Mortgage REITs are bleeding, where will they go? With a background in Corporate Finance, Yen Diep shares her study and thoughts.
First New Century went under, then comes along American Home Mortgage (AHM) (with billions of dollars off balance sheet) and Novastar Financial (NFI) and Accredited Home Lenders (LEND) are all in serious crash crunch condition or close to go under if conditions do not improve. Similar pattern presents when these companies take on increasing loans over the years, but their cash decrease depletes as interest rate rises as well as keeping up with paying dividends. Currently, most of the mortgage brokers and REITs are all trading under book value except for a few such as Annaly Capital Management and Capstead. On August 10, the Fed injected over $36 billion of liquidity into the market marking the first time ever since September 11, 2001 to stabilize the markets. However, the uncertainty of a rate cut still lingers. If the Fed cuts, it will be by how many basis points and how quick? Can these mortgage REITs such as TMA and CMO that primarily investments AAA ARM survive with a wave of reset this October? Is this a perfect storm that proves subprime is not contained. Thornburg Mortgage executives went on CNBC in recent months and said that their company is immune because it has mostly prime mortgages, which means people with good credit. On Friday, August 10, S&P cuts Thornburg Mortgage debt rating to B minus and placed it on negative watch. The stock tanks on Friday and hit 52-week low at 13.81 with a closing price of 14.28 and hit another low on August 14 to settle at 7.61 due to margin call on its loan as well as a dividend delay. On August 14, President of Thornburg Mortgage told CNBC on “Kudlow & Company” that “Financing in the jumbo mortgage space is difficult” and ruling out filing for Chapter 11. Looking at both New Century and American Home Mortgage little cash and liabilities of billions with high dividend yield before it went bankrupt spell similar memories to AAA ARM mortgage REITs that people once thought to be immune. If the dividend is too good to be true, it probably is too good to be true. These mortgage REITs take on more mortgage origination to boost its interest revenue as well as to lower the rate of deliquency so its revenues would be diversify. However, a small increase in delinquency could cause serious crash crunch.
TMA Investors Relations homepage state, “Our business strategy proves resilient in 2006 – Total assets $52.7 billion with annual mortgage originations of $5.6 billion and an annual dividend $2.72.” Does this sound similar? Beazer Homes also reports its second best earnings in not-so-distance future in 2006. We bring the numbers to light. According to the 2006 10K, the company increases its asset from $10.3 billion in 2002 to over $51.5 billion 2006, which is a 500% non-compounded increase in five years while its net interest income has increased from 2002 of $157,929 to $346,684 in 2006, which is a rate increase of about 120%. This is the pattern that has displayed with many mortgage REITs in which assets (loan investments) increase year over year with increasing interest rate while the rate of net interest has not caught up with the rate increase of loan investments. A possible explanation is that as interest rate has increased from 2002 to 2006; therefore, the interest spread has also narrowed. The interest spread is the difference between the interest rate charges on mortgages and the interests TMA earns from investments. TMA Portfolio Margin has decreased from 1.25% in 2004 to .73% in 2006, and its net interest spread also has decreased from 1.06% in 2004 to .56% in 2006. Its Return on Equity also has decreased from 17.66% in 2002 to 12.78% in 2006. According to TMA 2006 10K filing, it has increased its assets to over $51 billion. As of December 31, 2006, 27 of the 37,765 loans in the company’s $23.2 billion ARM Loan portfolio as of December 31, 2006 “were considered seriously delinquent (60 days or more delinquent) and had an aggregate balance of $20.9 million.” In addition, 35.2% of those loans resides in California (one of the largest number of foreclosures in the country), 80.8% is single-family and hybrid ARM loans is 90.3%. Half of the borrowers have credit score from 651 to 750 while the other half has a credit score of 750 or above. With such a big exposure in California, there is a higher risk of increasing delinquency. According to TMA 2006 10K as of December 31, 2006, the company had commitments to purchase or originate 630 millions of ARM Assets.
If TMA may not be immune, will Capstead Mortage with a market cap of $181 million trading 31 times above its most recent quarterly revenue of $5.77 million and above its book value of $8.32 per share? Capstead earns revenue by investing primarily in residential adjustable-rate mortgage (ARM) securities issued and guaranteed by government-sponsored entities, either by Fannie Mae or Freddie Mac, or by an agency of the federal government such as Ginnie Mae. It also invests in credit-sensitive commercial real estate. According to Capstead latest 10Q filing, the company increased its residential mortgage securities portfolio by about $238 million to $5.49 billion with purchase of ARM securities of about $1.13 billion. The company states in its 10Q Residential Mortgage Investments section that as of June 30, 2007, about $3.5 billion is set to reset in less than five months while its other $1.95 billion is its longer-to-reset ARM securities was 45 months. According to the 2006 Annual Report, CMO didn’t have any off-balance sheets and arrangements. The 10Q also states that “Agency Securities carry an implied AAA-rating with limited credit risk.” With over 60 percent due to reset within five months without the Fed lower rates quick enough, can the company survive and not be in similar situation with TMA’s crash crunch and worst go under like New Century and American Home Mortgage? The 10Q shows that the company has about $6.5 million, $78.5 million in receivables and other assets and $22.4 million in Accounts payable and accrued expenses as of June 30, 2007. It is best to stay away from these mortgage REITs until we see who’s really swimming naked.
Disclosure: I have shorted both NEW and LEND in the past and currently do not hold any positions in the companies mentioned above.
