Executives
Larry Goldstone – President & CEO
Clarence Simmons - CFO
Analysts
Stephen Laws – Deutsche Bank
Paul Miller – Friedman Billings Ramsey
Shelley Bergman – Morgan Stanley
Ravi Chopra – [Samlan]
Elliott Katz – Stifel Nicolaus
Omotayo Okusanya – UBS
Matthew Dundon – Miller Tabak Roberts Securities
Michael Hussey – Mid-Continent Capital
Jay Lustig – Equibond, Inc.
Kevin Stark – CRT Capital
Robert Clutterbuck - The Clutterbuck Firm
John Wagner – Camden Asset Management
Jeff Tudas – Summit Wealth Advisors
Unidentified Analyst
Jim Wallette – TBT Securities
Thornburg Mortgage, Inc. (TMA) Q1 2008 Earnings Call June 12, 2008 10:00 AM ET
Operator
Welcome to the Thornburg Mortgage earnings conference call. (Operator Instructions)
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 in or contemplated by the forward-looking statements due to a number of factors, including general economic conditions, interests rates, the availability of ARM securities and loans for acquisitions and other risk factors outlined in the company’s SEC reports and Annual Report on Form 10-K.
With that being said I would now like to turn the conference over to your host, Mr. Larry Goldstone; please go ahead sir.
Larry Goldstone
Good morning everyone and I’m also joined here by Clarence Simmons, our Chief Financial Officer who is going to help with some of the Q&A certainly as we move through this earnings call.
I guess we are certainly pleased to be able to issue this earnings release. We have been working very hard and very diligently to complete our financial statements for the first quarter. It has been an extraordinarily difficult and arduous and complicated process to get to this point and in fact, for those of you who that have seen the release you’ll note that we have not even attached a balance sheet or an income statement to this release because we have not completed those formal financial statements but we hope to be filing the 10-Q early sometime next week and obviously we will have a full set of financial statements in that 10-Q. But we felt that it was important to at least get as much news into the marketplace as we could, as soon as we could and this is the earliest opportunity that we’ve been able to provide this communication.
So we appreciate your participation this morning. So obviously a substantial loss; $3.3 billion. I’m not sure substantial is quite the right word, but $3.3 billion loss in the first quarter. I’m not so sure that I would call that necessarily an operating loss. I think that there were a number of factors that are non-recurring in nature and are accounting-driven more then anything else I would say that led to us posting a $3.3 billion loss.
The single biggest item in the first quarter is the fact that we recorded through income an unrealized fair market value loss on our mortgage securities portfolio and our securitized ARM loan portfolio in the amount of a little over $1.5 billion. That is an unrealized fair market value adjustment and we are required to run that through the income statement in this quarter and we were required to do the same, or we did the same in the fourth quarter because the company continues to have a going concern issue which is an accounting determination, it is not an operating determination, but it is an accounting determination with respect to our ability to hold these assets to maturity and because we cannot demonstrate a definitive ability to hold these assets to maturity, we are required to market them to market and run that market value adjustment through the income statement. So that generated a $1.5 billion fair market value loss.
The second largest item which is also accounting-related, and which has been principally responsible for the delay in our ability to release our earnings and in our ability to file our 10-Q, is the accounting for the senior subordinated note transaction that we closed on March 31st. It is an extremely complicated transaction because the issue has multiple instruments that were offered to those investors and not all of those instruments are necessarily going to be affective going forward and so consequently there are different combinations of outcomes that are possible depending upon how future events were to occur. And we had to fair value all of those individual component parts as of March 31st, which was particularly complicated by the fact that it was the last day of the quarter and so consequently when you fair value things you’re looking for market level pricing information but this transaction was barely even in the market, that is not even necessarily digested by the market and so this process has been very, very complex. And there is no definitive accounting literature or precedent that would have helped us through this process.
All said and done though, we determined that on March 31st, or we estimate that on March 31st the fair market value of the transaction was $950 million, or $949 million greater then the actual proceeds that we received from the transaction and so consequently we had to mark that $949 million fair market value difference as a loss from an income perspective and a reduction in our equity account. That loss is principally determined by two components. We determined on a probability weighted basis that the senior subordinated notes, just the notes—the debt instrument, excluding the warrants, excluding the Principal Participation Agreement, that the debt instrument alone had a fair market value loss of $428 million. And then we had to fair value all of the components of the warrants and this was particularly complicated as well because we had initial warrants, we have escrow warrants, and then we have contingent warrants and so all of those had to be fair market valued.
In addition we had to fair market value the Principal Participation Agreement which is an agreement whereby the senior subordinated note holders will be able to collect all of the principal pay-downs and the terminal fair market value of our mortgage-backed securities portfolio currently being funded in the reverse repurchase agreement market in the event that we do not successfully increase the number of authorized shares and we do not successfully complete the tender offer for the preferred stock. Obviously that is a probability-weighted calculation as well and so we determined that on a probability-weighted basis the fair value loss attributable to the warrants and the Principal Participation Agreement was $520 million.
We will be detailing the fine points of that transaction in the 10-Q. There are multiple line items that will be added to our balance sheet and to our income statement that will breakout the various component parts of the accounting for this transaction but the bottom line sum total is the fact that we are recording a $949 million fair market value loss, again an unrealized loss, as of March 31st attributable to the issuance in the senior subordinated secured notes.
The third principal item in this earnings release is the fact that during the first quarter we also sold $4.3 billion worth of our assets as the company received margin calls in excess of its available liquidity and therefore found it necessary to reduce the size of its reserve repurchase agreement borrowings through the sale of assets. And we realized a $651 million loss on the sale of $4.3 billion of our purchased ARM assets or our mortgage-backed securities. Additionally and the fourth item would be an additional unrealized loss of $126 million that was related to us entering into some permanent debt financing transactions whereby we took some of our own created mortgage securities and issued them into the market in the form of additional collateralized mortgage debt. But before we could issue those we had to fair market value them and so there’s an additional $126 million fair market value loss on that.
All told, that accounts for the lion’s share of the loss realized in the quarter. I think the next item to bring to your attention is the fact that the credit quality in the portfolio and this is kind of the disappointing part of this whole series of events, the credit quality in our portfolio continues to perform extremely well. We have seen a contingent modest increase in our 60-plus day delinquent loans, but losses on our loan portfolio continue to be very small—actual realized losses, continue to be real small, very low on our mortgage loan portfolio, and we don’t anticipate that our losses are going to get significantly out-of-hand certainly relative to our expectations and what used to be our old reserves levels.
I should also note however, that in the context of some of these unrealized fair market value adjustments that we’ve taken in the quarter many of those are in the form of impairments. Some of those impairments are going to replace what used to be our credit reserve and so effectively in the quarter we reversed all of our credit reserves and then we fair market valued those mortgage assets in the context of an impairment charge and the net of those two is the impairment charge or fair market value adjustment going forward and given that we believe we now have a $500 million fair market value impairment charge that is well in excess of any reserve requirement, so we don’t anticipate we’ll be taking any reserves on a going forward basis.
