above its IPO price for a few days before settling into a constant decline. I believe the reason for Quadra's failure is set out pretty plainly in the Company's IPO prospectus:

Although our Manager has been active in real estate operations and lending for many years, it has no experience operating a REIT and operating a business in compliance with the numerous technical restrictions and limitations set forth in the Internal Revenue Code or the Investment Company Act applicable to REITs.

Hypo had no prior experience with managing the day-to-day cash flow challenges that REITs impose, and without access to the capital markets (particularly CDOs) to fund Quadra's portfolio, liquidity was being squeezed by margin calls and haircuts on the warehouse lines. There was, quite simply, no back-up plan if CDO issuance was not an option.

I don't believe Quadra is the only commercial mREIT struggling to find its footing as capital markets remained closed. As earnings reports roll in next week, a key issue for management at the CRE mREITs is to have a well-defined strategy for managing the business in the absence of CDO issuance.

Tax Treatment of 2007 Dividends

Time for one of the more-telling but least-referenced metrics to evaluate mREITs - the tax characteristics of their dividends. Typically in January or February, the mREITs announce the classification of their dividends for tax purposes. The dividends are classified as one of the following flavors:

1. Ordinary taxable income
2. Capital gains income
3. Return of capital

Ordinary taxable income are taxable earnings generated through the normal course of business. 90% of an mREIT's ordinary taxable income must be distributed by the time it files its current year tax return (i.e. 2007 ordinary TI must be distributed by September 15, 2008). Dividends classified as ordinary taxable income are generally considered to be "earned".

Capital gains income resulted from the sale of appreciated investments or other assets. Distribution of capital gains income is optional for mREITs, but may occur if a large gain is realized on a one-time sale of portfolio investments and management determines that returning some or all of the profits to shareholders is an important part of overall return. Regular dividends generally should not be supported by capital gains income, however, as this is a unsustainable strategy in the long-term.

Returns of capital basically indicate that the dividend was not earned but instead represents a return of shareholder equity. In essence, shareholders loaned money to the corporation interest-free, only to receive it back in the form of a dividend months later.

In this post, which I will update on a periodic basis, I'll compile the tax treatment of 2007 mREIT dividends so you can see if your mREIT is covering its dividend with ordinary income.

• Capital Trust (CT): Paid $5.10/share in 2007 dividends (4 regular @ $0.80/share and a special of $1.90/share). All classified as ordinary taxable income.
• Bimini Capital (BMNM.PK): Paid $0.10/share in 2007 dividends. All classified as a return of capital.
• Redwood Trust (RWT): Paid $5.00/share in 2007 dividends (4 regular @ $0.75/share and a special of $2.00/share). All classified as ordinary taxable income.
• Alesco Financial (AFN): Paid $1.23/share in 2007 dividends (1 regular @ $0.30/share and 3 regular @ $0.31/share). All classified as ordinary taxable income.
• Arbor Realty Trust (ABR): Paid $2.46/share in 2007 dividends (1 regular @ $0.60/share and 3 regular @ $0.62/share). $2.32/share was deemed to be ordinary taxable income. $0.14/share was deemed to be a capital gain distribution.
• Anworth Mortgage (ANH): Paid $0.27/share in 2007 dividends (1 regular @ $0.12/share and 3 regular @ $0.05/share). All classified as ordinary taxable income.
• PMC Commercial Trust (PCC): Paid $1.20/share in 2007 dividends (4 regular @ $0.30/share). $1.068/share was deemed to be ordinary taxable income. $0.132/share was deemed to be a capital gain distribution.
• iStar Financial (SFI): Paid $3.595/share in 2007 dividends (3 regular @ $0.825/share, 1 regular at $0.87/share and a special of $0.25/share). $3.262/share was deemed to be ordinary taxable income. $0.333/share was deemed to be a capital gain distribution.
• RAIT Financial Trust (RAS): Declared $2.56/share in 2007 dividends (1 regular @ $0.80/share, 1 regular @ $0.84/share and 2 regular @ $0.46/share). However, because RAIT paid the final dividend of 2007 in 2008, it is electing to include it with 2008 for tax classification purposes. (Bad news - RAIT didn't earn enough taxable income to cover the full 2007 dividend.) $2.07/share was deemed to be ordinary taxable income. $0.01/share was deemed to be a capital gain distribution. $0.02/share was a return of capital.
• Newcastle Investment (NCT): Paid $2.85/share in 2007 dividends (1 regular @ $0.69/share and 3 regular @ $0.72/share). All classified as ordinary taxable income.
• Anthracite Capital (AHR): Paid $1.48/share in 2007 dividends (2 regular @ $0.29/share and 3 regular @ $0.30/share). All classified as ordinary taxable income.
• MFA Mortgage (AHR): Paid $0.415/share in 2007 dividends. All classified as ordinary taxable income.
• New York Mortgage Trust (NMTR.OB): Paid $0.10/share in 2007 dividends. All classified as a return of capital.

