Deerfield Capital RMBS sales improve liquidity, but REIT status threatened

By Caroline Salls

Pittsburgh, March 14 - Deerfield Capital Corp. said it now has enough liquidity to support its business following the sale of $1.8 billion of agency residential mortgage-backed securities and $103.2 million of AAA-rated non-agency RMBS, as well as a $2 billion reduction of its net notional amount of interest-rate swaps used to hedge the RMBS portfolio.

However, despite the improved liquidity position, the company said the recent sales could affect both its ability to qualify as a real estate investment trust and to maintain the exemption from registration under the Investment Company Act of 1940.

To qualify as a REIT, Deerfield said at least 75% of the total value of its assets must consist of qualifying assets at the end of each calendar quarter, including real estate assets, cash and cash items and government securities.

As a result of the sales of substantially all of the AAA-rated non-agency RMBS and a large portion of the agency RMBS, the company said it may not be in compliance with this test at the end of the quarter.

To remain qualified as a REIT, the company said it will need to acquire additional qualifying assets or dispose of a significant portion of its non-qualifying assets by March 31, or within 30 days after that date.

If the company fails to qualify as a REIT for the 2008 tax year, it will be subject to regular corporate income tax and it would not qualify as a REIT again until the 2013 tax year.

Deerfield said it is exploring strategies to maintain its REIT status, but it may be forced to explore alternative corporate structures to maximize value for shareholders.

In addition, the company said it is relying on a safe harbor REIT qualification exemption available for companies that have a bona fide intent to qualify but temporarily fail to meet the requirements of their exemption from registration as an investment company.

If the company is unable to restore its assets to compliance within a one-year period, it may be required to register as an investment company or to acquire or dispose of assets to meet the long-term exemption, according to a company news release.

Deerfield said the holders of its series A senior secured notes and series B senior secured notes have agreed to waive REIT qualification covenant compliance requirements included in the notes purchase agreements through March 31, 2009.

According to the release, Deerfield completed the sale and swap reduction transactions between Feb. 15 and March 10 in an effort to increase liquidity, reduce RMBS-associated risk and focus on its asset management business.

The company said it realized $61.3 million in net losses in connection with the transactions.

Also, the company said Gregory H. Sachs has resigned from its board of directors, effective March 10. There are now six members of Deerfield's board.

Deerfield Capital is a Chicago-based REIT with a portfolio composed primarily of fixed income investments, including RMBS and corporate debt.

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