Our mortgage securities portfolio continues to perform extraordinary well also. I believe that we had one security that was technically or was actually down-graded in the first quarter with a carrying value of about $5 million and we had 18 additional securities in the second quarter that were down-graded with a carrying value of about $80 million. Interestingly enough as we evaluate the credit enhancement structures, the credit enhancement level, we do not believe that we have any material risk of actual principal loss as a result of credit losses in those securities but what we are seeing or observing is that the credit rating agencies are getting more stringent and are changing even their historical guidelines for how they historically have rated old and existing securities in the marketplace.
But nonetheless on balance our credit quality continues to be extraordinary and consequently I think that suggests that many of these unrealized fair market value charges, which by the way now total $2.2 billion, are going to be very likely realized over the coming years as we accrete some of those impairment charges back into income and recapture that as part of our capital base going forward.
A couple of other issues, we want to talk a little bit about the origination business. We were seeing some very, very good rebuilding of our loan origination business as we got through the fourth quarter and got into the first quarter of this year. We were seeing sequential month-over-month increases in our loan fundings and sequential month-over-month increases in our locked pipeline, all of which came to a screeching halt once we got to the latter part of February and we were unable to resume loan originations and loan fundings until we got past our recapitalization plan and then we had to go back to our warehouse lenders and renegotiate warehouse lines of credit. But we were successful in accomplishing that in the April/May timeframe. Today we have $400 million of committed warehouse capacity. Those are six month facilities which we believe could be extended for another six months once we get to the end of the first six-month term. And with that $400 million of warehouse capacity we then began funding our locked pipeline that had been pending funding and all told we funded in the—sorry, since the end of the first quarter $239 million worth of loans.
Those loans are now set to be securitized. We’ve been working with the rating agencies and once we get our 10-Q filed we anticipate the possibility of being in the market with a securitization transaction. We have got some preliminary indications that this transaction will in effect get done and maybe even more optimistically we believe that we have seen mortgage spreads beginning to tighten in this second quarter; prices for mortgage securities improving and anecdotally I guess also what we notice is that there seems to be a lot of mortgage paper for sale in the market but not a whole lot of good quality mortgage paper for sale in the market and we happen to be a seller of good mortgage quality mortgage paper and so consequently we may get some preferential treatment, may get, some preferential treatment in the market once we are out there.
Once we get the securitization completed which we hope will be done by the end of this month, but may carry into July, we then hope to begin pricing our new loan products and figuring out which loan products we’re going to offer and hopefully begin to start locking new loans and taking new loan applications and that will be another step in the process of restarting our loan origination business.
We also want to talk a little bit about what we need to focus on going forward; obviously today is the Annual Shareholder Meeting. There is a very significant and important shareholder vote that is going to be completed today in addition to electing three Directors, we are asking our shareholders to approve an increase in our authorized number of shares from 500 million shares to 4 billion shares and in addition we’re asking our common shareholders to vote to modify the terms our four series of outstanding preferred stock. So we will be announcing the results of that vote towards the end of business today. That is a significant condition that we need to satisfy in order to allow us to ultimately terminate this Principal Participation Agreement which is instrumental in allowing the company to return to normalized operations.
The second hurdle that we need to get over with respect to allowing us to terminate the Principal Participation Agreement is the successful tender of our preferred stock. There are currently two issues that we are dealing with right this minute. One of them is that in order to begin to market the tender offer for the preferred stock, we need to file an S-4 with the SEC; that is a long form filing that will require up to 30 days of SEC review and potentially another couple of weeks after that for the company to process those comments and have an effective S-4 registration statement. That document will then allow us to announce and launch the tender offer and begin to market that tender offer and I believe we need to leave that offer open for at least 22 business days.
Right now we’re looking at probably an end-of-August earliest date for being able to successfully complete the tender offer. However for those of you who have been following the company you might also note that in the original senior subordinated note transaction there was a deadline imposed upon the successful completion of the tender offer, that being June 30th. And so the second thing that we are in the process of doing is we are in the process of working with the participants in the escrow agreement where the tender offer funds are currently being held, to get an extension of that escrow agreement from June 30th to September 30th to give us sufficient and ample time to complete the tender offer.
Once that is done we will then terminate the Principal Participation Agreement and at the same time the interest rate on the senior subordinated notes will revert back to 12% retroactive to March 31 of this year as opposed to what it could be which would be 18% if we don’t get over that issue. That’s where our attention is going to be focused. That S-4 filing cannot take place, the common stock resale prospectus for the warrants and the common stock that have already been issued, cannot be filed, a securitization cannot be completed and the resale prospectus for the senior subordinated notes cannot be filed until we get our 10-Q on file with the SEC. So completing the 10-Q, which we hope will be done as I said early next week, is a significant item that we have to get behind us and on the heels of that, will follow a whole series of filings that will then allow us to move to the next phase of this business as we try to navigate through this market environment.
I believe that that pretty much covers everything—well no, I guess I want to make one more comment. I will note that we have at the end of March, $31 billion in assets. We have an interest rate environment and a cost of funds that is very favorable. We are funding our repo book at LIBOR plus 35 basis points. We are funding our collateralized mortgage debt with a substantial amount of floating rate debt that is probably averaging LIBOR plus 25 basis points. The yield curve is positively sloped. We have seen a dramatic decline in short-term interest rates. We have eliminated virtually all of our interest rate hedging transactions and so consequently we do stand to benefit and do believe that we could be profitable at some point over the balance of this year, absent all of these one-time and non-recurring types of events.
The operating environment, while difficult from a portfolio financing perspective, is actually about as favorable as we’ve seen it in a long time from a yield curve and an interest rate perspective. And so consequently we do have some degree of optimism about where we might be able to go in the future here given the ability to continue to operate and deal with some of our financing and accounting issues.
I think that will conclude my remarks and I would be happy to open it up for questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Stephen Laws – Deutsche Bank
Stephen Laws – Deutsche Bank
In the press release it talks of fees totaling $70 million paid for committed lines and the termination of certain reverse repurchase agreements, can you maybe break that out between the two and is that $70 million a one-time in expenses or are the fees on the committed lines going to continue?
Larry Goldstone
The $70 million is a one-time fee. If you’ll recall from the third and fourth quarter earnings releases we had indicated that we had entered into some committed repo lines in order to ensure that we have financing over the end of the third quarter and over the fourth quarter. And those were typically four to six month repo agreements and so part of that $70 million is the expensing of the up-front commitment fee that we paid for those facilities. And I believe they were in the neighborhood of $2 billion or so.
We also had a variety of structured repo transactions which were long-term transactions where there were some interest rate features that were advantageous in certain environments and not so advantageous in others and we were required by our repo lenders to pair those off and terminate them and there was a fair market value loss associated with that. But I think the—we’ll break them out in the Q. I don’t think we know what the numbers are today.
Stephen Laws – Deutsche Bank
That’s fine, I’m just trying to get to—if I’m looking at projecting what net interest income is going forward that’s a $70 million I should not include in the expense side.
