Thornburg counterparties to reduce margin requirements; company to issue $1 billion in new convertibles

By Caroline Salls

Pittsburgh, March 19 - Five of Thornburg Mortgage, Inc.'s remaining reverse repurchase agreement counterparties have agreed to a contractual reduction of the margin requirements for financing the company's mortgage securities and a suspension of their rights to invoke further margin calls, according to a company news release.

Under the 364-day agreement, Thornburg must raise a minimum of $948 million in new capital net proceeds over the next seven days, which the company plans to raise through the issuance of at least $1 billion principal amount of contingently convertible senior subordinated notes due April 1, 2015.

The notes will carry an interest rate of 12% and an initial conversion rate of 1,333.3333 shares per $1,000 of principal amount of the notes, representing an initial conversion price of $0.75 per share.

The company said it will also grant the underwriters an option to purchase an additional $150 million principal amount of the notes. The underwriters for the offering include Friedman Billings Ramsey, UBS Investment Bank, Jefferies & Co., JMP Securities and Keefe, Bruyette & Woods.

In addition to the convertible notes, the company will issue warrants to the noteholders, with each notes purchaser to receive detachable warrants to purchase shares of common stock, exercisable at a price of $0.01 per share.

The warrants will be equal to roughly 5% of the company's then-outstanding equity.

The convertibility of the notes into common stock will be contingent upon shareholder approval of an increase in the authorized capital stock of the company, according to the release. Shareholders will vote at the company's annual meeting, which is scheduled for May 22.

Thornburg said the conversion of the notes could result in the issuance of more than 500% of its currently outstanding common stock.

If the shareholders do not approve the increase, the interest rate payable on the notes will increase to 25%, and the company will be required to issue additional warrants to noteholders.

According to the release, the issuance of the securities and the notes offering would normally require approval of the company's shareholders under the shareholder approval policy of the New York Stock Exchange.

However, the members of the audit committee of Thornburg's board of directors decided that any delay caused by securing shareholder approval before the issuance of the securities "would seriously jeopardize the financial viability of the company."

As a result, the New York Stock Exchange has accepted the company's application for an exception to the policy.

The company said it intends to use a portion of the new capital proceeds to pay reduced but unmet margin calls on reverse repurchase agreements and to auction swap providers of $530 million, plus $28.7 million in deficiency claims and an estimated $30 million of additional claims.

Absent this agreement, Thornburg said it would be obligated to pay an additional $90 million in margin calls and would also be responsible for meeting any additional margin calls that might have occurred as a result of the continued decline in mortgage securities prices since March 5.

Liquidity requirements

In addition to raising the new capital, the agreement also requires the company to establish a $350 million liquidity fund and to maintain in that account 5% of the monthly outstanding borrowings of its reverse repurchase agreement counterparties in investments that are either Treasury securities, agency mortgage-backed securities or retained classes of mortgage securities that arise from the company's loan origination business.

In order to continue to pay down its existing reverse repurchase agreement borrowings, the company has agreed to allow the reverse repurchase agreement counterparties to capture 100% of the monthly principal payments that they receive on the collateral they are holding, plus 20% of the monthly interest.

Thornburg said these funds will be applied to reduce the outstanding balance on these borrowings monthly. The company has also agreed not to borrow any additional funds in the reverse repurchase agreement market during the term of the agreement.

The reverse repurchase agreement counterparties and affiliates who entered the override agreement include Bear Stearns Investment Products Inc., Citigroup Global Markets Ltd., Credit Suisse Securities (USA) LLC, Credit Suisse International, Greenwich Capital Markets Inc., Greenwich Capital Derivatives, Royal Bank of Scotland plc and UBS Securities LLC.

"This is an unprecedented collaboration on the part of the company and its reverse repurchase agreement counterparties," Thornburg president and chief executive officer Larry Goldstone said in the release.

According to the release, Thornburg must further reduce its current reverse repurchase agreement borrowings with two reverse repurchase agreement counterparties by an additional combined $1.2 billion.

The company said it has already reduced one counterparty's balance by at least $500 million, leaving that counterparty with a remaining balance of $1.47 billion, and Thornburg has 60 days to reduce another $680 million of borrowings with a second counterparty.

Thornburg said it plans to achieve these reductions either through asset sales or transfers of collateral.

Once the reductions are complete, the company estimates that the agreement will affect $7.9 billion of outstanding principal amount of mortgage securities with an estimated dealer market value of $6.4 billion as of March 5. The securities are held in the company's portfolio and are collateralizing $5.8 billion in reverse repurchase agreement obligations.

In order to preserve cash, the company has also agreed to suspend its common stock dividend during the term of the agreement, although it can declare a dividend in December 2008, payable in January 2009, of up to 87% of its taxable income for 2008.

In addition, the company will suspend its preferred dividend if the amount in the liquidity reserve falls below 5% of the outstanding balance of the reverse repurchase agreement borrowings for three consecutive months.

In connection with the agreement, the company will also issue warrants to purchase roughly 47 million shares of the company's common stock at an exercise price of $0.01 per share to the agreement parties.

The warrants will be exercisable for a period of five years, and the common stock issuable upon exercise of these warrants would be equal to about 27% of the company's outstanding common stock.

Termination criteria

The counterparties can terminate the override agreement if the company does not pay all of the principal and 20%, or 30% in some circumstances, of the interest payments received for the collateral securing the reverse repurchase, securities lending and auction swap agreements, as well as if the company voluntarily or involuntarily becomes a debtor in a bankruptcy proceeding.

If the company does not fully comply with the reverse repurchase, securities lending and auction swap agreements after the agreement term, the counterparties will again have the right to invoke margin calls and exercise all of their other rights under the reverse repurchase, securities lending and auction swap agreements.

The company has also agreed to not pay any incentive management fees to manager Thornburg Mortgage Advisory Corp. as long as the agreement is in effect.

Instead, the payments will accrue, and the company will remit the cash to its reverse repurchase agreement counterparties as a way to reduce outstanding borrowing amounts.

"After careful consideration of our available options given the continued challenges in the mortgage securities markets, the company's board of directors determined that the override agreement and this proposed capital raise and warrants offerings, though highly dilutive for existing shareholders, are in the best long-term interest of the company," Goldstone said in the release.

"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 is a Santa Fe, N.M.-based mortgage lender specializing in jumbo mortgages.

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