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Executives

Larry Goldstone – President & CEO

Clarence Simmons – Senior EVP & CFO

Analysts

Annett Franke – FBR Asset Management

Bill Thatcher [ph] – Artesia Capital

Michael Fazio [ph] – R3 Capital

Hilliard Hester [ph]

Paul Spindler [ph]

Kevin Starke – CRT Capital

Bob Clutterbuck – Clutterbuck Funds

Geets [ph] – BR Capital

Ross Levin – Arbiter Partners

Ryan McCarthy [ph] – RM Capital

Stuart Morrow [ph]

Robin Holster [ph] – Power Research [ph]

Thornburg Mortgage, Inc. (TMA) Q3 2008 Earnings Call Transcript November 12, 2008 10:30 AM ET

Operator

Ladies and gentlemen thank you for standing by. Welcome to the Thornburg Mortgage third quarter earnings conference call. Certain matters discussed in this conference call may constitute forward-looking statements within the meaning of the federal securities laws.

Actual results and the timing of certain events could differ materially from those projected and are contemplated by the forward-looking statements. Due to a number of factors including general, economic conditions, interest rates and availability of ARM security and the loans for acquisitions and other risk factors outlined in the company’s SEC report and the annual reports on form 10-K.

At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator instructions) As a reminder, this conference is being recorded today, November 12, 2008. I would now like to turn the conference over to our host, Mr. Larry Goldstone, President and Chief Executive Officer. Please go ahead, sir.

Larry Goldstone

Good morning everyone. Thanks for joining us for our third quarter earnings conference call. I’m also joined by Clay Simmons, our Chief Financial Officer who’s going to help along with this call as well.

So let us see, let’s start at the top here. Obviously we reported $140 million in net income for the third quarter ended September 30, that was $1.23 per diluted common share with 110 million shares outstanding. I think that there are sort of two component parts, however to this earnings release. The biggest influence is the FAS 157 fair value adjustment that we are taking on the portfolio, both as a result of the impairment charges that we are required to take on the portfolio because of the going concern, accounting issue that remains outstanding, and secondarily, the fact that we have elected FAS 157 for purposes of fair valuing the senior subordinated debt transaction and its various component parts.

I would suggest that FAS 157 is probably the correct way to reflect those valuations, but I would also suggest that it creates a lot of confusion amongst our various constituent audiences, but ultimately, should the company be successful in accomplishing its balance sheet restructuring and eliminate its going concern issues, I think that all of these fair value adjustments are going to go away and things are going to return to a much more normal state of affairs if you will, with respect to these component parts.

In summary, we did book a $655 million loss impairment charge on the mortgage backed securities portfolio as of the end of September. Unfortunately, we have continued to see deterioration in the prices of mortgage backed securities and secondarily, that fair value adjustment was probably also affected by the fact that we have continued to experience credit downgrades in our portfolio by the various rating agencies and so that’s having a negative influence on the fair value of our MBS portfolio as well.

So the market’s not getting a whole lot better out there in sum and I think that’s sort of the conclusion that you can take away from the fair value changes that we continue to book in our portfolio.

Secondarily, as it relates to the senior subordinated note transaction, there were two principal fair value adjustments that we made, both of which benefited the company. There was a $594 million or $595 million fair value adjustment in the notes, primarily because the debt declined in value between June 30 and September 30 and that consequently results in a gain in our portfolio and then secondarily, there was $160 million fair value gain related to the fair value of the probability weighted principal participation agreement as opposed to issuance of the additional warrant liability.

And the primary driver there was the fact that the stock price went down and there was a diminished probability of completing the tender as implied by the difference between the preferred stock trading activity and the common stock trading activity and on balance, on a probability weighted basis; that also resulted in a fair value gain.

With all due respect to the accounting profession, I would argue that that’s all pretty much funny money and doesn’t amount to a whole lot of anything other than it’s supposed to improve our disclosure. So I hope you all feel far more enlightened at this moment than they were feeling before we announced those adjustments. What I do think is substantive and significantly important about this earnings release is in fact the core profitability of the company.

Net interest income for the quarter was a positive $80 million. That was up a little more than 50% from the prior quarter when we reported net interest income of $53 million and so consequently, there is substantial core profitability in this portfolio and our issues continue to reside in the ability to obtain financing for this balance sheet that is predictable and reliable and if in fact we can achieve that stabilization of predictable and reliable financing, this company stands to be highly profitable on a core operating basis as we move forward.

So, we are not struggling with the typical issues that you find in the financial services base today, which is rapidly deteriorating credit performance, rapidly increasing reserves and provisions and charge-offs for loan losses and I think that is a significantly differentiating characteristic for us versus just about any other financial services company with credit exposure in today’s market environment.

So I think that in my mind is a significant takeaway item here. I also want to remind everyone before we get into any more of the details here that we did in fact do a 10 for one or maybe a one for 10 reverse stock split at the end of the second quarter or third quarter and so consequently, all of the per share numbers, all of the book value numbers are now adjusted to reflect that one for 10 reverse stock split.

We did that just as a reminder in order to preserve our New York Stock Exchange listing, which requires that we try to keep the stock price over a buck for every 30-day time period. So, I think that we were successful in accomplishing that. Now as I alluded to just a moment ago, the primary challenge and the primary issue for the company is in fact to find predictable and reliable financing on a going forward basis.

To that end, as all of you know, we have been in and are still in continuing negotiations with the override lenders that are providing financing for our mortgage backed securities portfolio. Several months ago, dating back to early August, in light of some initial credit ratings downgrades on mortgage securities in our portfolio, we came upon a difference of opinion or a difference of interpretation with respect to how the override agreement was supposed to work and since that time, we have been engaged in a series of conversations and negotiations, all of which I would suggest have been positive and productive amongst the five different lenders party to the override agreement and we are continuing to be hopeful that we are going to come up with some sort of a negotiated resolution and some sort of an agreement on how to behave or act on a going-forward basis.

Unfortunately, as of this moment and as of the date of this press release, we are unable to provide any additional details with respect to where we are with those negotiations other than to suggest that we have not filed any default notices, we haven’t liquidated any collateral. Everybody is still financing our position and we are trying to come to some sort of an equitable resolution for all parties involved.