Clarence Simmons
Right, you should back that out.
Larry Goldstone
Maybe to offer one additional hint though or some guidance as you think about projecting interest expense is the warrants that we issued to the override lenders and then the contingent warrants that we may issue to the override lenders will be accounted for as “a commitment fee” is that the right way to think about it Clarence? Or as a discount on the repo financing and so the fair value of that will need to be amortized into—as a component of interest expense as we think about interest expense going forward.
Operator
Your next question comes from the line of Paul Miller – Friedman Billings Ramsey
Paul Miller – Friedman Billings Ramsey
On the escrow agreement where you are trying to get an extension, what’s the timeline on this if there’s one in—and also do you need to get 100% vote on this or 100% agreement by the shareholders?
Larry Goldstone
We do need 100% agreement from everybody that’s a participant in the escrow agreement and we need to get that done by June 30th.
Paul Miller – Friedman Billings Ramsey
On the business opportunities, we have the seen the yield curve has flattened out slightly over the past few weeks, are you seeing any changes with respect to margins on new loans?
Larry Goldstone
Well we’re not really originating any new loans right this minute. I think that the sequence of events with respect to us getting back into the loan origination business on an active way is as follows. The first we needed to do was get the warehouse lines in place, then what we did is we funded all of the previously locked and committed loans that were in our pipeline. That’s what the $249 million is that we referenced in the press release. Then we need to get those securitized and issued into the market and financed in a securitization transaction. That will then give us some market information and market intelligence about just exactly where our financing rates can be which will then drive what our mortgage rates are going to be and so my expectation is that its going to be July before we start originating new loans, making new locks and taking new loan applications.
Operator
Your next question comes from the line of Shelley Bergman – Morgan Stanley
Shelley Bergman – Morgan Stanley
Myself and my clients, they’re a pretty sizable position in a couple of the preferreds, why is an owner of the preferred, given the [inaudible] of nature, would even think about tendering it at $5.00 as share?
Larry Goldstone
Well it’s actually $5.00 a share plus roughly 3.5 shares of common stock. If the preferreds do not tender their shares and the tender offer is not successful, then this Principal Participation Agreement that I referenced earlier is going to remain in effect because it is in effect today. And what that means is that the participants of that agreement which are all of the senior subordinated secured note holders, are going to have the right to collect 100% of all of the principal cash flows on all of our mortgage-backed securities portfolio until the year 2015, after which they will be entitled to sell the remaining collateral and they will be entitled to the proceeds from that sale. Those payments will not be used to pay down the senior notes, $305 million of senior notes; they will not be used to pay down the $1.150 billion of senior subordinated notes; they won’t be used to pay down the $240 million of sub-notes; and so consequently it is very likely that the preferred shareholders will have nothing at the end of the transaction.
Shelley Bergman – Morgan Stanley
But the transaction cannot go through unless we approve it, correct?
Larry Goldstone
No, the transaction is a done transaction. It is simply a question of whether the company will have the ability to use its mortgage payments to operate the business and grow shareholder value and grow its origination franchise going forward or if it will be required to turn over all of those principal payments to the senior subordinated secured note holders in which case essentially the preferred shareholders are going to see absolutely no value.
Clarence Simmons
And also pay an additional 6% interest on the notes.
Larry Goldstone
That’s right; the notes will also collect 18% interest as opposed to 12% which is about $70 million in additional cash flow.
Shelley Bergman – Morgan Stanley
And did I hear you need a 66% vote?
Larry Goldstone
Well there are two issues, we need a 66 2/3% vote from each of the series of preferred stock holders plus a 66 2/3% vote from all of our common and common equivalent voters which includes the series F preferred shareholders in order to modify the terms of the preferreds. And so the term modification includes elimination of the cumulative feature; elimination of the right to have all cumulative dividends paid before we can pay dividends to common; elimination of any voting rights; elimination of our ability to issue senior preferreds; and there are a whole other series of modifications as well. So effectively if 66 2/3% of each class plus our common shareholders vote to modify the terms, then effectively the preferred shareholders are going to have a piece of paper that’s going to have virtually no rights and no cash flow at all.
Shelley Bergman – Morgan Stanley
But I’m getting back to the other scenario.
Larry Goldstone
But that does not get the tender successful. The tender is only successful if 90% of the preferred shareholders tender. So there are two issues that we have to accomplish with respect to that vote.
Shelley Bergman – Morgan Stanley
Now as a preferred holder and an outsider looking in, given the fact that we have an instrument that is cumulative in nature, senior to the common holders, where did the $5.00 number come from?
Larry Goldstone
The $5.00 number was—do I even remember where the $5.00 number came from?
Shelley Bergman – Morgan Stanley
Because I don’t ever think I’ve ever seen in my years on the street, a $25.00 par being called in at $5.00.
Larry Goldstone
Well effectively the preferred stock is worth nothing. If you look at the cumulative—if you figure that the company just lost $3 billion--
Shelley Bergman – Morgan Stanley
That’s today. You’re going to be an ongoing concern.
Larry Goldstone
We would not be an ongoing concern without the tender and we would not have been a going concern without the $1.350 billion senior subordinated note transaction. We would have been a liquidity entity and the preferred shareholders would have got nothing.
Shelley Bergman – Morgan Stanley
Do you think that in the liquidated entity, the preferred shareholders would have ended up with nothing? I understand the common shareholders would have ended up with nothing but you’re from the school that the preferred shareholders would have ended up with nothing. So you think this deal for the preferred shareholders is a fantastic deal?
Larry Goldstone
I think it is—I didn’t say it was a fantastic deal, but I said that it is a transaction that preserves more value then would otherwise have been preserved had we not entered into the transaction and been pursuing it this way. That is correct.
Shelley Bergman – Morgan Stanley
Have you got any pushback from any of the preferred shareholders that they feel that the price is inadequate?
Larry Goldstone
There has been of course some pushback from some but I don’t think that anybody—none of our shareholders preferred or common, have had the benefit of today’s earnings release and they have not had the benefit of reading our 10-Q which they’re going to be able to read hopefully next week and so consequently I don’t think anybody really understands just exactly how far the fair value of our mortgage securities portfolio has fallen in the face of this market environment. Now we’re talking about a company that reported $550 million of excess liquidity at the end of December, that has incurred market value losses, realized or unrealized, of $2.2 billion in the three months between December 31st and March 31st.
Shelley Bergman – Morgan Stanley
Sure but you feel good about the paper you’re holding that we all know its mark-to-market.
Larry Goldstone
It doesn’t matter. Our repo lenders would have liquidated all of that paper at a $2.2 billion market value loss. And somebody else would have been able to hold it. And so everybody would have been wiped out which is why we did not pursue a bankruptcy and which is why we did not pursue or why there were no other alternatives from an asset-sale perspective or a liquidation perspective to get us to where we are today. So I assure you, we would not be here today had it not been for this transaction and I do believe that this gives the preferred shareholders a significant opportunity to recover a lot of value and in fact, my recollection is that the $25.00 par value is not exactly where most of the preferreds have been trading. They were trading in the $10.00 range for quite some time and in fact they were trading in the $2.00 to $3.00 range in February and March. And so consequently there are a lot of preferred shareholders out there who are actually going to have a mark-to-market gain upon execution of this tender.