Arbor Turns Up Heat on CBRE

I noted Arbor Realty Trust's (ABR) interest in CBRE Realty Finance (CBF) about two months ago, when Arbor unsuccessfully offered a $8/share bid for CBF. Two months later, with CBF shares still well below the $8/share offer price, Arbor is mightily wielding its 9.4% stake in CBRE Realty. Earlier today, the company issued an open letter to CBF's CEO, demanding an update on the CBR Realty portfolio, specifically with respect to two troubled deals and CBF's November assertion that "[w]e [CBF] have no non-performing loans in our debt portfolio."

Although there is no indication that Arbor is getting any closer to acquiring CBRE Realty, open letters such as this one often serve as a precursor to a hostile takeover and puts CBF on notice that Arbor is not going away any time soon. One long-time investor in the mREIT sector, Wally Weitz, may be putting his bets on a deal sooner than later. In a recent 13G filing, Weitz disclosed that he had recently upped his stake in CBRE from 6.5% to 8.1%, his first addition to his position in nearly a year.

Agency mREITs Soar on Fed Panic

The Fed's panic-driven emergency 75 basis points sent the agency mREITs soaring, up 3.5% to 5.0% as last check. Annaly Capital (NLY) in particular looks to benefit as it holds a large portion of fixed-rate securities in its portfolio.

Meanwhile, Anworth Mortgage (ANH) had the good fortune of announcing a very timely 11 million common stock offering, which will raise about $90 million in net proceeds. Shares surged despite the news of the offering because the Fed rate action, so Anworth will benefit from attractive pricing for this issuance.

Origen Shares Tank on Ambac Agony

Manufactured home lender and residential mREIT Origen Financial (ORGN) has seen its shares sink by some 40% over the last three months. I surmise much of the recent tumble, despite improved operating results, is fallout from the turmoil at Ambac Assurance (ABK).

Ambac has underwritten Origen's last three securitization deals, and the credit enhancement it provided Origen's tranches of manufactured home loans were crucial to securing a AAA rating, particularly for the $126.7 million in notes issued and placed through the 2007-B trust in October. Even with the Ambac guarantee, the AAA tranche priced at one-month LIBOR plus 120 basis points.

Securing cheap financing is critical for Origen, which disclosed a net interest spread of just 1.86% as of September 30, 2007. As the Company noted in its 10-Q, "[c]ontinued access to the securitization market is very important to our business."

Ambac's downgrade from AAA to AA and the implications of writing no new business creates a spiraling effect for Origen.

With respect to existing securitizations, although Origen sold most of the tranches, it has retained approximately $43 million in residual interests. These residuals are financed by a repo facility with Citigroup, which has already increased the haircut on the residuals once during the third quarter and also exercised margin calls. Additionally, even though Origen sold the tranches, the sales did not meet the true sale requirements of FAS 140 and were recorded as financing transactions, meaning that Origen will have to absorb any mark-to-market losses. While such losses have no economic recourse to the Company, it will impact GAAP equity and book value.