Additionally, just another balance sheet, housekeeping item, if you will, I think during the third quarter, we took a different approach with respect to the way that we are reporting our liabilities on the reverse repurchase agreement lines.

You’ll notice a fairly substantial drop in the quarter-over-quarter balance of our reverse repurchase agreements and that’s principally driven by the fact that we had pledged in prior periods $267 million of cash that was collateralizing the reverse repurchase agreement book and we have now applied that cash to reduce the borrowed balance, which we believe is the correct way that that cash collateral should be applied consistent with a reverse repurchase agreement arrangement.

So, that accounts for a significant difference or a significant change in the balance of the reverse repurchase agreement book between June 30 and September 30. Credit performance in our portfolio is also an issue and a big issue. Obviously, it’s a hot topic in the mortgage space and the broader financial services space these days. I think a couple of different areas to talk about.

First of all, as it relates to our mortgage backed securities portfolio, as differentiated from our loan portfolio, we have continued to see downgrades in that portfolio in the August and early September timeframe, Fitch rating service was the principal rating agency that was going through and reviewing the prime and alt A, AA and AAA rated mortgage securities issuances in the 2005, 2006, and 2007 vintages and as we reported, I believe on August 22, we had about $1.7 billion of unpaid principal balance and mortgage securities downgraded at about a $1.1 billion fair value, carrying value.

Fitch sort of got their review done by the end of August or in early September. Then it was Standard & Poor’s turn. So, over the last couple of months S&P has been going through and they have been re-rating and reviewing their ratings on their universe of 2006 and 2007. AA and AAA, Alt-A and prime AAA backed mortgage securities and as a result they have also issued a series of credit downgrades that have affected the company’s portfolio as well.

Before I get into the details of the numbers, I will also want to indicate that Moody’s is a little bit further behind the curve. They have indicated through some of their public conversations or public releases that their plan is to begin their review of the 2006 and 2007 vintage prime and Alt-A, AA, and AAA space or mortgage securities beginning in November and they don’t expect to be done with their review until sometime early in the first quarter of 2009, next year.

So there’s going to be a third round of potential downgrades, although I would hope that with each ratings review there are fewer and fewer securities that are left to be downgraded as these guys go through this process. That said, if you recall, as of August 22, it was the date of our last disclosure on this item. We had about $1.7 billion in current phase or unpaid principal balance and about 1.1 billion in fair value downgraded.

As of September 30 those numbers grew to $2 billion downgraded unpaid principal balance and $1.2 billion of carrying value, and then since September 3 and we cut off on November 3 because this is obviously a moving target, potentially changing everyday, although it appears that things have slowed down a little bit over the last week or so. We had an additional $570 million of unpaid principal balance marked down with a carrying value of $372 million.

After taking into consideration all of those credit downgrades, if you continue to look at the highest of the three ratings categories, we continue to have 70.3% of our portfolio, our mortgage backed securities portfolio, in the AA or AAA ratings category.

That’s based on the lowest. Okay. Based on the lowest rating of the three, it’s 70% still in the AA or AAA ratings category and if you include all of our securitized loans in that calculation, you are looking at something in the neighborhood of 98% of our portfolio continues to be in the AA or AAA ratings category so we still have a pretty solid credit rating on our portfolio despite the fact that there have been some fairly substantial downgrades out there.

Additionally, and there will be some detail provided in the 10-Q once we file it and so I’m not going to go into the detail there, but additionally, we have looked very carefully at all of the credit classes in our portfolio and we are going to be providing disclosure about the remaining amount of credit enhancement in each ratings category of our mortgage portfolio.

We are going to provide information on cumulative losses to date, the loan-to-value, the original loan-to-value on each one of those categories of underlying loan collateral and what percentage of the remaining portfolio is currently 60 plus days delinquent and I think that what you will find is that at the very least, yes, delinquencies are up but there is still substantial credit support and in our view the losses are likely to be relatively minimal compared to the carrying value or the discount on our books which is roughly $3 billion that we have written down this portfolio by.

Secondly, it’s going to take quite some period of time before these losses actually flow through to the company, if in fact we realize them because all of the loans that are in the delinquent pipeline are going to have to be foreclosed upon, then they are going to have to be liquidated and then the losses are going to have to flow through and that process typically takes 18 months per loan.

So it’s going to be a long time before we actually see these losses flowing through, which only will happen once all of the credit enhancement has been absorbed. So I think we are looking at years, truthfully, but nonetheless, we are going to try to provide some transparency and some disclosure around our credit exposure there and what we have for credit enhancement. So despite the downgrades, bottom line is we still think we’ve got substantial credit protection and a very good performing portfolio.

Let’s turn to the loan portfolio now for just a moment. On the loan portfolio, which totals our total $21.4 billion as of the end of the quarter and consists of both loans that the company has originated and loans that we have bought in bulk packages from third-party sellers, where the majority of which has been securitized and financed in collateralized mortgage debt transactions. We did see a notable increase in the 60 plus day delinquency rate on that portfolio.

At June 30, we had 81 basis points of 60 plus day delinquent loans and REO and at September 30 that number almost doubled to 1.58%, 60 plus day delinquent loans and REO.

So there has been a notable increase in the delinquencies in our portfolio. However, if you look at what’s going on in the industry for prime adjustable rate mortgage lenders, at June 30, which this is not even the September 30 number, as reported by the mortgage bankers association, 8 1/4% of all prime adjustable rate mortgage loans are currently delinquent, 60 days plus or more or are in an REO category.

So we continue to do far superior to the rest of the industry and, in fact, these delinquencies statistics while higher than we would have hope are still within the realm of reasonable expectation on our part. Specifically, there is one category of loans we continue to talk about it on a quarterly basis. Those are the pay option ARMs that we purchased from one seller.

That balance is now $528 million out of $21 billion and the delinquencies are significant in that $528 million portfolio such that it’s doubling our delinquency rate or virtually doubling our delinquency rate just as a result of what’s happening in that one contained portfolio. So if you eliminate that portfolio, clearly our originated and bulk purchased assets are performing significantly better than the rest of the industry. The company had losses and charge-offs related to disposition of REO in the third quarter of $6 million.

