Thornburg Defaults Spark More Credit Fears

Shares of the company plummett after it failed to meet margin calls

The liquidity crunch at Thornburg Mortgage (TMA) has gone from bad to worse this week. On Mar. 5, the company said it had failed to meet a $28 million margin call on a $320 million repo loan, prompting one of its lenders to declare it in default on the agreement.

The lender, JP Morgan Chase & Co. (JPM), told Thornburg it plans to exercise its rights under the reverse repurchase agreement to seize the mortgage-backed securities (MBS) backing the loan. That will trigger cross defaults under all of the mortgage company's other repo agreements and secured loan agreements, Thornburg disclosed in a filing to the U.S. Securities and Exchange Commission.

The news sent Thornburg’s stock into a tailspin, plunging as much as 63% before finishing 51.5% lower at 1.65 on Mar. 6. The shares closed at 9.76 a week ago.

Thornburg isn't the only company with exposure to the paralyzed credit markets that has been thrust into a liquidity crisis. There was talk on Mar, 6 that Carlyle Capital, a unit of private-equity giant Carlyle Group, had failed to meet margin calls on its $21.7 billion portfolio. These developments have convinced the market that there's a wave of liquidation coming in the securities market, which would slash the value of many other financial players' portfolios.

Thornburg has a total of $11.5 billion in reverse repurchase agreements, all of which now could face liquidation by the lenders.

After the margin call disclosure earlier this week, Citigroup downgraded Thornburg shares to sell from hold, saying that Thornburg's inability to meet most of the roughly $270 million in additional margin calls would force it to sell assets in a distressed market or raise equity capital to meet the calls for extra collateral to back its repurchase agreements with a range of lenders.

"Failure to complete either of these two could put Thornburg at risk of bankruptcy," Citigroup analyst Donald Fandetti wrote in a Mar. 3 research note. (Citigroup or its affiliates acted as a manager or co-manager of a public offering for Thornburg and has provided investment banking services for the company within the past 12 months.)

The company has said the margin calls have been triggered not by deteriorating credit in its loan portfolio, but by falling home prices and weaker demand for residential mortgage loan securities.

Standard & Poor’s Ratings Services responded to the cross-defaults announcements by lowering its ratings on the Thornburg's senior unsecured debt to CC from CCC+ and on its preferred stock to C from CCC- on Mar. 6. Both ratings will remain on CreditWatch negative, with the risk of default increasing due to the company’s limited financial resources, the ratings outfit said.

Standard & Poor’s Equity Research downgraded Thornburg’s stock to sell from hold on Mar. 6, saying that "without a significant capital infusion, bankruptcy is the likely outcome." S&P also cut its target price to 1 from 7, citing limited value for equity holders in the event of a liquidation of the assets.

Some analysts were reluctant to call a bankruptcy filing certain, but they agreed that a rescue from anyone with deep pockets is highly unlikely.

Bose George, an analyst at Keefe Bruyette & Woods (KBW) in New York, says he’s heard there’s a bid list of Thornburg’s assets that's now circulating as lenders prepare to liquidate the assets they are holding. "Some of their assets are extremely good. I think people will just buy them at big discounts," George said. "It sounds like there’s a concerted effort [among the lenders] to do this in a way that avoids a fire sale."

George has a market perform opinion on the stock because he assumed the shares would trade at or below his 1 target price on Mar. 6. (KBW expects to receive or intends to seek compensation for investment banking services from Thornburg during the next three months, and makes a market in the company’s securities.


Until recently, Thornburg was believed to be much less vulnerable to the portfolio losses than other companies with exposure to mortgage-backed securities have suffered. That's because Thornburg's assets were deemed top quality, as the company had carved out a niche market in jumbo adjustable-rate mortgages for very wealthy homebuyers.

But the ongoing deterioration in home values has eroded confidence in MBS and led to a liquidity crisis where demand for this kind of paper has all but evaporated.

"What's going on in the last few days is really a liquidity crisis. The whole market is unwinding in terms of leverage," says George at KBW. "That’s an important part of the market, so people with assets like Thornburg end up going out of business."

Not everyone thinks that Thornburg is a victim of forces beyond its control, however. Larry Goldstone, the company’s CEO, has been criticized for clinging to repo financing instead of the more expensive term financing that would have allowed Thornburg to avoid margin calls, even after facing a similar liquidity crisis last August.

But most real estate investment trusts (REITs) like Thornburg don’t have access to longer term borrowing unless they provide assets to securitize those loans with, explains George. And with the securitized market closed down since last summer, repos were among the few options the company had left, he says.

"Thornburg positioned itself as being out of trouble. The [chief executive] talked regularly about having these great business opportunities," said Jason Arnold, an analyst at RBC Capital Markets in San Francisco. "When it gets down to it, their business relies on liquidity and the availability of borrowing."

Ultimately, it is the market's perception of the increasing risk of the MBS that Thornburg holds that will have led to the company’s downfall, he said. Arnold has an underperform rating on the stock. (RBC Capital Markets has provided Thornburg with investment banking and other banking services within the past 12 months.)

Even REITs with much safer loan portfolios, such as Annaly Capital Management (NLY), which owns 100% government-sponsored agency mortgage-backed securities, were caught up in the downward spiral on Wall Street on Thursday. That’s because the value of agency MBS have fallen in recent days. Says George: "The fact that companies like that are getting impacted shows you the extent to which the capital markets are falling apart."

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