Contact: [email protected]
First New Century went under, then comes along American Home Mortgage (AHM) (with billions of dollars off balance sheet) and Novastar Financial (NFI) and Accredited Home Lenders (LEND) are all in serious crash crunch condition or close to go under if conditions do not improve. Similar pattern presents when these companies take on increasing loans over the years, but their cash decrease depletes as interest rate rises as well as keeping up with paying dividends. Currently, most of the mortgage brokers and REITs are all trading under book value except for a few such as Annaly Capital Management and Capstead. On August 10, the Fed injected over $36 billion of liquidity into the market marking the first time ever since September 11, 2001 to stabilize the markets. However, the uncertainty of a rate cut still lingers. If the Fed cuts, it will be by how many basis points and how quick? Can these mortgage REITs such as TMA and CMO that primarily investments AAA ARM survive with a wave of reset this October? Is this a perfect storm that proves subprime is not contained. Thornburg Mortgage executives went on CNBC in recent months and said that their company is immune because it has mostly prime mortgages, which means people with good credit. On Friday, August 10, S&P cuts Thornburg Mortgage debt rating to B minus and placed it on negative watch. The stock tanks on Friday and hit 52-week low at 13.81 with a closing price of 14.28 and hit another low on August 14 to settle at 7.61 due to margin call on its loan as well as a dividend delay. On August 14, President of Thornburg Mortgage told CNBC on “Kudlow & Company” that “Financing in the jumbo mortgage space is difficult” and ruling out filing for Chapter 11. Looking at both New Century and American Home Mortgage little cash and liabilities of billions with high dividend yield before it went bankrupt spell similar memories to AAA ARM mortgage REITs that people once thought to be immune. If the dividend is too good to be true, it probably is too good to be true. These mortgage REITs take on more mortgage origination to boost its interest revenue as well as to lower the rate of deliquency so its revenues would be diversify. However, a small increase in delinquency could cause serious crash crunch.
TMA Investors Relations homepage state, “Our business strategy proves resilient in 2006 – Total assets $52.7 billion with annual mortgage originations of $5.6 billion and an annual dividend $2.72.” Does this sound similar? Beazer Homes also reports its second best earnings in not-so-distance future in 2006. We bring the numbers to light. According to the 2006 10K, the company increases its asset from $10.3 billion in 2002 to over $51.5 billion 2006, which is a 500% non-compounded increase in five years while its net interest income has increased from 2002 of $157,929 to $346,684 in 2006, which is a rate increase of about 120%. This is the pattern that has displayed with many mortgage REITs in which assets (loan investments) increase year over year with increasing interest rate while the rate of net interest has not caught up with the rate increase of loan investments. A possible explanation is that as interest rate has increased from 2002 to 2006; therefore, the interest spread has also narrowed. The interest spread is the difference between the interest rate charges on mortgages and the interests TMA earns from investments. TMA Portfolio Margin has decreased from 1.25% in 2004 to .73% in 2006, and its net interest spread also has decreased from 1.06% in 2004 to .56% in 2006. Its Return on Equity also has decreased from 17.66% in 2002 to 12.78% in 2006. According to TMA 2006 10K filing, it has increased its assets to over $51 billion. As of December 31, 2006, 27 of the 37,765 loans in the company’s $23.2 billion ARM Loan portfolio as of December 31, 2006 “were considered seriously delinquent (60 days or more delinquent) and had an aggregate balance of $20.9 million.” In addition, 35.2% of those loans resides in California (one of the largest number of foreclosures in the country), 80.8% is single-family and hybrid ARM loans is 90.3%. Half of the borrowers have credit score from 651 to 750 while the other half has a credit score of 750 or above. With such a big exposure in California, there is a higher risk of increasing delinquency. According to TMA 2006 10K as of December 31, 2006, the company had commitments to purchase or originate 630 millions of ARM Assets.
If TMA may not be immune, will Capstead Mortage with a market cap of $181 million trading 31 times above its most recent quarterly revenue of $5.77 million and above its book value of $8.32 per share? Capstead earns revenue by investing primarily in residential adjustable-rate mortgage (ARM) securities issued and guaranteed by government-sponsored entities, either by Fannie Mae or Freddie Mac, or by an agency of the federal government such as Ginnie Mae. It also invests in credit-sensitive commercial real estate. According to Capstead latest 10Q filing, the company increased its residential mortgage securities portfolio by about $238 million to $5.49 billion with purchase of ARM securities of about $1.13 billion. The company states in its 10Q Residential Mortgage Investments section that as of June 30, 2007, about $3.5 billion is set to reset in less than five months while its other $1.95 billion is its longer-to-reset ARM securities was 45 months. According to the 2006 Annual Report, CMO didn’t have any off-balance sheets and arrangements. The 10Q also states that “Agency Securities carry an implied AAA-rating with limited credit risk.” With over 60 percent due to reset within five months without the Fed lower rates quick enough, can the company survive and not be in similar situation with TMA’s crash crunch and worst go under like New Century and American Home Mortgage? The 10Q shows that the company has about $6.5 million, $78.5 million in receivables and other assets and $22.4 million in Accounts payable and accrued expenses as of June 30, 2007. It is best to stay away from these mortgage REITs until we see who’s really swimming naked.
Disclosure: I have shorted both NEW and LEND in the past and currently do not hold any positions in the companies mentioned above.
Contact: [email protected]