We are currently carrying this book at a $631 million impairment or discount to par. So we believe that we have more than adequately reflected the loss exposure in this portfolio in the carrying value of these assets as a result of the impairment that we have taken on this portfolio.

We don’t believe that our losses are going to exceed or even come close, truthfully, to that $630 million. In the third quarter, we did not complete a securitization transaction. We did have some loans on the balance sheet at the end of the second quarter. We had intended to securitize those into some sort of a permanent debt financing transaction.

We were unsuccessful in completing that transaction as the securitization market closed completely in the end of the third quarter. As a result, we elected to sell a portion of those loans in order to pay off our warehouse financing. We completed a loan sale in the third quarter of $111 million in loans and we were able to reduce our warehouse financing and then since September 30 we have an agreement to sell an additional $92 million worth of loans that is spending settlement in the next week.

We believe that we are on a pace to complete that transaction. That will allow the company to have sold all of its loans, pay off its warehouse lines in total and raise some excess cash as a result of that and we will have about $30 million or $35 million worth of loans on the balance sheet after that fact and we will disclose those details more precisely in a 10-Q as well, but sufficed to say, as far as we know, the warehouse financing lines will in fact be paid off over the course of the next week or so, which we also believe is good news.

Turning to the results of the third quarter, I think it’s notable again, the $80 million in net interest income as compared to $53 million in the prior quarter. The yield in the portfolio increased by 22 basis points to 7.17%, the cost of funds in the quarter decreased primarily as a result of the drop in LIBOR in the quarter to 6.01%, so we had a net spread and a net margin of approximately 115 basis points for the quarter. So, again, very strong profitability, a significant contributor was the accretion of the discount that we are carrying our assets at.

We booked an $82 million of discount accretion in the third quarter as a result of CPR at 12%, which was slower than what we have been experiencing in prior quarters, but we do expect that over the remaining life of these assets we are going to see some modest pickup over time in the CPR.

Again, $82 million of discount accretion, again I will remind everyone, we have about $3 billion of discount to accrete into earnings over the coming years. The second thing I will suggest is that discount accretion for us is an interesting calculation. We have a going concern opinion. As a result we are supposed to impair our assets. We can accrete discount on assets whose fair value either does not change or increases in any quarter.

For any asset whose fair value decreases during the quarter, we have to take an impairment charge which effectively reverses any prior period discount accretion and marks it to current market. So the $82 million of discount accretion for the quarter is only on that part of our portfolio that actually had no fair value change or an improvement in fair value change. Eventually we are going to get to a place, I suspect, where all of our portfolio is going to be subject to or allowed to have discount accretion and that number is going to increase even more substantially, which will increase earnings as well.

The other component or comment that I want to make is that in the quarter the company booked $53 million of swap expense. That was interest rate swap expense from terminated interest rate hedging instruments in prior periods and we took a loss and we deferred that loss over the remaining term of the hedging instrument and in the quarter we moved $53 million of that loss into income as a cost of funds adjustment.

There is $165 million left in OCI of deferred swap loss that will be realized over the next two or three quarters and eventually that $165 million is going to go away probably by the middle of 2009. So there are going to be two additional profit drivers for the company as we look out over the next three or four quarters. One is going to be hopefully the ability to accrete discount on all of our mortgage backed securities portfolio and the second is going to be the elimination of the swap expense that will obviously, improve our interest spread going forward.

Clarence Simmons

Senior subordinated.

Larry Goldstone

And the third thing is in fact the completion of the tender offer, which will end the issuance of the additional warrants which would also reduce our cost of funds by reducing the interest rate on the senior subordinated notes from 18%, which is what it was booked at in the third quarter, down to 12%.

So there is, you know, some tail wind behind this operating statement if you can cut through all of the noise and the static, if you will and not that the noise in the static isn’t important.

It happens to be what engages us these days and keeps us focused. Book value was a pretty significant negative number, $34.20 at September 30. However, I will suggest that if in fact we can complete the tender offer, we are going to move, you know, some portion of a billion dollars of preferred equity down into the common equity line item and so that’s going to help book value fairly significantly going forward.

I want to talk just a moment about the preferred stock tender. That gets set to close on November 19 based upon the information that we have and released in the press release, we are over the required 66 2.3% in three of the four series of preferred stock that we are tendering for.

We are about 40 basis points short, a little less than one half a percent short in the series F preferred stock and so consequently we are feeling fairly confident but certainly not too confident but at this moment fairly confident that we are going to be able to finally complete the tender offer, close the tender offer and you’ll be looking for an announcement to that effect on Wednesday of next week.

And then if you could just give us a few days, we will get those shares issued and then subsequent to that we will get the additional warrants issued to all the senior subordinated note holders just as quickly as we can.

I don’t think I need to go through the details. I think everybody has got that. I guess I’ll just make one more comment because I know it’s been a little bit topical out there based upon the feedback that we have been getting from our investor relations desk.

We have been engaged in exchanging part of our subordinate notes or a portion of our subordinate notes for common equity over the last three weeks or so. We believed that that was a very economically advantageous transaction as the company continues to try to convert debt to equity as we try to grow the equity portion of our balance sheet, we think that’s got a lot of benefit for the company and certainly the opportunity to retire debt at a substantial discount to par also saves the company interest expense and as you know, cash flow is an issue around here as well.

All that said, I think we have been very, very successful in retiring roughly $25 million to $30 million of the subordinate notes.

We had agreed, however, with the exchange participants that we did not want to be exchanging debt too close to the actual completion of the preferred stock tender, because we were in fact concerned that issuing shares was going to create some issues for the consideration offered for the preferred stock and so consequently we will be ceasing, exchanging, debt for equity in the very, very near term, certainly before the end of this week and we will give the stock a week or so, hopefully to recover some value if in fact it’s going to do that.

On the other hand, the market probably knows that we are going to be issuing roughly $130 million shares of common stock in exchange for the preferred stock and then subsequent to that, another $250 million shares to the senior subordinated note holders in the form of penny warrants and then assuming we can come to some sort of an agreement with the override lenders, there’s going to be another block of penny warrants issued to the five override lenders.

They are currently entitled to 4.04% of the fully diluted shares. That’s roughly another $130 million shares and so consequently, there is some stock coming into the market and maybe people will figure that out as well.

With that said, I don’t think there’s anything else we need to cover. I think we are willing to open it up to questions from the group.