Perhaps more importantly, however, is the impact on future securitizations. If Ambac discontinues writing new business, Origen will have to try find credit enhancement guarantees from another monoline insurer or significantly increase its overcollateralization in order to profitably securitize future loans. If Origen cannot attractively price future securitizations, the Company has few alternatives for financing its originations.

Origen has a unique niche within the residential lending universe, and although it has difficulty securing acceptable ratings for its collateral, its loans have performed remarkably well given the nature of manufactured home lending. The Company has already secured funding from insiders, and given the depressed share price, Origen could be a candidate for a management-led or private equity takeout.

Deerfield, Gramercy Drag Down CRE mREITs

News of Deerfield Capital's (DFR) writedowns and asset sales combined with Gramercy Capital's (GKK) penny miss on FFO estimates pushed shares of commercial-focused mREITs lower today. Particularly hard-hit were Quadra Realty Trust (QRR), dropping 10%, and NorthStar Realty Finance (NRF), which shed 9.7%. Also in the losing column, on sector weakness and the threat of significant Fitch downgrades, were Anthracite Capital (AHR) (-9.4%), Crystal River Capital (CRZ) (-8%), and JRT Investors Trust (-8.7%).

Look for commercial mREIT shares to remain under pressure through the end of January, until a potential Fed rate cut (January 30) and additional earnings news (February 4-7) shakes the sector out of its doldrums.

Fitch Focuses on B-Piece CRE CDOs

With a hat tip to PJ at HousingWire, Fitch Ratings has placed 188 tranches from 18 CMBS-Backed CDO "repack" transactions (representing $8.4 billion) on Rating Watch Negative. "Repack" transactions are basically financial alchemy, in which issuers take mezzanine-grade ABS, bundle them together, create a senior/subordinate structure, and form a CDO that receives ratings as high as AAA. This is nothing new; most mREITs (except the agency RMBS investors) engage in this type of activity. Included in the potential downgrades are $596 million from three Anthracite Capital (AHR) CDOs, $541 million from two Crystal River Capital (CRZ) CDOs, and $918 million from one JER Investors Trust (JRT) CDO.

We previously noted the troubles with Crystal River's CDOs, but Anthracite's and JRT's troubles are new. JRT's potential downgrades are particularly alarming given the dollar amount of tranches under review and the fact that JRT will bear most of the exposure as the purchaser of all the non-investment grade CDO notes. The CDO is just over a year old and backed entirely by B-grade CMBS and residuals, so the collateral is shaky at best.

Deerfield Divests Assets - Will It Affect the Dividend?

Update: Deerfield shares dove some 18% at today's open on the news.

Deerfield Capital Corp (DFR) announced today that it was taking mark-to-market adjustments of $75.5 million and $14.6 million, respectively, on its RMBS and ABS portfolios. These charges are non-cash valuation adjustments that will not affect taxable income (and consequently, the dividend).

More importantly, Deerfield disclosed the sale of $1.5 billion in RMBS and $0.3 billion in the Pinetree CDO. That amount represents about 20% of DFR's balance sheet and likely reflects the cash draining effect of rolling over its repo lines, which totaled some $7 billion at 9/30/07 and were all 90 days or less in duration.

Though it reduced DFR's exposure to subprime collateral, the assets sold likely represent some of the Company's highest-yielding assets and may cause a material hit to taxable income during 2008. Although Deerfield had a decent amount of undistributed taxable income at 9/30/07, a continuation of dividends at the current rate will eat into any 2007 spillover fairly quickly.

Crystal River's CDO Could Cause Problems

Crystal River Capital (CRZ), a diversified mortgage REIT managed by Brookfield Asset Management (BAM), is a relative newcomer to the mREIT universe. The Company came public in July 2006, one of the last successful mREIT offerings before the downward credit spiral began.

