Mortgage REIT Insider: Commercial mREITs Get Clobbered
Shares of commercial mREITs were clobbered on Wednesday, following a string of negative comments about the state of the commercial real estate market. The Federal Reserve’s most recent Beige Book managed the first volley, suggesting that "[c]ommercial real estate conditions varied in April and May, with some Districts reporting that activity had softened. Leasing activity eased in Boston, New York, Philadelphia, Richmond, and San Francisco. Vacancy rates edged higher in Boston, Kansas City, and San Francisco, as well as in pockets of the Richmond and St. Louis Districts." That was followed up by research firm Real Capital Analytics, which reported that U.S. commercial property sales transactions were off nearly 70 percent in the first quarter of 2008 versus a year earlier. Moody’s Investors Service also piled on, noting that "[t]he main issue is a standoff in the CMBS industry. Issuers don't want to make new loans unless they can sell the resulting bonds to investors, but investors don't want to buy bonds until the spreads have settled down. More people are sitting on the sidelines." The comments weighed heavily on the commercial originators on Wednesday, pushing down shares of Arbor Realty Trust (ABR) by 14 percent, American Mortgage Acceptance (AMC) by 23 percent, Gramercy Capital (GKK) by 6.7 percent, and iStar Financial (SFI) by 6.6 percent. With the exception of iStar, all these stocks made new 52-week lows during the week, despite Gramercy’s continuation of its $0.63/share dividend. Agency Agony The other major sector of mortgage REITs, agency mREITs, was also hit hard this week. The latest comments from Fed officials, along with a downgrade of Annaly Capital (NLY) had agency mREITs reeling. Boston Federal Reserve President Eric Rosengren confirmed on Tuesday that the Fed believes "total inflation," not the so-called core rate, is really what monetary policy should focus on targeting over the long-run. Rosengren also expressed concern over continued high commodity prices, noting that "...it seems to be taking quite a long time to date for long-run supply and demand influences to rein in oil price increases." Partly as a result of Rosengren's comments, investors now believe the central bank will leave benchmark rates on hold at their current 2 percent level in the upcoming FOMC meeting. Tough talk on inflation from a string of Fed officials in recent days has even prompted the markets to begin pricing in an eventual rate hike, as early as August. The economic news prompted JP Morgan Chase & Co. (JPM) analyst Andrew Wessel to downgrade Annaly Capital from "overweight" to "neutral," saying the stock is fairly priced given the likelihood of short-term interest rate hikes. Wessel commented in a note to clients that he believes "…a tightening environment could slow or even halt Annaly's recent pace of accretive follow-on offerings." Agency mREITs reacted strongly to the economic data and analyst actions: particularly hard-hit were recent IPOs Hatteras Financial (HTS) and American Capital Agency (AGNC). Both stocks shed more than 10 percent on the week, though the sector as whole recovered somewhat following Capstead Mortgage’s (CMO) late Thursday announcement that it would hike its dividend by 13 percent to $0.59/share. Thornburg’s Testy Tell-All Thornburg Mortgage Inc. (TMA) spent most of Thursday in the confessional, hosting both its first-quarter earnings call and its annual shareholder meeting on the same day. The company expects to post a massive $3.3 billion loss for the first quarter of 2008, of which $2.5 billion was due to valuation adjustments and the accounting for the issuance of stock warrants and its senior subordinated debt. Thornburg admitted that its financial statements were not yet completely finalized, though it expected them to be ready early next week, when it plans to file its first quarter 10-Q with the SEC. The company discussed its $1.35 billion financing transaction in a bit more detail, claiming that the deeply dilutive deal was the best option available to it at the time. CEO Larry Goldstone asserted that "[d]eclaring bankruptcy would likely have resulted in the liquidation of our mortgage securities, and existing shareholders would have received nothing." The assurances didn’t stem the tide of angry preferred shareholders on the earnings call, who hammered Goldstone on the terms of the transaction and the rationale behind the deal. Although Goldstone repeatedly made the point that the preferred shares were worthless if not for the tender offer, one angry investment manager closed his questions by muttering "[a]ll right, well at least the court battle will be interesting." The lone bright spot for Thornburg was its continued excellence in credit metrics. Delinquencies were reported just in 158 of its 36,316 loans, or 0.65 percent of the total loan portfolio. The company originated $548.7 million of loans in the first quarter, but aside from funding its existing pipeline of $239 million in loans, Goldstone admitted that "we're not really originating any new loans right this minute." Credit Suisse Group (CS) analyst Moshe Orenbuch set a 12-month target price of 50 cents on the stock, which he calculates to be a 25 percent premium to the expected book value. "As a result of the additional shares, we now estimate that book value (using principal outstanding) is about 35 cents to 40 cents, compared to our estimate of 60 cents under the initial terms of the note," he wrote in a note to clients. "Common book value would be negative using current market values of the assets." After the bell Wednesday, Thornburg announced that shareholders had approved an amendment to increase the number of authorized shares of capital stock from 500 million to 4 billion shares and to modify the terms of each of the company's existing series of preferred stock to facilitate a planned tender offer for all outstanding shares of preferred stock. Thornburg shares gained a few cents in Thursday’s trade, as a result, with little after-hours activity. Editor’s note: Patrick Harden is a Certified Public Accountant with three years of experience in auditing publicly-traded real estate investment trusts. For the past two years, he has been involved in the mortgage finance industry as a member of the financial reporting group at a publicly-traded mortgage bank. His column covering mortgage REITs runs every Friday. Disclosure: The author was long ABR and CMO, and held no other positions of relevance, when this story when it was originally published. 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