Question-and-Answer Session

(Operator instructions) Your first question comes from the line of Annett Franke; please go ahead.

Annett Franke – FBR Asset Management

Hi, good morning. Larry, quick question you mentioned that you can finally close the tender offer. Do you still have to get some more solution to the override agreement first or has that changed somehow that you can actually close the tender now before resolution can be found to the override concerns?

Larry Goldstone

No, we don’t need resolution to the override agreement. Because we have changed the consideration for the tender, meaning we are not offering cash plus stock anymore, we are only offering stock, and it’s the elimination of the cash component which effectively was a cash dividend to the preferred shareholders that was prohibited under Maryland law and so the elimination of the cash consideration allows the company to go ahead and proceed with an all stock tender and so, assuming that we get the required number of consents and the required number of shares tendered, we believe that the preferred stock tender will in fact get closed next week.

Annett Franke – FBR Asset Management

Okay. And just a second question. Could you talk about how the principal and interest payment on the repo ARM books flows, you had previously mentioned that some of the P&I is retained by the repo lenders and depending on how the cash flow goes, have you booked the full interest income, interest on that repo ARM book in the year in the net interest income or how should we look at that?

Larry Goldstone

Well, we did book all the interest as interest expense and paid down the repo debt at the same time, so we are booking at consistent with our understanding of the way funds should be applied. And then I think secondarily, I’m not sure if you were asking, but the override lenders are continuing to capture all of the principal and interest that’s being generated or earned or paid on the underlying mortgage securities, so they are not remitting any funds back to the company as of today.

Annett Franke – FBR Asset Management

Okay. Thank you very much.

Operator

Thank you. Our next question comes from the line of Bill Thatcher [ph] with Artesia Capital. Please go ahead.

Bill Thatcher – Artesia Capital

Hi, guys. I just wanted to follow up on the prior question about the preferred tender. To understand the 10-Q delay does not at all impact the expected closing of the tender and your understanding right now is all you really need to do is receive 2/3 of each class and you will close the tender on the 19; is that correct?

Larry Goldstone

Yes, that’s correct. We have five days – we have to have our 10-Q on file and we have on file and we have to give the market five days to, quote Digest that information and so we have to file the 10-Q by tomorrow and that is our current plan. Maybe we will get it done sooner but certainly by tomorrow. Filing date tomorrow is what we need, and, yes, we need 66 in 2/3 of each series of preferred stock and then we can successfully close the tender.

Bill Thatcher – Artesia Capital

And you intend to, correct?

Larry Goldstone

We do.

Bill Thatcher – Artesia Capital

Thanks.

Operator

Thank you. Our next question comes from the line of Chris Dennis with R3 Capital. Please go ahead.

Michael Fazio – R3 Capital

It’s Michael Fazio [ph] from R3. Just a quick question on the override agreement should there be a disagreement over the evaluation and the down grade, the way the agreement stands right now, if your understanding that the lenders have the last say on what the ultimate – what or the collateral haircut will be?

Larry Goldstone

Well, no the collateral haircuts are contractually defined in the agreement and so there is no disagreement with respect to the collateral haircuts. The disagreement arises primarily around whether a security needs to be re-margined on a downgrade based upon a change in the haircut and the change in fair value or is it just the change in the haircut and that’s where the difference of opinion lies.

Our view being that it’s the change in the haircut which is contractually specified. So, all of the parties to the override agreement are living under the same haircuts schedule based upon the credit category in which securities are rated.

Michael Fazio – R3 Capital

And on that agreement, on the override agreement, I believe it’s governed by the laws of the state of New York. You’ve been negotiating with the override with the lenders for quite sometime. Should you come to an impasse would you litigate with them and if so, what would be the venue for that litigation?

Larry Goldstone

Well, I think that, our goal is to come to some sort of a resolution. For whatever ambiguities exist in the document, I think that all of the parties are struggling with those ambiguities. We have one interpretation, they have another interpretation. What I think is somewhat notable here is the fact that we have been now in negotiations for the better part of three months and there has not been an event of default declared.

There has not been a liquidation declared, everybody is sort of living under the agreement and at least respectfully agreeing to disagree while we try to negotiate some sort of a resolution and I believe that we are going to get a resolution, but certainly, if we need to litigate, we are prepared to litigate. I just hope it does come to that because that’s going to be a long and protracted process.

Michael Fazio – R3 Capital

And just last thing and then I’ll let you move onto the next caller. I assume that any resolution that you come to would contemplate both the Fitch action that’s already occurred, the S&P action that’s happening real time and the Moody’s action that you alluded to for the first half of ‘09?

Larry Goldstone

Yes, that is correct.

Michael Fazio – R3 Capital

All right. Thank you very much. Thanks for taking my call.

Operator

Thank you. Our next call comes from the line of Hilliard Hester [ph]. Please go ahead.

Hilliard Hester

Yes. I would like to just get a clarification on the conversion rate because we got a letter just dated October the 22. It was talking about a 0.077 conversion rate of common stock per liquidation preference of series E.

Clarence Simmons

So, it’s just divided by 10. So, the original conversion rate was 3.5 shares at $5 conversion rate.

Hilliard Hester

Oh, they have a conversion rate? Once talk this is Amy pell

Amy Pell

The series E had an initial conversion rate of 0.77, something and because we did the 1% reverse stock split, that conversion rate has been divided by 10. So that’s effectively, that’s what the letter that you received is telling you.

Hilliard Hester

But, I mean, if you have, say a thousand shares of the preferred series E, what are you going to wind up with as far as common stock?

Clarence Simmons

3000 shares.

Hilliard Hester

Okay. That was what I was trying to get because this was somewhat confusing when it looks at a 0.077 conversion rate. The second question, and I’ll move on, what is the either loan or total value of the loans that Thornburg has outstanding now?

Clarence Simmons

The market value?

Hilliard Hester

Yes.

Clarence Simmons

I believe that we are disclosing the market value of the loan portfolio. We’ll have to look that up. We didn’t include that in the press release that is in the maybe I can tell you now.

Hilliard Hester

Well and just one other and I will move on. When do you looking forward think that you are going to be profitable after all of the other, as you called it, static staff is taken and consideration and done away with?

