Thornburg up sharply on margin-call news; Michaels moves around; Ainsworth pulls secured notes deal

By Paul Deckelman and Paul A. Harris

New York, March 18 - Thornburg Mortgage Inc.'s bonds jumped on the news that the beleaguered Santa Fe, N.M.-based jumbo mortgage originator's bankers had agreed to a one-year moratorium on margin calls on its short-term, mortgage-backed borrowings. Traders did not see much sector strength in the bonds of such other mortgage providers as Residential Capital LLC and Countrywide Financial Corp. - although E*Trade Financial Corp. scored solid gains.

Michaels Stores' bonds were seen trading actively around at mostly lower levels, coinciding with the announcement by the Irving, Tex.-based specialty retailer that its president and chief financial officer is leaving, as well as the release of quarterly earnings data.

High yield names were generally stronger, in line with a stock market surge following the Federal Reserve's 75 basis points cut in its federal funds target rate. Notable gainers included GMAC LLC as well as Ford Motor Credit Co.

In the primary arena, Ainsworth Lumber Co. Ltd. was heard by high yield syndicate sources to have withdrawn its planned offering of up to $75 million of six-year secured notes.

Market indicators point higher

A trader saw the widely followed CDX index of junk market performance as having jumped 1¾ points on the session Tuesday to 88 bid, 88¼ offered. Meanwhile, the KDP High Yield Daily Index rose 0.32 to end at 72.36, while its yield tightened by 8 basis points to 10.08%.

In the broader market, advancing issues topped decliners by a nearly five-to-four margin. Overall activity, reflected in dollar volumes, zoomed by some 62% from Monday's anemic levels.

Fed cut helps boost market

"What a difference a day makes," a trader marveled, noting the contrast between Tuesday's relatively buoyant session and Monday's soggy one.

The major catalyst behind the generally higher junk market was the 75 bps cut in the Fed's key lending rate, which fell to 2.25%, its lowest level since late 2004. Bonds took their cue from stocks and advanced, even though the cut was smaller than the 100 bps reduction many people in the financial markets wanted to see.

"As that rate cut happened, " a junk trader said, "the equity market gave up about 100 points" in apparent disappointment that the cut wasn't as big as hoped for, "but man, did it change course fast, and [the Dow Jones Industrial Average] ended up 400-odd points." The bellwether equity index in fact finished the day up 420.41 points at 12,392.66.

Treasury bonds, he said "gave back most of their gains on the day, with the 10-year off 1½ points, so you definitely saw some giveback there," while equities rose. "The interesting thing," he continued, "will be what kind of followthrough there will be [Wednesday] - will equities give half of it back, or will we really have a rally that people will be in? Or was it just big short-covering at the end on the equity side? We'll see the overnights [markets]. [Wednesday] morning will be the tell-tale sign."

High yield, he said "was choppy, but I think you had some continued strength across a ton of different sectors - or at least some improvement. Stuff was beaten down so badly last week, I don't know how much of an improvement it really is - more like less of a loss."

Another trader frankly expressed a sense of surprise that the Fed did not go all the way and cut the benchmark rate by 100 bps, the figure that many in the market had been expected. He noted that the central bank's message accompanying the rate cut was unrelenting bad news - inflation has "been elevated," financial markets "are under considerable stress", the outlook for economic activity "has weakened further," while credit and housing are "to weigh on economic growth," and "downside risk to growth to remain."

"Unless I'm missing something, it's all negative, isn't it?" he asked, rhetorically. "So why wouldn't you do a full-point cut?" He noted the sharp reduction of the stock gains immediately following announcement of the smaller cut - but acknowledged by the end of the day, the Dow had bounced back for its 420 point gain.

But the consensus of opinion seemed to be that if the junk market was disappointed, it hid it fairly well, with a number of issues up at least a point or more and market indexes generally pointing higher.