Shelley Bergman – Morgan Stanley
Well I guess we’ll find that out after we see how effective this is.
Operator
Your next question comes from the line of Ravi Chopra – [Samlan]
Ravi Chopra – [Samlan]
What’s the implication for Thornburg if you don’t receive an extension on the escrow from 100% of the senior sub-investors?
Larry Goldstone
Well effectively it’s less money for the tender, so we’ll return the monies that don’t extend, we’ll return those monies. We’ll have less money for the tender and in fact if there are not enough monies, then we won’t be able to affect the tender.
Ravi Chopra – [Samlan]
In an 8-K in April you put out some slides that had an estimated pro forma balance sheet, you had made some estimations for the balance sheet as of March 24th, I was hoping you could just compare what the actuals ended up being as of the end of March based on your press release today versus what you had estimated back then in terms of the unrealized and realized losses in the portfolio?
Larry Goldstone
I actually think they were pretty close. I think the unrealized market value loss was $1.5 billion and that’s actually what we’ve ended up reporting. I believe that we were unclear about the realized loss on the sale of the $4.3 billion in assets at that time and so I don’t know whether we made any estimates with regard to that. I think our balance sheet forecast was pretty close. The difference being the fact that on March 24th I believe that we still had $700 million worth of borrowings with Merrill Lynch which according to the terms of the override agreement needed to be paid off by May 16th and so those borrowings were on the books as of March 31st at a reduced number because we were liquidating or selling that position out and I think we were estimating about $5.5 billion in repo proceeds and my sense is that’s going to be pretty close to where we’re going to get on an actual basis at the end of June.
So the long and the short of it is I think it was a reasonable approximation, or reasonably accurate estimation of where we ended up being.
Clarence Simmons
I think there was about a 3.7% decline in the value of our ARM that’s between the 24th and March 31st just as a result of market spread movements and our valuation of the assets at that time.
Ravi Chopra – [Samlan]
Okay and does that have any implication in terms of financing of assets?
Larry Goldstone
No.
Operator
Your next question comes from the line of Elliott Katz – Stifel Nicolaus
Elliott Katz – Stifel Nicolaus
Just to clarify the actual official tender for the $5.00 of share for the preferreds has not gotten underway yet, is that right?
Larry Goldstone
That is correct. In order for that to begin, the company has to file a 10-Q and then it has to file an S-4 with the SEC. That has to be reviewed and then it has to be completed and it has to go effective and then the tender offer will commence.
Elliott Katz – Stifel Nicolaus
And that looks like the end of June?
Larry Goldstone
No, that’s probably not going to be until the end of July.
Operator
Your next question comes from the line of Omotayo Okusanya - UBS
Omotayo Okusanya – UBS
Just going back to some of the commentary you made earlier that hopefully the company can become profitable sometime in the back half of 2008, when you kind of think about that scenario, what basis assumptions are you making that will get you back into a profitable state?
Larry Goldstone
Well I think you’ve got probably a 5 ¾% to 6% coupon on our portfolio. You’ve got somewhere in the neighborhood of $2 billion of accretable discounts which is being carried on the books today in the form of an impairment charge but that is going to be realized in income as a yield adjustment going forward. So that’s going to be realized over the next four or five years, whatever the average life is. Plus you’ve got a funding cost that’s going to be LIBOR plus 35 on the repo book and maybe LIBOR plus 20 or 25 on the floating rate portion of our collateralized mortgage debt. And so consequently you’ve got a pretty decent interest margin between the effective yield on the portfolio and the company’s cost of funds.
It’s a little bit challenging right this minute to talk about just exactly what that might mean because you’ve also got some additional expenses related to the amortization of the warrants against our cost of funds, and some other adjustments but the long and the short of it is, on a GAAP basis, the company will be profitable and on a cash flow basis and on a taxable basis, the company will be profitable as well.
Operator
Your next question comes from the line of Matthew Dundon – Miller Tabak Roberts Securities
Matthew Dundon – Miller Tabak Roberts Securities
So my principal question had to do with the disclosed 2Q08 origination activities which you largely clarified as working through your—some pre-crisis pipeline, is that correct?
Larry Goldstone
That’s right.
Matthew Dundon – Miller Tabak Roberts Securities
What is the state of your offices and your sales network? Have you had layoffs? Is there anything in abeyance or are people ready to step up and start to work at origination as soon as you feel that you have the legal and funding regime in the correct order for that?
Larry Goldstone
We are ready to go. We have not had any layoffs within the organization. The staff is fully intact. I would say as a general rule probably one of the significant challenges that we’ve had to deal with, I mean there have been many challenges, but one of the significant challenges that we’ve had to deal with is the employee morale around a financing environment and the mortgage environment and an earnings release like this one, in terms of keeping people believing that there is a potential opportunity down the road. But I think we’ve done a good job at trying to maintain employee morale. We’ve put a number of programs in place intended to try to retain our talented employees and everyone is here and I think everyone is very, very anxious to get moving forward and we are fully capable of proceeding once we get a few of these other sort of financing issues out of the way.
Matthew Dundon – Miller Tabak Roberts Securities
What is your sense as to your sales and introducing channel? Have the people who bring you new loans been going to other people in the meantime? Have your competitors sort of not been out there too so there’s still plenty of opportunity for you when you—in other words when you get back in, are you expecting people to be picking up the phone and calling you? What are your thoughts there?
Larry Goldstone
Well I think realistically it would not be reasonable to say that everybody is going to be there for us but I think that maybe a little broader commentary on the mortgage market in general as we see it. Particularly in this super jumbo segment of the market which is where we operate, I would define the mortgage market in the super jumbo space as a highly dysfunctional and highly fragmented market. We kind of have a couple of different worlds out there. Number one you’ve got community and to some extent regional banks who are fairly active in the lending business and they are doing loans for their retail customers and they are funding them with deposit liabilities and federal home loan bank advances. So that part of the market to some extent seems to be working fairly well however anecdotally what I hear is the process for a borrower to get underwriting approval is a long-term, arduous process maybe taking 60 to 90 days to get a loan approved.
For the mass market lenders they seem to be pretty much out of the market other then for retail customers. And if you think about our business or the way we think about our business, our sales force so-to-speak, is our correspondent and mortgage broker or wholesale network. Many, many lenders have shut down their correspondent and wholesale sourcing channels and are only making loans directly to retail customers. And so we believe that there is a substantial niche out there that we are fully capable of taking advantage of because we’ve already got the systems and the infrastructure in place to lock loans, underwrite loans, due diligence loans, fund loans, warehouse loans, and securitize loans. So we think we’ve got a fairly good opportunity out there that is going to meet a big chunk of the market, maybe as much as 60% of the market that is being underserved today.