Clarence Simmons

Well, actually, can answer to your first question, it looks like we will be reporting the fair value of our loan portfolio at September 30 at roughly $19 billion.

Hilliard Hester

Okay.

Clarence Simmons

And so that’s the fair value. That’s not the carrying value.

Hilliard Hester

Right.

Larry Goldstone

And secondly, again I think that the completion of the tender offer and the elimination of the principal participation agreement and the issuance of the additional warrants will eliminate a couple of the substantial fair value adjustments that we have been recording each quarter in this most recent quarter, it looks like that totals about $750 million, so that will go away, that will simplify our financial reporting going forward.

The company needs to resolve its financing issues. It needs to be able to eliminate its going concern opinion from our auditors and once we have done that, we will be able to then stop booking impairment charges on the mortgage-backed securities portfolio and so, that will eliminate another substantial income statement line item and then the company will be profitable. We are already profitable on a core basis today.

Hilliard Hester – Independent Investor

Right. That sounds good. Thank you very much.

Larry Goldstone

You bet.

Operator

Thank you. Our next question comes from the line of Paul Spindler [ph], Private Investor; please go ahead.

Paul Spindler

Hi, Larry. I just need a clarification on the series F. You said that you need 66 in 2/3% tender of each series and that you were a little short on the series F, but I was under the impression that you had over 90% tendered originally on all the series. So were series F or other preferred shareholders opposed to do an additional tender of some kind? Is there something else we need to do to make sure our shares are tendered?

Larry Goldstone

No. I think that what tends to happen is many investors tend to withdraw their shares from the tender process until pretty much the last minute and we had this experience with the tender offer, when we were trying to close it back in August and then ultimately we had to back away.

In the very few remaining days of the tender, we saw a fairly significant flurry of shares getting tendered and pushed us up to the top and in fact you were correct. Under the old consideration, the old terms and conditions, we did in fact have 99.8% of the preferred shares of all classes submitted for tender.

My guess is that as we move into next week, Monday, Tuesday and the percentages continue to be this high. We are going to see a lot of investors, large holders come in with their shares to tender as well and so, again, we are hopeful that we are going to be over the threshold on Wednesday and be able to announce that we are going to close the tender.

Paul Spindler

Okay and so, if an investor has tendered his preferred shares and he never took any action to withdraw the tender, then he is tendered and he will be converted next Wednesday?

Larry Goldstone

That is correct.

Paul Spindler

Okay and then if I may be permitted one follow-up.

Larry Goldstone

Certainly.

Paul Spindler

The lenders originally agreed to not do any more margin calls for a year. You’ve said in press releases that they subsequently did do margin calls that seems like unfairness worse than anything, we have faced all through this whole process and that issue seems to have quieted down. Do we have any recourse there and can a court undo a margin call for us?

Larry Goldstone

Well, a court potentially could. I think it would be fair for me to be a little bit more middle of the road here. Let the override agreement does is it does say that the lenders agreed to not make any additional margin calls, but it did have a carve-out for securities downgrades. The issue that we have is the document was not clear with respect to how to handle margin calls on downgraded securities.

Additionally, the document did not specify what rating agency had preference, if you will. Convention in the business historically has been the highest of the three ratings is the rating that carries today and we believe that our agreement with lenders was that they could margin the collateral differently, but not market-to-market again and the lenders don’t agree with that. So, it wouldn’t be fair to suggest that the lenders had no ability to margin call.

I think rather it’s a question of how downgraded securities get treated and the truth is that I don’t think any of us, any of the five lenders nor the company anticipated that we see the magnitude of downgrades that have been sort of precipitated by the rating agencies and in many cases the rating agencies have rewritten the rules with respect to what qualifies as a AAA, a AA and A with hindsight and in a rearview mirror that’s a little bit problematic as well, but that was it is. So, I think that’s the right way to characterize it. Again, we certainly believe that we have a strong case, if we had to litigate, if we had to arbitrate, but we are trying not to go there.

Paul Spindler

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Kevin Starke with CRT Capital; please go ahead.

Kevin Starke – CRT Capital

Good morning, Larry.

Larry Goldstone

Good morning, Kevin.

Kevin Starke – CRT Capital

Back all the way to the next question about the previous extensions of the tender. You changed the terms of the offer to stock instead of cash plus stock. I think on September 30 or October 1, but then you have I think extended the tender signing Maryland law at least once maybe twice since that and I’m wondering what’s changed?

Larry Goldstone

No, we didn’t sign Maryland law. I think very likely in the massive disclosures and the massive filings that we are doing, it might have gotten confused that the extension of the tender from October 31 to November 19, was really more, I guess logistics and procedural in nature. We were probably once again a little bit too optimistic on September 30, when we thought we could complete the tender by October 31.

We ran into substantial operational issues related to the release of the escrow warrants, the pick consent shares, the pick bonds, fair value opinion we needed and a myriad of other complications that required us to extend the tender from October 31 to November 19, but none of the extensions since we changed the terms of the tender related to Maryland solvency issues.

Kevin Starke – CRT Capital

Right. So, are there any hiccups that could arise aside from not completing the 10-Q between now and November 19?

Larry Goldstone

No, I have hedged my bet; I hope everybody here hears that I am hedging my bet. We are certainly hopeful that we get this done by November 19. This is like waiting for it though, but in fact in this story it will show up, but, I mean, who knows. Kevin, everything we have tried to do dating back to March of this year has been fraught with unexpected turns and pitfalls and potholes and land mines and I certainly hope that we don’t have any more over the course of the next week, but I’m not going to take a bet on whether we will or we will not. We are just going to keep our fingers crossed and keep working, get the 10-Q filed in the next day here and attempt to close this tender next week.

Kevin Starke – CRT Capital

Okay. The closing of the tender constitutes a triggering event under the PTA subscriber agreement. They make me wonder, without the override sort of firmly and safely in place, why would the PPA participants necessarily want to step to the bottom of the capital structure?

Larry Goldstone

So, the PPA participants aren’t stepping to the bottom of the capital structure. I think well, I don’t think they have a choice. We have the opportunity to terminate the PPA upon the successful completion of the tender and the issuance of the additional warrants, and so that’s kind of the way the deal works.