GMAC gets better, Ford Credit also

One of the more notable gainers was GMAC, which has exposure to both the troubled mortgage market, via its ownership of ResCap, and to the sagging domestic automotive market, since its main business is automobile finance. With the prospect that the latest Fed rate cut might help steady those important sectors of the economy, GMAC's bonds were seen up from 2 to 6 points on the session. A trader saw its widely followed 8% bonds due 2031 about 2 points better at 68 bid, 70 offered.

A market source at another desk saw GMAC's 6 7/8% notes due 2011 up by as much as 3 points on the day to just under the 75 bid level, in very active dealings, while the company's 7¼% notes due 2011 jumped more than 6 points on the day to end at 79. Another source saw GMAC's 6 7/8% notes due 2012 up some 3 points on the session at 72 bid.

GM's major rival in automotive finance, Ford Motor Credit - whose bonds were seen down by points on Monday on the heels of bearish comments about the company by a Credit Suisse analyst - seemed on the road to recovery Tuesday. A trader saw Ford Credit's 7.80% notes due 2012 nearly 3 points better at the 81 level, while its 7% notes due 2013 were around a point improved at 74. The company's 5.80% notes due 2009 were better by a point, just below 95.

Thornburg up on margin-call freeze

But the major gainer of the day was Thornburg Mortgage. Those bonds were seen having fallen over the last several sessions, including Monday, from their recent relative highs, but they were back on the upside with a vengeance on Tuesday, encouraged by the news that five of its lenders had agreed to freeze their demands for additional collateral to back its borrowings. That freeze would run for a year, through next March.

The company's 8% notes due 2013 were seen having pushed all the way back above 50 bid, their recent high, on the news. While they initially pulled back from that peak, back to about the 45 mark, by late in the afternoon they had once again risen, with a trader quoting the paper at 51.5 bid, trading with accrued interest.

A trader who saw the notes get up to around 50 bid, 51 offered from around 40 bid said he'd seen "people trading it with [accrued interest] again, instead of trading it flat with due bills" as happened after the company had recently picked up several notices of default on its margin calls. He said the bonds "caught a bid late" to move up to that 50-51 area, and said that it was a case of investors "selling into strength and buying into weakness."

A third said the bonds had gone home Monday at 37 bid, 40 offered, and pushed up to 51 bid, 53 offered Tuesday, while yet another one said the bonds closed at their high point for the day of 52 bid.

One market source, quoting the bonds at 50 bid, 53 offered, said they were "up a decade [10 points.] The [margin-call] freeze is a big positive."

Tuesday's climb was the latest leg of the rollercoaster ride which those bonds, and their investors, have been on for the past three weeks. The bonds had been trading at levels just below 90 as recently as Feb. 27, but began heading south the next day when Thornburg disclosed in its 10-K annual filing with the Securities and Exchange Commission that over the previous two weeks it had received margin calls - demands that it put up additional collateral - on its reverse repurchase agreements, or short-term borrowing instruments secured by mortgage-backed securities. Thornburg explained that the lenders wanted more collateral to compensate for the reduced value of the mortgage securities, which are backed by alt-A mortgages that it wrote for borrowers choosing not to document income and resources. While not considered as risky as subprime mortgages, the alt-As have come under increasing critical scrutiny as the whole credit environment has tightened up since last summer.

Although Thornburg said that it had met those margin calls, totaling $300 million on some $2.9 billion of borrowings, it quickly found itself in a downward spiral, reflected in its falling bond and share prices, after new disclosures in subsequent days of additional margin calls that the company for the most part could not pay, as well as a notice of default from J.P. Morgan Chase on some of the calls.

But after bottoming at 28 bid on March 7, the bonds began moving back up last week on investor sentiment that the selling had been overdone, plus expectations that the Fed and other authorities would continue to ease interest rates and credit conditions, and Thornburg's own statements that it was in talks with its lenders on resolving the margin-call problem and paying everything off. The bonds topped out at 50 in the middle of the week, but then began to slip back down later in the week on news of yet another notice of default, this one from Morgan Stanley. They were being quoted as low as the 37-38 bid area on Monday, before finally going home around 40.