The last point I’ll make is that as we look at mortgage loan pricing in the jumbo and super jumbo space, I don’t think in my career I’ve ever seen a less efficient, more dysfunctional set of pricing; everything from a 5.5% to 6% interest rate to an 8% to 10% interest rate, depending upon who you go to. So there is no real market out there today and so we’re pretty optimistic about getting out there but obviously you’ve got to get there and we need to be out there to be able to comment more definitively.
Operator
Your next question comes from the line of Michael Hussey – Mid-Continent Capital
Michael Hussey – Mid-Continent Capital
Earlier in response to a question about the preferreds, you said that if the term modification goes through then the preferreds essentially will be worthless so that the—with no cash flow at all so that the tender should be attractive to the preferred holders.
Larry Goldstone
Yes.
Michael Hussey – Mid-Continent Capital
Well no cash flow at all, I’m not sure if that’s right. They may not be entitled to their cumulative dividends, but you just said that you expect to be profitable on a GAAP and cash flow basis.
Larry Goldstone
Yes but we’re not obligated to pay any dividends. The profitability of the company would be greatly diminished if the tender offer is not successful.
Michael Hussey – Mid-Continent Capital
No I follow that but what I’m saying is that you’re not obligated to pay any dividends but certainly you’re obligated to pay dividends to your preferred holders before paying any dividends to your common holders.
Larry Goldstone
That is correct. We could always give up our REIT status.
Michael Hussey – Mid-Continent Capital
That’s true as well.
Operator
Your next question comes from the line of Jay Lustig – Equibond, Inc.
Jay Lustig – Equibond, Inc.
Not to beat a dead horse with this preferred but—and its obvious that we try to do—you are trying to do some sort of reorganization outside of the bankruptcy proceeding, and its commendable, what I’d like to do is get my hands around this Principal Participation Agreement, what I’m most concerned with is that you’re asking the preferred holders and my clients have a very large amount of series F preferred, you’re asking us to make a decision stripping us of our rights without providing us with adequate information and then there’s no guarantee that you’re going to do the tender anyway. There’s nothing set in stone. You’re not binded by it.
We had an obligation that you were going to pay this preferred at a certain rate and at a certain par and you were unable to honor that commitment. So here we’re being asked, without a 10-Q to vote on whether or not we should allow you to strip the series F preferred of their rights. It’s unbelievable. The watchword for SEC monitored votes is disclosure, disclosure, disclosure. And if you are struggling with how to value some of these new fangled punitive type of financing agreements, how do you expect the average investor to make a decision when they have zero data? Other than this press release, we have zero data. I mean you had total equity of $1.759 billion going into this quarter, you then raise with the amazing chutzpah you raised additional money via preferred and then that was dead on arrival so who knows how much more preferred you have.
So let’s say you’re somewhere north of $2 billion before you had this $3.3 billion write-down of which a lot of it is, hey okay we’ll mark this thing down to $1.5 billion, we’ll say that the new financing cost us another $950 in write-downs. So a lot of this is we’re pulling numbers that are arbitrary. And you’re asking the average investor to try to figure out what do we do with this piece of paper. I don’t think that’s right. What I’d like to find out rather then beat a dead horse in that arena, is I’d like to get more clarity on this Principal Participation Agreement. Now you mentioned you had close to a $31 billion portfolio. It is my understanding that this Principal Participation Agreement does not cover all $31 billion; there’s a certain percentage.
So I’d kind of like to know what portfolio we’re really talking about. Where is it being marked down presently? What’s the likelihood of principal payments? And then when you do make a principal payment that is going to be glommed by the owners of this Principal Participation Agreement, how is that treated from accounting standpoint? Is it a deduction, an income tax deduction? An income deduction for the company? Is it ordinary income or principal payment for the recipient of that money? Maybe you can run us through exactly how that Principal Participation Agreement works and what it all encompasses.
Larry Goldstone
I guess maybe the place to start is in terms of the assets that are addressed by the Principal Participation Agreement. We have roughly $8 billion of original face, or current face of mortgage-backed securities that are being financed in the reverse repurchase agreement market. We have written those securities down by a total of $2.2 billion to their fair market value and I will suggest to you that that is not an arbitrary mark, that is a mark that is based upon a pricing service that has been reviewed by our auditors and accountants and it is an agreed upon level one or level two or level three pricing methodology depending upon how we classify it. But I think the majority of our assets—well do we go to level three because the market is—level two and level three.
So this is not an arbitrary number. This has got some foundation or some grounding in where mortgage securities trade in the marketplace today. So that $8 billion of current principal that probably has a carrying value of roughly $6 billion is the subject of the assets that are part of or identified by the Principal Participation Agreement. So right now all of those assets are being financed in the reverse repurchase agreement market. They are subject to the override agreement where five of our reverse repurchase agreement lenders are financing that collateral for us until March 16th of 2009, at which time the override agreement will expire. In that interim period of time we are paying 100% of the monthly principal pay-downs plus 20% of the interest pay-downs to reduce that outstanding borrowing amount and that is a contractual condition of the override agreement with those lenders.
That’s amounting to about $100 million or so of cash flow a month. If the Principal Participation Agreement is effective, meaning that the tender offer is not successfully completed, then beginning with all principal payments in April of 2009, and until March of 2015, all of the principal payments that are received on those assets, that $8 billion universe today which are primarily AAA-rated and we think are primarily money-good, are going to be—those principal payments are going to be paid to the participants in the Principal Participation Agreement. And so the company will not have the benefit of being able to reinvest any cash flow that’s coming off of those instruments on a going forward basis and so consequently there will be no improvement in profitability as a result of that and secondarily, the fair market value loss is going to be captured by those principal participation participants as opposed to common shareholders.
Now the rest of the portfolio which is about $22 billion is all financed with collateralized mortgage debt. Those are all structured financed transactions where we have deposited our loans into a trust and we have issued mortgage-backed securities against them. Those mortgage-backed securities that we’ve issued against them are accounted for as a financing so they are on our balance sheet and in those structures the way that they work is 100% of the principal cash flows are directed to the AAA-rated classes first until they are paid down to let’s just say a diminimous amount. And so there is not principal cash flow being generate today net to the company on those obligations. All of that principal is being used to pay down the senior classes of those mortgage securities transactions and that’s part of the way the credit enhancement structure works.
It’s an accelerated pay-down structure that gets the AAA’s paid off more quickly and it build credit enhancement over time. The subordinate classes of all of those securities are owned by us and they are held as part of our securitized ARM loan portfolio and those are being held by the reverse repurchase agreement lenders as part of the override agreement and so ultimately those principal cash flows are going to be diverted to the Principal Participation Agreement participants as well. And so there will be no principal payments made to anybody other than the Principal Participation Agreement in any future period unless we are able to terminate the PPA.
Now just to go a step further here, if the Principal Participation Agreement—I mean there are lots of potential outcomes that can then come about. Why would a repo lender continue to finance the company’s repo book if in fact the Principal Participation Agreement is in effect? We believe that there are potentially some tax sale issues that are going to result of the fact that all of the principal payments are going to be directed to the PPA and so consequently we may lose our REIT status, we may have a tax sale of the all the assets; I think that there are a number of potential and very negative and adverse outcomes that arise out of the fact that the tender offer does not complete.