Kevin Starke – CRT Capital

And the PPA isn’t contingent upon the continued health and existence of the override agreement?

Larry Goldstone

Not that I am aware of it, no.

Kevin Starke – CRT Capital

Okay. That matches my reading. All right, I’m not clear on how the repo collateral changed from the end of the second quarter to the end of the third quarter. I wonder, if you could give me the end 2Q amount and maybe just probably go through what might have changed in the interim.

Larry Goldstone

I believe with the repo collateral itself, I believe we had an unpaid principal balance of about $7.8 billion at the end of the second quarter. You have the number there, right?

Kevin Starke – CRT Capital

That’s face value, right?

Larry Goldstone

Overall unpaid principal balance as of June 30, on the repo balance?

Clare Simmons

The repo balance, the UPB.

Larry Goldstone

On during…

Kevin Starke – CRT capital

The collateral.

Clare Simmons

The unpaid principal balance on the collateral that was on repo?

Larry Goldstone

At June 30.

Clare Simmons

About $77.8 – a $7.9 billion.

Larry Goldstone

$7.9 billion and that is now paid down to $7.3 billion.

Kevin Starke – CRT capital

Okay.

Larry Goldstone

The fair value – do we have the fair value at June 30, Clay?

Clare Simmons

Well, the fair value if you exclude the IOs, the fair value…

Larry Goldstone

No, put the IOs in.

Clare Simmons

Okay, $6.6 billion.

Larry Goldstone

So with $6 billion of fair value at June 30 and it is $4.8 billion of fair value at June 30 or at September 30.

Kevin Starke – CRT capital

Does the application of liquidity reserve fund or restricted cash reduce the outstanding balance?

Larry Goldstone

The liquidity reserve fund does not.

Kevin Starke – CRT capital

Okay.

Larry Goldstone

The restricted cash does in – at September 30, but it did not at June 30.

Clare Simmons

Anything that the repo lenders have either been paid in cash or have collected and not remitted to us has been applied to the balance.

Larry Goldstone

At September 30.

Kevin Starke – CRT capital

So, if you take funds out of your restricted cash to queue pay the repo lenders using take back that collateral and put it back on your own balance sheet, so just...

Larry Goldstone

No, we don’t. The restricted cash on the balance sheet in general is cash collateral that the repo dealers have and are entitled to and are titled to. It’s not – it is not something that we control.

Kevin Starke – CRT capital

Alright, but if you were to pay-off a principal amount of repo borrowings using restricted cash, then what happens to the collateral under that?

Larry Goldstone

It is retained by the repo counterparties.

Kevin Starke – CRT capital

It seems to find a way to win with these guys. Net interest margin, does that include the – accretion effects that you have been talking about?

Larry Goldstone

Yes.

Clare Simmons

Yes.

Kevin Starke – CRT capital

On a percentage so, is there a way to calculate what would be without accretion?

Larry Goldstone

The accretion is 122 basis points.

Kevin Starke – CRT capital

122 basis...

Larry Goldstone

The virtually all of the spread.

Kevin Starke – CRT capital

Okay.

Clare Simmons

Well, I mean, there’s – the accretion on the asset side is 122 basis points and if you look at the swap re-class from OCI plus the 18% or the 6% extra interest on the senior debt, that is a 100 basis points on the liability side. So, if you are looking for temporary, effects or whatever the 122 basis point higher yield on the asset side as a result of accretion and a 100 basis point higher cost on the liability side from the extra interest and the swaps.

Kevin Starke – CRT capital

So, net impacted something was 22 basis points?

Larry Goldstone

Clare is 22? Yes, that would be.

Clare Simmons

Yes.

Kevin Starke – CRT capital

So your net interest margin of 1.15, if you backed out 22 basis points that might be sort of like a core number? Would that be fair?

Larry Goldstone

Yes.

Clare Simmons

Yes.

Kevin Starke – CRT capital

Last question for me. This is before my time, the holders of the junior sub-note I guess, was originally $240 million outstanding and I guess you can back $53.5 million out of that?

Clare Simmons

No, we didn’t complete the entire exchange of $53.5 million.

Kevin Starke – CRT capital

Okay, but the original face amount was 240, right?

Larry Goldstone

Yes, that is correct.

Kevin Starke – CRT capital

Now, is this a deal marketed at all to one investor or a small group of investors or…

Larry Goldstone

That was one investor.

Kevin Starke – CRT capital

Okay. So he is only liquidating one part of that?

Larry Goldstone

Well…

Clare Simmons

Converting it into stock?

Larry Goldstone

We agreed that we would try to exchange his entire $53 million position for stock.

Kevin Starke – CRT capital

Okay.

Larry Goldstone

We have not been able to effect in a reasonable way all of that $53 million exchange and so I believe we have completed somewhere between $25 million and $30 million and there are some reasons why we are not going to be able to complete any more of it, some related to his issues, some related to our issues, but as we – it was always understood that as we got closer and closer to the completion of the tender that we did not want to be competing with the preferred shareholders in the market for the company stock.

Kevin Starke – CRT capital

Right, if I recall correctly, the entire junior sub note was $240 million, is that correct?

Larry Goldstone

That is correct.

Kevin Starke – CRT capital

And that’s held by other investors?

Larry Goldstone

Yes.

Kevin Starke – CRT capital

None of whom are necessarily agitating for similar treatment?

Larry Goldstone

Well, there’s all sorts of folks that are looking to exchange their stock and my guess is that once we get the pref tender completed and the additional warrants issued and kind of get the stock price settled down, after all of that we are very likely going to be looking at potential other opportunities to exchange debt for equity.

Kevin Starke – CRT capital

Okay. Thank you very much.

Larry Goldstone

You bet.

Operator

Our next question comes from the line of Bob Clutterbuck with Clutterbuck Funds; please go ahead.

Bob Clutterbuck – Clutterbuck Funds

Good morning, Larry.

Larry Goldstone

Hi, Bob.

Bob Clutterbuck – Clutterbuck Funds

It just seems to us that obviously, on a relative basis if somebody gets the tender completed, which you should do next week; a relative basis things are going pretty well except for the ten time the rollout the override agreement, but even if you resolve the override agreement tomorrow, the override agreement plus or minus expires in six months and everything seems to be going pretty well except for the financing. Can you talk about, would you have the liberty to talk about, is there any discussions on an extension of the override agreement to get it resolved, past the April or May date or and if there aren’t, what your considerations and thought processes are at this time?