Thornburg's New York Stock Exchange-traded shares, which since the end of February had come down from around the $10 level to as low as 69 cents early in March, jumped on Tuesday in tandem with the bonds, zooming 73 cents, or 32.44%, to $2.98 from Monday's close at $2.25. Volume of 25.1 million shares was over twice the usual turnover.

Thornburg said in its latest regulatory filing late Monday that it had, in fact, received a total of five notices of defaults from its lenders, which triggered cross-default provisions in its other reverse repurchase agreements as well as its secured loan agreements, and it made known the existence of what it termed "an override agreement with five of our remaining reverse repurchase agreement counterparties which freezes additional margin calls through March 2009."

However, the company included the usual regulatory filing boilerplate cautions about being unable to give assurances that it will be able to obtain sufficient liquidity to satisfy its liabilities or that the override agreement might not be terminated by its counterparties and further margin calls issued, and reiterated its previously announced "going concern" warning.

Thornburg has also said that it may sell securities from time to time to repay debt and make capital expenditures.

Other mortgage names mixed

Countrywide Financial's bonds did not go anywhere on Thornburg's good news, with a trader seeing the Calabasas, Calif.-based mortgage lender's 6¼% notes due 2016 "still" at 62 bid, 64 offered, while its 3¼% notes coming due in May were "still" 94 bid, 95 offered. He saw Residential Capital LLC's 6½% notes due 2013 up ½ point at 44 bid, 46 offered. At another desk, ResCap's 8 7/8% notes due 2015 were a point better at 46 bid.

However, E*Trade Financial Corp.'s 7 3/8% notes due 2013 were called up 4 points by a market source at 67.5 bid.

The news that Fremont General Corp. has opted to delay the scheduled interest payment on its 7 7/8% senior notes due 2009 had little impact on the bonds. A trader said they'd last traded on March 6 around the 60 area. While he saw an offering for the bonds at par Tuesday, he said "I don't know if they traded. It's a free-for-all. You pick it [the level at which the bonds might trade]."

Michaels active on personnel news

Elsewhere, a trader noted that Michaels Stores' 10% notes due 2014 were among the most active bonds of the day, pegging them down nearly 2 points at 84 bid.

"A lot of bonds were traded," another said, pegging the bonds at 83.5 bid, 84.5 offered - up from their morning lows around 82 bid, 84 offered but still down from opening levels around 85 bid, 87 offered.

"They were bouncing off their lows, but were definitely down from this morning," he said, also characterizing the company's 11 3/8% subordinated notes due 2016 as "hanging in" around a 76-78 context.

The 10% notes, another trader said, "were off 3 points" at 83.5 bid, 84.5 offered, while the 11 3/8s were "down a couple" at 75.5 bid, 76.5 offered. "They were both down 4 or 5 points, but then rallied back to only end down a point or two."

Michaels announced on Tuesday that its president and CFO, Jeffrey Boyer, will leave the company effective April 4. The company is splitting Boyer's CFO duties between two interim replacements while it seeks a permanent successor.

Michaels also announced fourth-quarter numbers. For the fourth quarter, net income increased by $120 million, primarily due to the absence of merger-related expenses, from a net loss of $67 million in fiscal 2006 to a net income of $53 million in fiscal 2007, even though sales for the period were off 4.4% to $1.301 billion, a decline driven largely by a 3.4% drop in same-store sales - the retailing industry's key metric - as well as a calendar quirk which gave the year-ago period one extra week.

Quiet in the primary

Meanwhile the Tuesday primary market produced no news.

The day ended as it began, with FairPoint Communications Inc. on the road with the only deal now in the market: a $540 million offering of 10-year senior unsecured notes (B3/B+) via Banc of America Securities, Lehman Brothers and Morgan Stanley.

