Thornburg reports second-quarter earnings of $412.3 million while downgrades present new challenges

By Jennifer Lanning Drey

Portland, Ore., Aug. 26 - Thornburg Mortgage, Inc. reported a profitable but tumultuous period since the close of the first quarter as earnings were impacted by a series of gains and losses related to one-time items, while ratings downgrades caused an impasse between Thornburg and the parties to the override agreement with its repurchase agreement lenders, chief executive officer Larry Goldstone said Tuesday.

"At every turn, we find new challenges, but we continue to make good progress," Goldstone said during the company's second-quarter earnings conference call.

Thornburg reported second-quarter net income of $412.3 million, compared with net income of $83.4 million in the second quarter of 2007.

The current-year results included a $536.9 million fair-value gain related to the principal participation agreement entered into in connection with the company's March 31 senior subordinated note transaction and additional warrant liability. They also included a $209.6 million loss on further impairment of the company's mortgage-backed securities portfolio that was partially offset by a $14.3 million net gain on the sale of adjustable-rate mortgage assets and real estate owned.

Additionally, Thornburg reported a $24.9 million fair-value gain in the second quarter related to its senior subordinated notes and a $23.0 million gain on the extinguishment of the company's remaining asset-backed commercial paper debt.

"If we strip all of that away - eliminate all that - the company is still profitable on a core basis. I do think that represents somewhat of a minor positive when it's all said and done," Goldstone said.

Adjusted income after eliminating the impact of the items was $22.7 million for the quarter ended June 30.

"We think we've got a myriad of ideas and strategies to pursue over the next six months to continue to further stabilize, diversify and solidify our financing platform. We think as we succeed there, that we are going to come out of this process not unscathed, but definitely with a return to profitability," Goldstone said.

Downgrades create new challenges

Following the close of the second quarter, Thornburg was presented with new challenges as Fitch Ratings began to take significant actions on ratings of all classes of mortgage securities, Goldstone said.

While Thornburg isn't worried about the downgrades as they relate to credit performance, the downgrades have caused the company and the lenders party to the override agreement with its repurchase agreement lenders to reach an impasse regarding interpretation of the document with respect to handling haircut changes, price changes and margin calls in the context of the downgraded securities, Goldstone said.

"In the context of negotiating the override agreement, nobody anticipated this massive amount of credit downgrades, so I think everybody has been taken a little bit by surprise here," he said.

So far, Fitch has led the way with the downgrades; however, Goldstone said he expects Standard & Poor's and Moody's Investors Service won't be far behind.

Negotiating final resolution

The parties have currently reached a compromise under which Thornburg used funds in its liquidity fund to pay margin calls of $219.0 million on Thursday. The payment amount is based on the company's interpretation of the agreement and may be less than the counterparties to the override agreement's interpretation.

As of Friday, Thornburg has identified additional downgrades in the portfolio that would result in similar margin calls of $25.9 million.

Goldstone said Thornburg is optimistic that it will come to a resolution on the matter, but the company noted in its earnings release that it had no assurances it would reach a resolution or avoid further margin calls exceeding the balance in its liquidity fund.

One of the primary issues being negotiated is whether margin calls can exceed the $350 million liquidity fund, which Thornburg believes is the limit.

All parties have agreed to negotiate in good faith, Goldstone said.

"I believe there is likely to be a resolution of this issue, and I believe longer term, the company does have other strategies and prospects for resolving its repo financing issue. We just need some time in order to effect these strategies," Goldstone said.

Still looking to restart loan origination

Also during Tuesday's call, Goldstone noted that Thornburg has not been able to complete securitization as planned and, accordingly, has not been able to restart its loan origination effort, although the company is working on strategies to make it happen.

"Our plan now is to effect a sale of the loans that are on the warehouse line. We believe that we are going to be successful in selling our loans and, in fact, we believe that will get done in the third quarter."

Exchange offer appears successful

Goldstone also said during the call that Thornburg believes it will successfully complete the exchange offer and consent solicitation for all of its outstanding preferred stock, although some previously tendered shares have been untendered as a result of extensions.

Thornburg has extended the deadline on the exchange offer to Sept. 3.

As previously reported, Thornburg must successfully complete the exchange offer by Sept. 30 in order to eliminate the principal participation agreement entered into in connection with its March 31 senior subordinated note transaction and to reduce the annual interest rate on its senior subordinated notes to 12% from 18%.

The tender will also eliminate questions surrounding the company's continuing real estate investment trust status.

"Everything that we do seems to take more time and is far more complex than we anticipate it's going to be because our circumstances are somewhat precarious, to put it mildly," Goldstone said.

Thornburg is a Santa Fe, N.M., lender specializing in jumbo mortgages.

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