SHartwell

Is Thornburg Mortgage Common Really Worth $3.88B?

Historical 5-year ARM to 5-year treasury spread has been 125 basis points. Today it's 309 basis points. Great for spread business companies.

If you assume the repo portfolio recovers (which everyone is implicitly assuming), the $1.2 billion in new debt can be levered up in a great spread environment. So earnings of $0.09 per share are difficult to reach, but not ludicurous.

This said, I still don't see much upside in TMA from here, particularly with the share overhang.

Is Thornburg Mortgage Common Really Worth $3.88B?

Good analysis, and one with which I generally agree. However, let's be "Pollyanna-ish" for a moment...

TMA earned roughtly $280 million in 2005. This divided by 3.1 billion shares is roughly $0.09 per share. There may be upside to this number, as many of TMA's competitors are gone and spreads have widened. (yes, there is now the interest on the new debt, but if markets recover this is also capital that can be put to good use).

$0.09 times a P/E of 15 is $1.35. Not too far off the current share price. So shareholders are clearly being hugely optimistic (unjustifiably so in my opinion), but they may not be downright delusional...

Haven't We Heard this Market Song Before?

Hardnosed: Unfortunatly, common shareholders have been placed in "checkmate".

If you vote "no", the company files for bankruptcy and - the way the deal docs are written - the new investors walk away with the whole company and common holders get nothing.

If you vote "yes", you get a small slice of the new company.

This was basically a bankruptcy - but much faster, without all the messy paperwork and legal fees, and with a net result that gets the shareholder more than they otherwise would have had.

Don't blame the new investors - they just took advantage of the situation (I'm not one of them, unfortunately). Instead blame the "brilliant" management that tried to finance a long-term obligation (the mortgages) with short-term funding (the repo) and got caught with their shorts down.

So the only reason to vote "no" here is because you're mad (justifiably, in my view) and you're willing to forgoe that last $1.20 per share to express your frustration.

Haven't We Heard this Market Song Before?

Sorry folks, this deal is done. The reason JPM renegotiated the Bear deal is because they messed up the original documents. Unless you find a similar mistake the the TMA documents there's nothing you can do about it (and even then you'd have to foot the bill for a lawsuit).

So the choices are to vote for the share increase, in which case the shares are worth the diluted amount (around $1 by my very rough estimates) or vote against and have the company declare bankruptcy - in which case you'll get zilch.

In bankruptcy you'll get nothing because of the clever way the docs have been structured. TMA has an unrealized loss of around $1.5 billion on its repo position (hence the current book value of 8 cents per share, pro forma).

The hope is that the repo position recovers in the coming year - in which case the diluted common will have a book value of around $0.55 (by my rough calcs). But if you don't vote for the new shares, the deal has all the repo recovery going to the new bond investors - and hence you're right back to 8 cents (at best) - before the costs of bankruptcy.

Bear was in a similar postion. The market value of their $30 billion mortgage book collapsed, and on a mark-to-market basis their book value of $80 rapidly approached zero. Had the Fed not stepped in, they would have declared bankruptcy. The Fed bought the book at a knock-down price (hence Ben's comments today that they might make money on the deal). While it hasn't been disclosed, I suspect that post this transaction Bear's book value wasn't far off the $10 price. Another reason for bumping it from $2.

Had the Fed (or somebody else) stepped in and bought TMA's mortgage book at a similar price, the company would have been bankrupt and the common would have been worth zero. And the new buyer would have received the potential upside of the prices returning to reality.

The way this deal is structured, you've got a shot at some of the upside, as long as you play ball and vote for the share increase. Hence the shot at a book value of $0.55, with more profits to come after that. So it's not a great deal relative to where the stock used to trade, but it's actually a pretty good alternative to bankruptcy.

As for Cayne's $61 million (and much though I dislike the guy based on what I've read), keep in mind that it was less the 10% of what his shares were worth at their peak last year (6%, actually).

TMA's peak last year was $24. 6% of TMA's peak price of $24 is $1.44 - which is about where we are now on TMA and surprisingly close to the discount Cayne got.

Whether he should have ever been paid the shares in the first place is a different discussion...

Will Thornburg's New Scheme Avert Bankruptcy?

Sorry, but in my opinion your current shares of TMA aren't worth much.

According to the press release, current shareholders will own a scant 5.5% of the new company's common (post the issue of around 1.5 billion new shares at $0.01 per share).

So even if the company goes back to its "old" value of $14.00 per share, the value of YOUR stock is $14.00 * 0.055 = $0.77 per share. And this is if everything goes absolutely great.

In light of this I'm very curious as to why people are presently paying $1.45 per share. I just can't do the math to get there...

If Thornburg Gets Its Funding, I'll Take Preferred Over Equity

First, given the no news and approaching deadline, the likelihood of bankruptcy has risen substantially today (in my view). This makes me very leery of the prefs.

I think owning the common at this price is nuts.

Even if the deal goes through, the common will (again in my view) get killed. There are 172 million shares outstanding. The new noteholders get warrants equal to 90% of the common shares. This means 1.548 billion (that's BILLION) new shares at $0.01 each.

Post this issue, and assuming that the balance sheet recovers to end-07 levels (there's currently a $1.5 billion hole on the repos), this still leaves a book value on the common of $0.55. So even assuming the deal goes through, your still paying nearly 3 times a "I hope it gets back there" book value.

Finally, IF the deal goes through, what's the first thing a warrant holder is going to do? Short the common to lock in the profit! (They can't legally do this before the deal.) With warrents equaling 9x the number of ordinary shares outstanding, i don't want to stand in front of that train.

Thornburg's a Huge Bargain After Monday's Crash

TMA is getting margin calls because the market price of their holdings has been hit - hard. In setting these prices, the market might be stupid. Indeed, with the defalut rate on the mortgages themselves as low as it is, the indication is that the market IS stupid (or that either the default rates will soar). The buyers of TMA are all clearly betting that the market will eventually realize that the default assumptions presently implied by Alt-A pricing are way too pessimistic.

But this isn't the whole story. The main risk TMA investors are isn't whether or not the market is valuing the Alf-A loans correctly. Instead, it's whether the lenders will force TMA to sell these loans at the currently depressed prices due to the company's inability to meet the margin calls. If this happens, the money is lost - even if Alt-A prices do eventually recover.

In rough terms, TMA has $2.0 billion in equity. $825 million is preferred, leaving $1.175 in common equity. If TMA is forced to get out of its $11.5 billion reverse repos at a 10% loss, you're wiped out. This might not happen, but there's a huge risk that it does - even if the prices at which the Alt-A assets are liquidated are "stupid".

So Jack, you might only care about the DEFAULT rate, but the investor who benefits from that low default rate may well be the hedge fund who picks up the asset at a fire-sale price when TMA is forced to sell (as opposed to you).

And to those "if they can't make it" investors: Yes, TMA has a great portfolio of loans. But their huge leverage and asset/liability mismatch make this company effectively the classic "short puts" investment. 10 out of 11 years, shorting puts looks like a great return strategy. In the 11th year you get completely wiped out. This could well be TMA's 11th year.