The merger financing deal is expected to price during the post-Easter week.

However sell-side sources told Prospect News that new deals - even drive-by deals - are not out of the question.

One investment banker is looking for some new issue action should the rally in stocks continue for a couple of more days.

Another banker, from a different institution, said that higher quality corporate issuers with near-term liquidity needs may look to jump in with small deals.

Pricing in defaults

One of these syndicate sources seemed just a bit irritated by the dearth of deals now in the market.

"Right now spreads are awesome," the banker insisted.

"Soon we'll be at the point where it won't make mathematical sense not to invest in bonds...unless of course default rates skyrocket."

The official defined a skyrocketing default rate as one above 10%.

"Right now portfolio managers are pricing in default rates of between 4.5% and 5%," the banker said.

A portfolio manager, hearing this, said that the range which the investment banker specified, 4.5% to 5%, seems consistent with recent data from the ratings agencies.

Late last week Standard & Poor's said it expects the U.S. speculative-grade default rate to increase to 4.6% in the next 12 months. For the 12 months to the end of February the rate was 1.02%.

The previous week Moody's Investors Service forecast that defaults would rise to 5.4% by the end of 2008, and set the present rate (to the end of February) at 1.3%.

However the money manager, whose portfolio includes junk bonds, contended that even though default rates remain at near-historic lows, the number of bonds trading at distressed levels telegraphs that the market expects some increase in defaults.

The rest of the story

The money manager went on to assert that regardless of credit quality the high yield market's present lack of liquidity, due in part to the removal of a lot of marginal buyers - the CLOs and CDOs and hedge funds, "which are gone from the scene, or else are much diminished" - have reduced the potential demand for junk.

"Even though nothing bad has happened yet, as far as defaults, when people look at the write-offs in CDOs and SIVs and the banks, it really diminishes the risk appetite," the investor added.

"Also a lot of the banks and financial companies have raised cash by doing convertible preferred deals, which have come with hefty coupons, which are competitive with top tier high yield.

"That has helped to push down the pushout spreads."

Hence, even though defaults are low the market is nervous, the money manager said.

"The high yield market doesn't like risk as much as it did a year ago," the buy-sider added.

"A year ago risk at a spread of 300 [bps] was great. Now risk at 800 [bps] is not what people want."

Bunch of bad choices

The money manager was expecting the Fed's 75 basis points short-term rate cut, on Tuesday.

"You still don't have a positive yield curve, which tells you they're probably going to cut again," the buy-sider commented.

The investor more or less concurs with recent moves to on the part of the central bank: opening up the discount window to a wider variety of collateral, lengthening the term for borrowing at the discount window, and allowing for investment banks, like JP Morgan, to borrow at the window using any kind of investment grade collateral.

The source also has no problem with Tuesday's rate cut.

"If you flood the system with money it always has a stimulative effect, with a little bit of a lag," the investor said.

"The thing is, no matter how low the rate is, it won't solve the problems in the financial sector.

"There the problem is not the cost of funding. The problem is that they are choking on billions upon billions of dollars worth of poor quality loans.

"And they're going to have massive losses."

The investor lamented that the Fed's window of opportunity for addressing the cause of the present mess in the credit markets, by curtailing activity in subprime mortgage lending, has long been closed.

"Now you have a bunch of bad choices," the source said.

"You flood the system with liquidity, no matter what that does to the dollar and inflation. And you have to render extraordinary assistance to financial intermediaries.

"There isn't much of a choice other than the collapse of the financial system."

Prospect News asked the money manager whether any more spectacular failures, such as the one which unfolded last week at Bear Stearns, seem probable.

"Every crisis has a major corporate failure, whether it's Drexel Burnham or WorldCom or Enron," the investor said.

"The financial institutions will continue to absorb very large losses related to mortgages, if housing prices continue to decline, which they likely will.

"That indicates there will be more stress," the investor said, "...maybe a couple of more quarters."

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