Thornburg Mortgage Series F Preferred: Another Way to Skin a Cat

Folks may wish to take a look at the preferred stock of Thornburg Mortgage (TMA) and consider its risk profile relative to an investment in the underlying common shares of the company.

I particularly like the Series F preferred which has these features:

(1) Cumulative coupon of either $2.50 per year, paid quarterly, or greater if the yield of the stock is greater than 10% (the original yield of the preferred). Given current prices this is around an 10.5% current yield.

(2) Convertible. The preferred can be converted into the common stock at a conversion factor of about 2.2.

(3) Safety. There would have to be significant losses at the company before you could lose any of your principal. In fact, since Thornburg has reduced its leverage significantly and has eliminated its risk to liquidity issues the risk of the preferred is now lower than it was when the yield on some of the preferred was 8% or less before the liquidity crunch earlier this year.

(4) The company may redeem the preferred in 5 years at 130% of its liquidation value ($25). That brings the conversion price on redemption to $32.50 in five years. The company would only do this if the stock is trading at a price high enough to justify that value. However, investors would likely convert into common before that occurred.

The downside of the preferred is protected by its yield and the safety of its principal. However, the upside is great as one initially gets 10.5% but may also benefit by an improved dividend, an increase in the price of the common stock, or a decrease of the yield on the preferred.

It sure looks like a good risk/reward profile to me - certainly relative to other investments which pay over 10% in current yield.

Disclosure: Author has a long position in TMA

Comments

[Sluggo1988]

I think the author is wrong about a $32.50 ($25 x 130%) redemption price after five years. The way I read it, if the price of the common exceeds 130% of the conversion price ($11.50) for 20 of 30 consecutive days, the company may, at its option, force conversion of the preferred to common. This is not the same as saying they can redeem it at $32.50. It means they will give you 2.17 shares of common for each share of preferred. If the price of the common has declined, the value would be less than $32.50, and would not be in cash in any case.

2007 Dec 15 12:55 PM

[daver]

Technically you are correct, however the two are the same thing for all intents and purposes.

Just keep your eye on the ball and when the stock exceeds the 130% threshold, sell the corresponding number of shares short, convert your F, and deliver the shares from the conversion to close out the short position.

2008 Feb 07 12:54 PM