Larry Goldstone

Well, I’m really not at liberty to discuss a whole lot of details around what we are doing to try to resolve the financing issues other than to suggest that it is first and foremost in our minds with respect to, that is the big issue right now. I would say the biggest frustration that we have experienced is the fact that this override disagreement has proven to be a substantial distraction of management time and management effort and management’s ability to try to resolve our financing issues and that’s the saddest news.

That’s the most disappointing part of this continued and protracted disagreement with the override lenders is that our time has been substantially compromised and distracted and diverted from focusing on what we believe is our top priority and that is the resolution or the finding some form of alternative financing that is going to be more predictable and more reliable than what the override lenders are offering.

I can’t speak to whether the override lenders would consider an extension or not. I certainly believe that the override lenders would like their financing book reduced, if not completely paid off by March of 2009 and our goal is to find ways to get that done.

We have a number of different thoughts and strategies that we are trying to pursue and implement along those lines and we are not leaving any stone unturned here.

So, at some point in time, as we make some progress here and feel like we have got something to talk about, we will be more than excited and more than anxious to share that with everybody, but right now just suffice it to say that we are looking at a myriad of different ideas and angles to try to find a way to get this book financed.

Bob Clutterbuck – Clutterbuck Funds

Perfect. I appreciate those comments. Okay.

Larry Goldstone

Thanks, Bob.

Operator

Thank you. Our next question comes from the line of Richard Downes with BR Capital; please go ahead.

Larry Goldstone

Hello.

Operator

Our next question comes from the conference of Mr. Geets [ph], BR Capital; please go ahead.

Geets – BR Capital

Hi, Larry.

Larry Goldstone

Hi, Richard.

Geets – BR Capital

I’m a little confused on what the various comments that you made in the press release and on the call today regarding the credit quality of the portfolio with respect to ratings and specifically, if I understood right, you say that 98.1% of the book is of the ARM exposure that you have, both in loans and securitized form is AA or AAA?

Larry Goldstone

Right.

Geets – BR Capital

Is that the right interpretation?

Larry Goldstone

That’s correct.

Geets – BR Capital

So, by those numbers, then 1.9% would be below that?

Larry Goldstone

Right.

Geets – BR Capital

And that would imply something like $500 million plus or minus, I think, of loans that don’t fall into the AA or AAA category, loans or securities?

Larry Goldstone

Carrying value, that’s correct.

Geets – BR Capital

Okay, but then I thought you said that as of September 30, you had $1.2 billion in carrying value of securities that had been downgraded, so some of those down grades from AAA to AA?

Larry Goldstone

The 98% represents the highest rating; historically, we have reported that number, which has been in the queue forever based on the highest rating, which is typically the way the financing markets work. What we are reporting on the, in terms of the downgrades, we are looking at the lowest rating that has been obtained on any of the collateral and there are a lot of split rated bonds, as the rating agencies go through their exercise here.

Moody’s hadn’t downgraded much of anything. S&P is in the midst of their process and Fitch is somewhat complete. So, I think there is a bit of a disconnect between, looking at the portfolio historically at its highest rating and disclosure on the downgrades, which we have made on the basis of the lowest rating, which is the way the repo lenders are looking at it right now.

Geets – BR Capital

Right understand. So, if you were to look at the entire portfolio and on a lowest rating basis, what percentage of it would be AA and AAA still?

Larry Goldstone

I think like…

Geets – BR Capital

1% number if you were to do that on a lowest rather than highest rating?

Larry Goldstone

I don’t have that right in front of me. Probably going to be 95%, as a guess, 93% difference.

Geets – BR Capital

Okay. Thank you.

Operator

Thank you. (Operator instructions).Our next question comes from the line of Ross Levin with Arbiter Partners. Please go ahead.

Ross Levin – Arbiter Partners

I think my question may have already been answered, but since I’m not bright. I’ll ask to go through the numbers again. If we start out with sort of a cash NIM, net interest margin and then go through the numbers for accretion, which I gather was a 122 basis points and then you mentioned swaps in excess interest on the senior note were or the senior loan was collectively a 100 basis points, could you break down that 100 basis point figure? And also could you help me out with the starting sort of cash NIM figure, before all of this?

Clarence Simmons

Cash NIM is going to be based on the 5.8% yield, right. While the cash the coupon, right. The net interest margin, including the accretion on the mortgage side is $220 million or $498 million, so you’d back out around $82 million from that number, which would be the impact of the accretion to get down to the cash NIM. On the liability side, we paid $17 million more interest on the basis of going from 18% from the 12% that we would again have the tender offer been completed, and then there’s 50 some million in the swaps.

Ross Levin – Arbiter Partners

50 to 94.

Clarence Simmons

No, that’s the impact the $82 million of accretion against $60 million of liability impact.

Ross Levin – Arbiter Partners

Versus $498 million in sort of stated net interest margin inclusive all of those?

Clarence Simmons

That interest income and then your total net interest income after the liabilities are backed out is $80 million, so, 418 of interest expense.

Larry Goldstone

Interest income; 418 of cash interest income.

Clarence Simmons

No, it’s 198 of cash interest income and 418 of interest expense for the quarter.

Ross Levin – Arbiter Partners

Gotcha, and just help me out there, the 418 of interest expense, includes or does not include the $17 million in excess interest?

Clarence Simmons

It includes the $17 million of excess senior subordinated note interest and it includes the swap.

Ross Levin – Arbiter Partners

Okay. Thank you, guys.

Operator

Thank you. Our next question comes from the line of Ryan McCarthy with RM Capital. Please go ahead.

Ryan McCarthy – RM Capital

Hello.

Larry Goldstone

Good morning.

Ryan McCarthy – RM Capital

I had a dream last night that your stock was going up. As a satellite concern I viewed about, what are you doing to make my dream come true? In other words, a lot of our stock pricing is confidence and confidence in the stock, and that the confidence that is going to go higher.

So, what are you doing in terms of maybe in your investor relations regards to maybe going on CNBC, going on Bloomberg or doing anything to regain confidence that the company is doing the right things and getting investors interested in the stock and getting investors getting back into the company and raising the stock price?