However, the Company commenced operations in March 2005, and operated as a private entity for over a year before its IPO, so significant business activities took place prior to coming public. One such activity was the launch and deployment of Crystal River Capital CDO 2005-1, a diversified issuance backed by whole loans, CMBS, and RMBS. As disclosed in the third quarter 10-Q, CRZ retained "all of the non-investment grade securities, the preference shares and the common shares" related to the 2005-1 CDO.

Normally, CDO issuance is viewed positively for mREITs, since they allow for "match-funding" of assets and liabilities. That is, cash flows from the collateral pool pays the interest on the debt securities issued by the CDO. The problem arises when the collateral pool does not perform as expected and is downgraded by the rating agencies. Such a downgrade can trigger failure of overcollateralization tests and divert cash flow from subordinate holders to the senior classes. Somewhat esoteric, I know, but the bottom line is that Crystal River retained the junior classes of the 2005-1 CDO and sold the senior tranches, betting that the CDO would perform as expected.

Enter a serious problem. On January 11th, S&P cut the rating of 2005-1's investment grade tranches F,G, and H to junk, which may trigger the failure of O/C tests and certainly cuts the value of the non-investment grade tranches held by CRZ. Thus CRZ is still liable for payments on the debt securities but may not receive the corresponding cash flows from the collateral pool.

While CRZ is able to weather some failures in collateral performance, if additional senior tranches are downgraded in the future, a significant mismatch in interest income and interest expense may occur.

Luminent to Lose Listing?

It's just a matter of time before the Big Board boots Luminent Mortgage Capital (LUM). The struggling mortgage REIT disclosed earlier today that the NYSE had notified it of its noncompliance with the share price deficiency rule, as LUM hasn't traded near a buck in over a month.

Although Luminent claims it will be able to cure the deficiency within the allowed six-month window, LUM's market cap of $28 million is just above the $25 million threshold for REITs. Furthermore, as I noted in this post, Luminent won't be able to hang on to its REIT status beyond September 2008.

Much like NovaStar and Impac, Luminent's life as a viable entity continues to hang in the balance.

MFA Shoving Shares Out the Door

Update: MFA priced its offering at $9.25/share, which will raise approximately $220 million in net proceeds before overallotments.

MFA Mortgage (MFA) is launching its third public offering of stock in four months - a 20,000,000 share offering this time, less than a week after disclosing a controlled equity offering of 12.5 million shares through Cantor Fitzgerald.

MFA must be getting while the getting's good. MFA closed today at $9.28/share, yet disclosed in the offering prospectus a 11/30/07 book value of just $6.80/share. While all the agency mREITs have done recent offering to capitalize on the opportunity for accretive issuances, MFA has by far been the most voracious. Either the Company sees lots of attractive MBS purchases in the market or the margin calls on the repo lines has continued to drain the Company of capital.

FBR Throws In Towel on First NLC

FBR announced that First NLC Financial Services, FBR Group's mortgage origination subsidiary, will liquidate its assets in Chapter 11 bankruptcy as a result of the continued deterioration of the non-prime market.

In addition, FBR Group announced that it would not close the previously disclosed recapitalization and sale of FNLC. In connection with the expected Chapter 11 filing, FBR Group does not expect to recover its remaining $12 million investment in FNLC.

NovaStar News

Quite a wild week for the last independent subprime lender! NovaStar Financial (NFI) terminated its top two executives, received another month's extension on its waiver with Wachovia, laid off 170 of its remaining 200 employees, and lost its NYSE listing.

As expected, NovaStar has completed its transition to a portfolio manager. It is no longer originating or servicing any loans, and is entirely dependent upon the ratings agencies and the performance of its previous securitizations to continue to be able to pay off the Wachovia debt.

Wachovia has become increasingly aggressive with NovaStar, demanding the termination of a residual facility and requiring NovaStar to pledge those loans towards the non-investment grade facility...and pay a $4.5 million termination fee for the privilege.

