Thornburg Mortgage: A Victim of Its Own Success

In a terse post-bell 8-K filing, Thornburg Mortgage (TMA) said it failed to meet a $28 million margin call from JPMorgan Chase (JPM), triggering a series of "material" cross-defaults on various lending agreements.

JPM's lending agreements with Thornburg total about $320 million, a small fraction of the $11.5 billion in reverse repurchase ("repo") agreements that TMA had as of December 31, 2007. Nonetheless, JPMorgan refused to budge, notifying Thornburg that it planned to exercise its rights under the loan agreement (i.e. seize the underlying collateral) due to the default. Shares of TMA obviously tanked on the news.

But why jump at the chance to seize residential-mortgage backed collateral instead of working something out with Thornburg? Because JPM (and everyone else) knows that Thornburg's paper is of excellent credit quality, its just temporarily an illiquid investment. When mortgage investors use repo agreements to finance their assets, they do so on a "haircut" basis -- they have to overcollateralize the repo agreement by a certain percentage. Therefore, if JPM seizes the collateral and holds it long enough for the credit markets to thaw, they stand to realize an immediate built-in gain because the AAA paper is likely worth more than par, yet JPM "acquired" it at a fire-sale price.

Contrast the JPM-Thornburg situation with the Wachovia (WB)-NovaStar Financial (NOVS) situation. NovaStar has been out of compliance with its Wachovia lendings for months, yet Wachovia continued to waive the default. Unlike Thornburg, NovaStar's paper is subprime and unlikely to recover in value enough to make Wachovia whole. Wachovia does better by taking its chances that the NovaStar mortgages will perform to an extent that NovaStar can repay its obligation. If Wachovia declared NovaStar in default and seized the collateral, WB would be locking in a significant loss.

However the Thornburg situation ultimately resolves itself, the greedy grab by JPMorgan underlines the risk of dealing with ruthless Wall Street investment banks.

Disclosure: none

Comments

[Augustus:]

You may be correct about the ultimate value of the TMA mortgages. The borrowers are making the payments at moderate rates. Nominal costs of funds should be very low in the short term Fed Funds mkt for a real bank. Very positive carry condition.

However, because JPM has decided to execute on the collateral does not particularly mean that they get to keep the collateral. It gets sold with any positive amounts delivered to TMA. What that really means is that there is a whole lot of similar collateral available and no one wants it.

2008 Mar 06 10:15 AM

[notsosmart:]

the bottom line is "GOD".everybody&ev... is ruthless and the fine small print rules the day.the ethics of the handshake is long gone &if you have been to jail as a crook the only mistake you made was getting caught.but thats soon forgotten.

2008 Mar 06 10:18 AM

[Wez:]

Lol, JPM probably took part in packaging the crap mortgage products that are at the root of this whole problem. They help create a problem and than capitalize on those who suffer from their actions, capitalism at its finest.

2008 Mar 06 05:47 PM

[helplessobs...:]

The same thing often happens often to mortgage borrowers. If a troubled loan has high equity it is one of the first forclosed on to take advantage of the cushion. Loans underwater are just more toxin to infect the lenders balance sheet. All of this ruthless activity will be well remembered when new enterprises rise out of the ashes. Guys like Goldstone will look for every opportunity to get back at JPM.

2008 Mar 06 08:11 PM