Larry Goldstone

Well, I think that we are doing everything within our power, but we also have to be cognizant of the fact and careful of the fact that we are still in a difficult portfolio financing situation, and we are in a difficult market environment and I for one am certainly not interested in creating any more shareholder lawsuits for disclosing or being overly optimistic when we need to be pragmatic and realistic about our prospects.

I believe that as it is evidenced by this call and other things that the company is doing. We are trying to point out the core competences and the core strengths that are embedded in our balance sheet and our income statement for investors to try to understand, but we have to tamper that with the knowledge that we need to, we have got a lot of work to do to resolve our financing issues and to stabilize our financing, and beyond that. I think if we can get to that point, things are going to; investor confidence is going to be greater.

I think secondarily, we are trying to be a thought leader. There is a lot happening in the broader mortgage industry and the financial services space with respect to government policy. With respect to ongoing disclosure by other financial services companies and I think that it is important that we as an organization play a role in trying to help the market understand and interpret what those various policy pronouncements and other announcements in from our perspective. The environment is very challenged as I’m sure you know and I think we are doing our part to be, to maintain the brand, to maintain awareness, to maintain our integrity and too hopefully we will be adding some value as we navigate this environment.

Ryan McCarthy – RM Capital

Alright, thank you very much.

Operator

Thank you. Our next question comes from the line of Stuart Morrow with Suntrust Financial Services. Please go ahead.

Stuart Morrow

Hello. I’m a private investor. I just wanted to ask this question, if you look at the common stock price today it approximates $1 in a quarter. The preferred F also approximates $1 in a quarter, which you anticipate a three to one exchange ratio. Do you have any observations for why that has persisted for a while? And why that price is? What it is?

Clarence Simmons

I do not. I’m not quite sure, but I understand it. Obviously, the market seems to think that when we issue 130 million shares of common stock, that it might have some impact on the trading price of the common stock, but on this perplexed by that as our view

Stuart Morrow

Thank you.

Operator

Thank you. Our next question comes from the line of Robin Holster [ph] with Power Research [ph]. Please go ahead.

Robin Holster – Power Research

Hi, Larry I wanted to ask you a question about sort of how you see the company positioned going forward. You’ve talked a lot about the necessary financing arrangements you’re looking to get in place, but originally your business was, mortgage originations, securitization. Can you say a little bit about how the company will look in terms of like the mortgage business going forward? Or are you sort of more or looking to be just a holding company realizing the value of the portfolio that you currently have?

Larry Goldstone

No, I think that our goal and objective is well beyond just simply being a holding company. I think that the near term goal is to be able to hold the assets that we currently have, but we still have our loan origination franchise. It has been downsized for sure as we have tried to reduce expenses and maximize cost efficiencies, but the core underlying loan origination capability is intact and could be restarted in a relatively short period of time.

What we need is to find a financing partner, if you will. Now, clearly, the financing partner is not going to be the historical financing partner, which is the capital market securitization of our mortgage loan, because that market continues to be broken and nonfunctional or dysfunctional today, but we do believe that there are potential pockets of capital out and pockets of financing out there. That potentially could facilitate a hold to maturity type of loan origination effort and that’s what we are striving to try to accomplish.

Robin Holster – Power Research

Okay. Do you want to maybe say just a little bit about, sort of what you see the future of mortgage securitization, sort of how that looks now and how you might imagine it will play out over the next year or two?

Larry Goldstone

Sure, I think in the near term the mortgage securitization business is going to continue to be this functional and probably not exist, and I think that part of the reason, there are two primary reasons why that’s the case. Number 1, there is a lack or a shortage of capital in the traditional mortgage investors and lets be real. Traditional mortgage investors are the banks and the savings and loans. That’s where the lion’s share of mortgage paper has been held over the years and that sector is challenged because they don’t have capital to be expanding their balance sheets.

They are not expanding their loan holdings or their mortgage securities holdings and absent the banking sector to have capital to put to work, there’s not enough demand for mortgage investments outside of the banking sector to support the business. That’s not going to change for sometime to come because I think the capital continues to be destroyed at a rate that’s generally faster than it’s being created because of the credit deterioration across virtually all sectors of the economy, whether it’s single-family loans, mortgage loans, home equity loans, student loans, automobile loans, leases, commercial, I mean, you name it, credit cards, there is still capital being destroyed, not created.

So that’s going to take a little while the second component is the whole regulatory and I will lump rating agency and underwriting component into that category as well. There’s substantial uncertainty about what the regulatory environment is going to look like for mortgage lenders and mortgage securitizes and mortgage rating agencies going forward. Congress has not been even remotely clear about what they intend to do and how they intend to change the regulatory environment other than, my guess is it’s going to be, you know, fairly substantial.

Secondly, I think that the rating agencies have lost total credibility with respect to their process and that there was an investor earlier talking about confidence. The rating agencies truly have a crisis of confidence and they have got a long ways to go before they restore that and so consequently, you’ve got to have a different securitization and ratings process that people can rely on and that doesn’t exist right now. A year or so down the road, I think that market is going to come back, it’s an integral part of the mortgage finance business, it’s an integral part of mortgage credit.

It’s an integral part of all consumer credit and so consequently we are going to live in a very, very difficult world and a very depressed world if we don’t have cheap capital available to support consumer credit and home finance credit down the road.

Robin Holster – Power Research

Okay. Thank you.

Operator

Thank you. (Operator instructions) At this time, Mr. Goldstone, there are no more questions in the queue.

Larry Goldstone

Okay perfect. Thank you, Kim and thanks, everyone for joining the call this morning.

We will continue to release news and information as it becomes relevant and we appreciate everyone’s understanding and patience as we continue to navigate this challenging environment. Thanks again.

Operator

Ladies and gentlemen, this conference will be available for replay after 1.30 Eastern Time today through December 12 at midnight eastern time. You may access AT&T executive replay system at any time by pressing 1-800-475-6701 and entering the access code 968830. International participants may dial 320-365-3844. Those numbers again are 1-800-475-6701, 320-365-3844 and the access code is 968830. This does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconferencing services. You may now disconnect.

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Source: Thornburg Mortgage, Inc. Q3 2008 Earnings Call Transcript
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