Finally, none of those Principal Participation Agreement payments are going to be used to reduce any of the unsecured debt of the company. And so consequently the preferred stockholders at the end of the day are going to be left with a company in 2015, if we can make it that far, that has no assets and will have $305—actually it will have roughly $2 billion in debt senior to the preferred stockholders with no assets and no cash flow.
Jay Lustig – Equibond, Inc.
When you say no cash flow, what about the net interest income, which was by the way if back out all your non-recurring stuff you had about $30 million last quarter?
Larry Goldstone
Well the senior notes have about a $24 million annual interest expense. The senior subordinated notes are going to have $180 million annual interest expense. The subordinated notes have roughly a $70 million annual interest expense. And so consequently there’s going to be very little--
Jay Lustig – Equibond, Inc.
The bottom line, the 18% that you’re paying for the senior subordinated notes, so what if you would have got a great rate it would have been 8%. So you’re paying a 10% type of—it’s costing you $100 million for that money in addition to cutting a deal with them to give you the hammer over preferred because if it wasn’t for this Principal Participation Agreement you wouldn’t have a hammer over the preferreds. In fact, you’re going to be incurring $200 million of more debt to buyback the preferred at $0.20 on the $1.00.
But my question is, on the $8 billion of portfolio that concerns this PPA, of the $8 billion, what is--given the state of refinancings and the market as it stands right now, between 2009 and 2015, of this $8 billion--the write-up doesn’t concern me because they don’t get a percentage of the write-up they get a percentage of the principal payment. So of the $8 billion of portfolio what is a reasonable amount in this environment of which the PPA would generate and then my other question had to do with when they get—let’s just say for an example we pay them $100 million in one year because that’s how much we received in principal on that $8 billion. What is that? Is that an interest deduction? What do we call—how are you treating that on the books? And what is the recipient, when they get that $100 million of principal payment under the PPA, what do they consider that? Is that interest income? What is that?
Larry Goldstone
Well to them I believe its going to be a return of capital and for us we’re not talking about $100 million a year, we’re talking about $100 million a month.
Jay Lustig – Equibond, Inc.
That’s with interest too. The $100 million I thought you said was with interest.
Larry Goldstone
No, that’s just principal.
Jay Lustig – Equibond, Inc.
So you’re trying to tell me that $8 billion has a run off of $1.2 billion a year?
Larry Goldstone
Yes. That is correct.
Jay Lustig – Equibond, Inc.
And that’s the best deal you could have done—you mean giving somebody $1.2 billion a year and what did they pay for this PPA, $100 million, is that the number?
Larry Goldstone
That’s correct.
Jay Lustig – Equibond, Inc.
So they paid $100 million and for that $100 million they’re getting the right to receive $1.2 billion a year. And that was the best deal we could have done?
Larry Goldstone
Only in the—that is the best deal we could have done.
Jay Lustig – Equibond, Inc.
There is no one else who would have given you a deal—they could have done the deal for—why wouldn’t you do some sort of right’s offering to the preferred—everybody would do that deal? I mean—what the PPA does it gives you a hammer over the preferred.
Larry Goldstone
Excuse me, excuse me. We didn’t have time. We had two weeks. We had two weeks and the repo lenders were going to liquidate the portfolio. And then we would have had a $2.2 billion loss and it would have been game over and no assets because all of the assets would have been gone.
Jay Lustig – Equibond, Inc.
Well the good news is now we have $1.1 billion from the senior subordinated preferred—what about the issues, you’re asking people to make a decision without the facts? Why not wait until you have the 10-Q?
Larry Goldstone
We have not solicited our preferred shareholders for a tender offer.
Jay Lustig – Equibond, Inc.
You are asking them to relinquish their rights.
Larry Goldstone
No, I’m not. There are two votes they’re going to be required to change or modify the terms. The common shareholders, according to Maryland law, commons shareholders have to vote on a modification of terms because the rights are basically articles—part of our Articles of Incorporation. And so in order to amend the Articles of Incorporation, we have to get the common shareholders to approve it and then separately the preferred shareholders to approve it. And so when you get your tender offer materials, you’re going to be asked to do two things. You’re going to be asked to vote to change the rights in the terms of your series of preferred that you own, plus you’re going to be asked to tender your shares. And in that document you will have a 10-Q, all the current financial statements, as well as all of the information you need in the form of an S-4 filing. And so we are not asking anybody to make any decisions with information that they do not have.
Jay Lustig – Equibond, Inc.
When the series F and the common vote together, are they treated separate—are they going to be treated separately because its obvious that the common would always vote to do anything to crush the preferred—that’s a no-brainer. I mean of course they would vote. Any common shareholders for any company in the world for any company, would always say, oh yes, let’s screw over the preferred holders. I mean that’s obvious they would vote for it. Is the series F vote going to be combined with the common shares for that third proposal?
Larry Goldstone
There are two votes. There is a vote for common shareholders that includes the series F preferreds who have the right to vote 2.17 shares of common for every share of preferred that they own. So they are voting in the class of common shareholders. So there are roughly 79 million votes that the preferred shareholders have out of a total of about 440 million total votes. So that is the class of all common shareholders which includes the preferreds right to vote as common shareholders. So you are correct; they are a minority in that universe and so consequently they may be deemed disadvantaged or not but they are being asked to vote as common shareholders, not to vote as preferred shareholders in a theoretical sense.
They will then be asked to separately vote as a class. So all of the series F preferred shareholders are going to be asked to vote separately as a sole class and we will need to obtain 66 2/3% of that vote in order to modify the terms.
Jay Lustig – Equibond, Inc.
Alright, well at least the court battle will be interesting.
Operator
Your next question comes from the line of Kevin Stark – CRT Capital
Kevin Stark – CRT Capital
Would you be able to give us some idea of what your shareholders equity would be as of the March 31st 10-Q?
Larry Goldstone
It’s going to be roughly negative $2.1 billion and that includes the preferred. That’s all equity.
Kevin Stark – CRT Capital
I could wait a week to see this but I was wondering if you could just give some broad breakdown of the capital structure right now between repos and floating rate debt?
Larry Goldstone
Well there’s about negative $1.1 billion including the preferred is part of the equity account. And then the repo book is going to be about $6 billion at the end of March and the collateralized mortgage debt is about $22 billion and I believe about $18 billion of that is floating rate.
Kevin Stark – CRT Capital
The way the transaction was set up; do you believe that the PPA would have resulted in a default on for example the 8% senior notes at some point before maturity?
Larry Goldstone
No. It’s not a technical default. I think there is some question, or there could be some question, about whether we would have adequate cash flow to pay off the senior notes at maturity if the PPA were in place. But that’s five years down the road and a lot can happen between now and then.
Kevin Stark – CRT Capital
But in fact you think you would have been able to service the interest payments on that?
Larry Goldstone
Yes.
