Shareholders Bear Brunt of Thornburg’s Pact With Lenders >TMA

Mar.19, 2008 in Market Outlook

Last Update: 3/19/2008 4:54:32 PM

By Aparajita Saha-Bubna
Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)–Wednesday marked the second bailout in a week on Wall
Street as Thornburg Mortgage Inc. (TMA), the beleaguered lender and investor of
home mortgages, sidestepped potential bankruptcy after its creditors agreed to a
ceasefire.

Earlier this week, JPMorgan Chase & Co. (JPM) rescued embattled investment bank
Bear Stearns Cos. (BSC) by agreeing to buy it for $2 a share.

That said, concessions to Thornburg’s lenders - including a proposed $1 billion
offering of securities that morph into shares, suspension of dividends, and
contracts offering Thornburg stock for as little as one cent apiece - come at a
steep cost to its equity investors.

The company’s shares lost about half their value Wednesday, wiping out gains from
a day earlier on the preliminary news of the lending pact, to close down $1.48,
or 49.7%, to $1.50. So far this year, the stock has fallen 83%.

“Common shares will be worth pennies on the dollar as a result of the massive
amount of dilution,” said one investor at a hedge fund who declined to be
identified. “The value of the stock is wiped out.”

As part of the pact - sketchy details of which were first disclosed late Monday
in a filing with the Securities and Exchange Commission - five lenders providing
about $5.8 billion in so-called reverse-repurchase lines of credit agreed to
freeze additional margin calls through March 2009 and lowered demands for their
money back from Thornburg.

Strings Attached

In exchange, one of the many conditions the Santa Fe, N.M., real estate
investment trust has to meet will be to raise within the next seven business days
at least $948 million in capital. It plans to do so with a $1 billion sale of
10-year convertible securities. Under the proposed offering, these convertibles
will pay 12% in interest and morph into shares at a stock price of as low as 75
cents. If this conversion occurs, it will increase the number of Thornburg’s
existing common shares by more than 500%.

Noteholders also get warrants for every $1,000 of principal invested, allowing
them to buy just under 67 shares at one cent each.

In August, the company also sold $500 million of convertibles to bolster its
finances. At the time, the securities paid 10% and could be converted to common
stock at $11.50 per share.

Another investor who declined to be identified said the lending pact was akin to
a “cram-down,” where a company struggling to keep afloat attracts new investors
by introducing a new pecking order, squashing the claims of existing
stakeholders.

“This is because new investors in a company that is virtually insolvent don’t
want to come in on the same terms” as current investors, the source said.

Under the new agreement, Thornburg will give lenders - Bear Stearns, Citigroup
Inc., Credit Suisse Group, Royal Bank of Scotland Group PLC and UBS AG - warrants
allowing them to buy 47 million shares at one cent each. If exercised, this
comprises 27% of the stock outstanding.

The deal “will buy Thornburg one year but at a relatively high cost,” said Sean
Egan, a managing director at independent credit-rating firm Egan-Jones Ratings
Co. in Philadelphia. “On balance, the company is probably better off with this
arrangement than it would have been in filing for bankruptcy protection. It’s a
restructuring out of bankruptcy court.”

Bondholders signaled their approval for the pact, trading Wednesday Thornburg’s
8% notes that mature in 2013 at 67.125 cents on the dollar, up from 50 cents a
day earlier, according to S&P’s Leveraged Commentary & Data.

“After careful consideration of our available options given the continued
challenges in the mortgage securities, the company’s board of directors
determined” the terms of the lending agreement, “though highly dilutive for
existing shareholders, are in the best long-term interest of the company,” said
Larry Goldstone, Thornburg’s chief executive officer, in a prepared statement
Wednesday. “By placing a one-year moratorium on margin calls and raising the
required amount of capital specified in this agreement, we believe we will have
the necessary liquidity and staying power to manage through this highly volatile
and uncertain mortgage market environment.”

Thornburg, for the time being also suspended its dividend. And it agreed to not
tap additional funds in the reverse-repurchase agreement market, where it borrows
short-term funds from investment banks using its mortgage securities as
collateral.

“It’s like Thornburg is back from the grave, but doesn’t have a pulse,” said
analyst Jason Arnold at RBC Capital Markets, who recommends investors sell the
company’s shares.

The company will reduce outstanding borrowings on reverse-repurchase agreements
with two lenders by an additional $1.2 billion. Thornburg will also decrease
borrowings by allowing lenders to keep all monthly principal payments and, as
much as 30% of interest payments stemming from mortgages it has put up as
collateral. The company also agreed to pay down unmet demands from creditors and
set up a $350 million liquidity fund.

Thornburg, which earlier this month cast doubts over its survival, said in its
SEC filing Monday that “there is no assurance” the company will be able to garner
enough funds to meet its obligations, that the value of its assets won’t fall
further or that it will be able to honor the conditions of its lenders, and it
again raised the question of its ability to survive.

A lender of large or jumbo home loans to creditworthy borrowers, Thornburg’s
ability to package these securities to sell to investors has also suffered a
setback as potential buyers of these investments stick to the sidelines amid
fears that the subprime mortgage malaise has spread to the safer reaches of the
market.

Mounting Woes

Thornburg’s problems began at the end of last month when declining prices on
securities backed by Alt-A mortgages - that is, near-prime loans that lack
adequate documentation of income or assets - decreased the value of the
collateral the company was using on its borrowing agreements.

As a result, its lenders demanded back, through margin calls, a portion of their
funds, forcing Thornburg to sell its mortgage securities at a loss.

As margin calls multiplied, the company fell short of meeting its creditors’
requirements.

As of March 12, Thornburg had received default notices from Morgan Stanley & Co.
(MS), Goldman Sachs & Co. (GS), JPMorgan, Natixis Securities N.A. and ING
Financial Markets because it couldn’t satisfy margin calls. These outstanding
margin calls totaled $610 million as of March 6.

Last week, the company restated its 2007 results to show a fourth-quarter loss
instead of a profit, reflecting losses in its securities portfolio that it didn’t
recognize earlier. As a result, the company reported a fourth-quarter loss of
$4.74 a share, instead of the previously reported profit of 33 cents a share.

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