Thornburg Braces for Tough Times Ahead

The mortgage company cancels its dividend as its CEO frets about a possible liquidity freeze-up

After a brutal quarter, Thornburg Mortgage (TMA) is husbanding its resources carefully. The company said Oct. 17 that it won't pay out a dividend in order to save cash -- just in case the credit crunch returns.

This summer's credit problems clobbered Thornburg. Its stock dropped 65% in two-and-a-half weeks and it was forced to sell off $21.9 billion of assets to raise cash. There's still a chance those bad days could return, Thornburg President Larry Goldstone said Oct. 17.

"We are concerned about the potential for another mini-liquidity crisis in the market going forward," Goldstone said as the company announced a third quarter loss of $8.83 per share, vs. earnings of 64 cents a year ago.

Thornburg was an unlikely casualty of this summer's credit crunch. A real estate investment trust or REIT, it focuses on originating and buying up mortgages to wealthy homeowners with great credit quality.

It offers only jumbo mortgages, above at least $417,000. Meanwhile, it was defaults on low-quality, or subprime, loans to risky borrowers that spooked the credit markets in July and August. Nonetheless, investors ended up fleeing from almost all mortgage debt. The resulting freeze on mortgage credit markets punished Thornburg and subprime lenders alike.

After much pain for Thornburg's investors, its survival no longer appears to be in question, says Standard & Poor's equity analyst Jason Willey. Still, the decision to not pay out a dividend was unexpected and unusual. As a REIT, Thornburg typically pays a large percentage of its earnings in the form of dividends.

Goldstone said the board of directors were divided on whether to pay out a dividend. The company had the money, he said, but wants to save cash because of heightened worries this week about structured investment vehicles, or SIVs, that hold hundreds of billions of dollars of mortgage debt. Rising mortgage default rates has hurt the value of this debt, putting at least some SIVs in trouble.

That raises the chances that their collateral "get[s] dumped on the market at fire sale prices," Goldstone said. Big banks, prodded by the federal government, are putting together a rescue plan to prevent this from happening.

Thornburg's earnings report, and the unexpected cancellation of its dividend, shocked the stock market. By late in the trading session on Oct. 17, Thornburg shares were off 13%, trading at $9.91 per share.

The earnings report offered investors a view of the credit crunch damage that was worse than already low expectations. At the beginning of the quarter, Thornburg held $57.55 billion in assets; at the end, it held $36.3 billion. The sell-off of $21.9 billion, much of that forced or even confiscated by Thornburg's debt holders, caused a loss to earnings of $1.09 billion, the firm said.

Thornburg also had to put the brakes on issuing new mortgages. Loan originations of $1.3 billion in the quarter fell well short of the firm's $2 billion target. That's a problem because a great way to revive Thornburg's stock price would be to re-build its damaged mortgage portfolio.

PiperJaffray (PJC) analysts wrote that Thornburg's shares would have limited upside "given the challenging mortgage financing market, which limits portfolio growth," and the uncertainty about future dividends.

S&P's Willey says Thornburg has hit bottom and may have at least some advantages rising back up again. The credit crunch pushed many competitors out of the market. Higher mortgage rates can provide Thornburg more revenue. And, eventually cuts in interest rates by the Federal Reserve should make it easier for Thornburg to raise capital.

Still, Willey added, it will be tough. "While things fell apart fairly quickly, it's going to be a much longer road rebuilding things." (S&P, like BusinessWeek, is a unit of the McGraw-Hill Companies.)

As the number of defaults and delinquencies rise quickly on many kinds of mortgage debt, Thornburg can continue to brag about the high quality of its mortgages. By one measure, the delinquency rate on Thornburg's loans rose to 0.27% from 0.23% a quarter ago. However, the delinquency rate for the rest of the industry was at 2.81% a quarter ago and is assumed to have risen since then. "There is absolutely no problem with the credit performance of our portfolio," Goldstone said.

Thornburg's results arrived amid continued terrible times for the mortgage industry. The Mortgage Bankers Association said Oct. 17 that it expects the number of mortgage originations to decline 15% in 2007, 18% in 2008 and another 6% in 2009. Problems include a fall in home prices, slower home sales and tough conditions on the credit markets.

Countrywide Financial (CFC), the nation's largest mortgage lender, said Oct. 17 that it will take a charge of $125 million to $150 million as part of a cost-cutting plan it previously announced.

Thornburg expects to return to paying out its dividend at the end of the year. But the level of the dividend will depend on conditions in the housing and credit markets that, like the summer's credit crunch, remain well outside of Thornburg's control.

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