Kevin Stark – CRT Capital
Now this $950 million reduction to equity because of the transaction, does some of that potentially get reversed if the Principal Participation Agreement is taken out?
Larry Goldstone
No, it’s not going to be driven by the Principal Participation Agreement—well actually there is components of this valuation will change depending upon whether the Principal Participation Agreement is in effect or not but--
Clarence Simmons
The values can change and stuff can move back through earnings because the warrants or the Principal Participation Agreement which we’re calling a derivative financing liability, that’s fair valued and the notes are fair valued and so as there are changes in the fair value—for example if the trigger of that happens its likely that the value of the notes will go up so that would create a fair value adjustment; that would be a loss. To the extent that the common stock would decline in value based on perception in the marketplace or additional dilution that occurs, that would result in a gain. But it’s all based on the fair value of the components of the transaction. The Principal Participation Agreement in and of itself—in general if there’s no trigger that would reduce the value of the package.
Kevin Stark – CRT Capital
So effectively the loss was attributable to the fact that if you took the value of the warrants received along with the subordinated notes, the implied value of those notes was probably something like 300% of face value, is that roughly a fair description?
Clarence Simmons
It’s not that much, it’s about double. And that largely is the result of the common stock price right at April 1st remained relatively high. Because the deal was done at 03/31, in doing the valuation we were not able to use subsequent market activity in the common stock price in order to make the value closer to what its intrinsic value would be. It’s really—it’s a fair value level one, level two market information.
Kevin Stark – CRT Capital
So presumably, as the market takes into account the dilution from the transaction, some of this $950 could be reversed.
Larry Goldstone
Yes. That’s correct.
Kevin Stark – CRT Capital
Now your largest shareholder is set to become the controlling shareholder of one of the largest homebuilders in the United States, have you had any discussions about whether that could provide a source for your origination business?
Larry Goldstone
There have been some preliminary conversations but truthfully I don’t really know what Standard Pacific does for a business. We are a super jumbo mortgage lender. I’ve never known them as a homebuilder to be in the super jumbo home construction segment of the market. But if they are, then there could be some potential synergies there.
Operator
Your next question comes from the line of Robert Clutterbuck - The Clutterbuck Firm
Robert Clutterbuck - The Clutterbuck Firm
Our enormous concern is exactly what’s been exhibited on this phone call, anyone who reads the Participation Agreement knows there’s only two choices; you either get $5.00 plus shares or you get zero. But clearly the institutions are going to get it but we’ve had a lot of experience with retail and retail really doesn’t understand it. How big of a marketing—if you can lay this out, people are going to vote for it, but you’re going to have to get out there and market this thing I believe. Not to get the institutions but to get the retail. We’ve had four calls where people just don’t understand they’re going to get nothing. How active are you going to be in marketing this thing?
Larry Goldstone
Well I think its going to be a substantial effort on our part and we definitely realize the challenge that we’ve got ahead of us. The series Cs and the series Fs have a fairly substantial component of institutional holders many of which are also participants in this new financing transaction. But you’re right, the Cs and the Ds are largely retail and it is going to be a grassroots effort. We have hired a solicitation firm and we are developing marketing materials and we will have websites and we’ll be doing conference calls and we’ll be doing other information dissemination in order to try to capture their attention and I think the other thing is, there’s a pretty interesting arbitrage out there even for retail investors. There’s a fairly substantial arbitrage available to buy the preferred stock, buy additional preferred stock for your existing preferred stock shareholders in the retail system at $4.30 a share, tender it for $5.00 and three shares of common. That’s a pretty nice upside return.
Robert Clutterbuck - The Clutterbuck Firm
Well it’s a [inaudible] arbitrage as long as people get it and don’t think that—don’t’ understand what their alternative is. Again, that’s the only concern otherwise it’s a slam dunk.
Larry Goldstone
I understand it and we are going to spend as much time and effort—I mean look, the whole future of the company rides on this. Regardless of—we’re not happy about the transaction but you know I can go to bed at night and I know that we gave it our all. We turned over every rock. We looked at every possible transaction. I’ve got not qualms with where we ended up because I know what the market environment was like and what the constraints were like in that February and March timeframe and I can assure you, there was no alternative. This is it. And so we are going to spend a lot of effort over the next couple of months, first getting our S-4 effective, and then marketing this preferred tender.
Robert Clutterbuck - The Clutterbuck Firm
Well I’m glad to hear that because that’s what it is, it’s a marketing job at this point.
Larry Goldstone
Yes.
Operator
Your next question comes from the line of John Wagner – Camden Asset Management
John Wagner – Camden Asset Management
Now that you’ve convinced all of us that indeed as preferred holders we should tender, what’s the incentive to grant the extension from the people that hold the other side of this transaction? And could you maybe give us some insight as to what you think the likelihood that you’ll get 100% participation from them and if you get 90%, how is that going to work?
Larry Goldstone
Well I think that our goal is to get 100% consent. We believe that there is a substantial incentive for the escrow participants to extend the escrow agreement for three months. There is—as a going concern and given the opportunity to return to normalized operations, we believe that the escrow participants are going to have substantial upside in their warrants that—because there are warrants—I guess this is what I should say. The escrow agreement holders have currently deposited $200 million in cash in an escrow account that’s earning some money market rate of interest today, pending the completion of the tender.
Upon completion of the tender, they are going to get a 12% note and then they’re going to get warrants equal to the value of their investment comparable to what the initial warrant grant was. And then they’re going to get contingent warrants which is effectively going to give them in the neighborhood of 2.8 billion shares of common stock that they’re going to own at $0.01. And so there is a substantial upside return opportunity for them and the cost is for them to sit in an escrow account at a money market rate of interest for three months.
John Wagner – Camden Asset Management
On the other hand presumably these guys also own the existing notes and if it doesn’t go through then they get all of the—if the tender doesn’t go through then they get the enhanced cash loads off the pole which isn’t the worst thing in the world either.
Larry Goldstone
That’s true but the upside opportunity for—in other words the protection they get from the Principal Participation Agreement plus the notes is probably going to be roughly a return of principal maybe 1.5 times return on their principal investment but they’re likely not going to get their $1.350 billion back at maturity. The alternative is a much bigger return. As a going concern and an operating entity well capitalized, outside of the override agreement, with the ability to reinvest cash flows, this could be a 3x, 4x, 5x times return. And so consequently there is substantial motivation for them to want to continue to see, to play it out. It’s really just a question of $200 million sitting in a money market account for three months to see how it goes.
John Wagner – Camden Asset Management
So you sound like—the rub here pretty much getting the retail participation on the two—the rest of the transaction, why the spread exists, you would say is probably uncertainly over how the two smaller preferred issues vote in this transaction and whether you get 66%?
Larry Goldstone
Yes, I think there’s some uncertainty about that. We know its going to be a challenge but the good news is there is a very attractive arbitrage and so consequently we suspect that there are [arbs] that are buying the preferred today with the expectation of making a very nice return for tender and we suspect that that momentum will pick up once we are allowed to market the transaction and talk about the transaction which can only happen after we have an effective registration statement with the SEC.