Clearly, NovaStar is in the process of orderly liquidating its assets. It remains to be seen if the TruPs holders will allow the orderly process to continue or whether they will force NovaStar's hand. In any case, as the last independent subprime lender standing, NovaStar's story has been a lesson for all.

Note: Author was previously a long-time shareholder of NovaStar Financial (NFI).

Thornburg Forced to Secure More Capital

By request, here is a link to Thornburg's prospectus supplement that was the source of much of the information in this post.

Thornburg Mortgage (TMA) is not out of the woods yet. After the market close today, Thornburg announced surprising concurrent equity offerings - a combination of 4,500,000 shares of its Series F Preferred Series and 11,000,000 shares of common stock. Although neither deal has yet to price, the two deals could be expected to raise approximately $200 million in fresh capital for Thornburg.

With Thornburg's common stock trading under $9/share, surely the deal would be dilutive to book value, right? Not necessarily. In the accompanying prospectus, Thornburg disclosed that book value per share of common stock has fallen to an estimated $9.29 per (pre-offering) share at November 30, 2007, down from $10.14 book value per share of common stock as of September 30, 2007. TMA believes that about 70% of that change is attributable to declines on hedges as a result of falling net yields on its swap agreements, while the remaining 30% is due to valuation adjustments on the ARM securities portfolio. According to Thornburg, the trend continued through December, though more heavily weighted towards mark-to-market writedowns. Based on a preliminary review, TMA believes it had an additional $110 million in writedown exposure and $14 million in swap declines during December.

From a liquidity perspective, TMA's position "materially" declined from September 30 to the end of the year due to additional margin calls and changes in margin requirements. The Company cannot access commercial paper nor has it been able to issue any collateralized mortgage debt since October. Although TMA is able to rely on structured and committed reverse repurchase lines for now, this type of financing is much more expensive than securitized borrowings or standard repurchase lines. To prevent another round of forced asset sales, Thornburg has no choice but to turn to the equity markets once again to stay afloat.

Deutsche Bank "Mortgage REITs" Panel

A few of the companies in the mREIT universe are participating in Deutsche Bank’s “Mortgage REITs” panel on Thursday. Thus far, I've only seen announcements from Anthracite (AHR) and Gramercy (GKK).

Let's just hope that Deutsche Bank isn't participating. DB completed its acquisition of former highflying mortgage REIT, MortgageIT Holdings (MHL) in January 2007, and the company is all but done. Deutsche Bank paid $430 million for the Alt-A lender, which wound up shuttering its retail operations back in November.

Of Note: NorthStar Realty

Blogger David Phillips over at the 10Q Detective has done a nice write-up on NorthStar Realty Finance (NRF). NorthStar continues to perform well in the CRE mREIT space, but its stock price has been punished due to NRF's heavy reliance on access to the capital markets for sources of funding. NRF has two series of preferred shares outstanding and eight different TruPS issuances. With the very weak CDO market, NRF has been forced to turn to warehouse lines and commercial paper for funding, which has weakened the balance sheet some.

The bright spot for NorthStar is that it has a diversified revenue stream, including lease income, investment income, and interest income. However, the diversification and investments create an operating structure with complex and difficult accounting. With a 16% yield, however, investors willing to take a leap of faith may be richly rewarded.

Anthracite's Waiver Suggest Serious Losses

Anthracite Capital (AHR) dove nearly 6% on Monday, as the company disclosed the receipt of a waiver from Bank of America (BAC) with respect to its GAAP book value. Anthracite last reported a GAAP book value of $9.40/share as of September 30, 2007.

It took a bit of digging, but I found the credit agreement appended to Anthracite's first quarter 2006 10-Q. It's not entirely clear, but it appears that the minimum tangible net worth is $400 million, or a GAAP book value of approximately $6.34/share. That would imply a huge fourth-quarter loss of at least $3/share during the fourth quarter 2007.

The math is back-of-the-envelope, but the conclusions are serious nonetheless. Anthracite has been trading at a discount to its book value, so the stock may be overvalued by as much as 12% at its current level.