John Wagner – Camden Asset Management
I also understand if you get 66% but not 90%, can’t the people in the pool deem it as a successful tender rendering the remaining preferreds pretty much—the people that don’t tender, their share is worthless and the people that did tender get the $5.00. Is that true?
Larry Goldstone
That is true, that is the way the document reads, yes.
Operator
Your next question comes from the line of Jeff Tudas – Summit Wealth Advisors
Jeff Tudas – Summit Wealth Advisors
I had a follow-up to that personnel question that was asked a little bit ago, in the May 13th issue of The Wall Street Journal in the career section, you advertised a number of positions. In looking at that, I took that as a positive and I just want to confirm that, that what you’re saying is you lost no employees up to this point and you’re actually adding on. My second question is it looks like it has to do a lot with firming up your systems, you asked for an SEC reporting manager, tax compliance manager, budget manager, asset and liability manager, and then it says other mid and senior level finance and accounting positions. And I guess my third question is how successful have you been? I realize it’s only June 12th now, so you haven’t had quite a month, but how successful have you been in those efforts?
Larry Goldstone
Well let’s see, you are correct, we are in fact advertising for some mid and senior level folks. The reality is this has been an extraordinarily difficult market environment dating back to August of last year and it has put a lot of stress on a lot of folks around here, particularly in our accounting and our capital markets areas. And there are some individuals within those areas who have indicated either a desire to leave the company and there are some others who have effectively tendered a resignation for some time later this summer. There are no immediate defectors and virtually everybody that is looking to leave the company is giving the company more then ample notice so that we can hire replacements and train replacements.
Additionally we have had historically a couple of positions that were never filled and so consequently we were asking some of our existing staff members to wear two hats instead of one hat, combined with such things as maternity leaves and other things like that that further put some strain on staff. The point is in normal operating circumstances, we were more then adequately staffed. In abnormal and stressful and unusual market environments, this has put a substantial amount of pressure on some of our employees and they’re looking for some lifestyle changes and obviously we’re willing to accommodate them.
But we do believe that we have a significant positive future, that there is a significant opportunity within this organization and we are definitely looking to not only replace those folks, but hire some additional staff as well. Some of them have even agreed to stay for awhile just on a consulting basis so that we don’t have this mass exodus of folks. We’ve definitely got some challenges in the employment and the personnel area and I think we are trying to aggressively address those.
Operator
Your next question comes from the line of Unidentified Analyst
Unidentified Analyst
Could you disclose the average carrying value as a percentage of face of the mortgage securities that you have financed by repurchased debt and secondly of the $2.2 billion of realized and unrealized losses are all of those related to the mortgage securities portfolio or some showing up in other parts of the balance sheet?
Larry Goldstone
I think we’re marked at about $0.80 on the $1.00 and then you’ll be able to figure it out when we file the Q, but that’s pretty close. And then that is only the mortgage—actually it’s two component parts. It’s a little complicated for us but it is the mortgage securities portfolio and on our balance sheet we refer to it as purchased ARM assets, but it also includes a mark on securitized ARM loans which are loans which we originated and securitized. We never issued them in the form of a permanent debt financing transaction, so we carry them on our books as mortgage securities but they’ve never been issued as securities. So from an accounting perspective they are loans and they are financed on the repo lines. Is that complicated enough for you?
Unidentified Analyst
So there’s no mark taken to the CMO?
Larry Goldstone
That’s correct. The [inaudible] is collateralizing debt and the collateralized mortgage debt are not mark-to-market, those are still loans.
Operator
Your next question comes from the line of Jim Wallette – TBT Securities
Jim Wallette – TBT Securities
We have addressed a lot of the preferreds but with regard to the common stock, the dilution and then the possibility of a reverse split, can you comment on that?
Larry Goldstone
Well I think that the first issue is that we need to get a successful vote to increase the authorized shares. That will happen today. And so we’ll know the results of that vote by the end of this afternoon or after the Annual Shareholder Meeting which is going to end no later then 3:00 pm MT today and we’ll make an announcement there. After that I believe that The Board of Directors is set to consider a resolution that would authorize the reverse stock split. We do not need shareholder approval for that. And we are—I’m sure that’s going to still be subject to debate and so The Board is still going to talk about that a little bit, but my sense is that that can be effected fairly quickly after that resolution has passed and we would—I think generally speaking like to pursue a 10 for 1 reverse stock split and get the stock trading back on the New York Stock Exchange.
Jim Wallette – TBT Securities
Okay, with regard to the dilution itself, how much of that impact has already been felt in the price of the common?
Larry Goldstone
Well that’s for you to decide. We’re not quite sure that we understand or have a good view into that.
Operator
Your next question is a follow-up from the line of Matthew Dundon – Miller Tabak Roberts Securities
Matthew Dundon – Miller Tabak Roberts Securities
I think I might have missed the number, could you break down the repo and the non-repo balance sheet estimates? I think you said $6 billion repo as of March 31, but what was the balance of that?
Larry Goldstone
Yes, about $6 billion—let’s just say it’s about $6.5 billion of repo and commercial paper debt and $22.5 billion of collateralized mortgage debt.
Operator
Your final question is a follow-up from the line of Michael Hussey – Mid-Continent Capital
Michael Hussey – Mid-Continent Capital
In terms of dealing with your preferred shareholders, you can simply tell them they have to be wiling to accept a double amputation versus dying of gangrene. But it seems more subtly then that I think you need to be able to explain to the preferred shareholders who might need the explaining, they can understand going along with the term modification, but what happens to them if they decide, well I’ll take a chance on being in that 10% that doesn’t tender? Because it’s sort of a prisoner’s dilemma isn’t it?
Larry Goldstone
Well you know I think that if they choose to be in that category, they’re essentially going to be holding a piece of paper that is not going to ever have a dividend. There’s going to be no cumulative dividend rights. They’re going to have no voting rights. They’re going to be delisted so they’re not going to trade. And so we think that’s really not a particularly good place for an investor to be and the truth of the matter is, that 10% is really a carve-out for sort of a tender offer reality which is there are going to be shares of preferred stock that are going to be buried in somebody’s safe deposit box somewhere or lost certificates or hermits and the unsuspecting who just will never ever know about this preferred stock tender and so they’re not going to be aware of what’s going on.
Michael Hussey – Mid-Continent Capital
I thought of that but you said not going to ever have a dividend, how can that be unless you’re declaring now and forever you’re never going to pay a dividend on your common stock?
Larry Goldstone
One of the modifications of the terms would allow the company to pay a dividend on the common without having to pay dividends on the preferred.
Operator
Gentlemen, there are no further questions in queue at this time.
Larry Goldstone
Well I think you all very much for your time and your good questions. We certainly as management have learned a lot from this conversation and we appreciate your input and your feedback. We obviously stand ready through our Investor Relations department to answer any follow-up questions that any of you have and otherwise I will also remind you the Annual Shareholder Meeting will be webcast today for anyone who wants to listen in. And we will be announcing the vote of the Annual Meeting at the end of business today. So thank you very much and have a great day.
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