FYI | Aug 15 2007
By Greg Peel
In the US a “jumbo” mortgage is a full-documentation mortgage for a loan amount greater then the limit set on “conforming” loans by the two government sponsored lenders Fannie Mae and Freddie Mac. That limit varies from state to state, but is typically about US$400-600,000. If you want a loan greater than that amount you go to a mortgage lender authorised to provide a jumbo loan and provide full credentials. These are “prime” mortgages.
One such lender, Thornburg Mortgage, saw its shares tumble as much as 46% in last night’s trade. Thornburg was downgraded by Moody’s and Standard & Poors on Monday, and by a raft of stock analysts last night. Thornburg’s problem is not defaults, for according to its CEO defaults number 58 in a portfolio of over 38,000 loans. Thornburg’s problem is that it has leveraged its operation. As a result of the current credit crisis, it is struggling to raise overnight funding.
CNNMoney reported this morning the rationale behind Moody’s move to downgrade the company:
“These rating actions reflect the significant funding and valuation volatility in the single-family mortgage market, coupled with Thornburg Mortgage’s highly levered balance sheet and reliance on short-term financing, as well as an adverse prospective business environment”, said Moody’s analyst Brian Harris in a statement.
“Thornburg is a prime mortgage lender. ‘The credit quality of the REIT’s [Real Estate Investment Trust] mortgages has consistently been excellent, and Moody’s believe that the REIT has maintained its underwriting quality”, Moody’s said.
“However, Thornburg has aggressively used leverage to boost its equity returns, leading to limited financial flexibility”, the ratings agency added. “In addition, the REIT remains exposed to continued margin calls related to its repo financing, which represents 42% of the firm’s debt funding.”
And that, in a nutshell, is the reason why this is not a “subprime crisis” at all but a full blown credit crisis. Subprime defaults were merely the catalyst to the exposure of excessive leverage in the global financial system.
One thing Thornburg has done, however, is mark its loan portfolio to market. It has thus opened its books to the market for all to see, and for all to assess as to the level of damage. The most compelling reason we are currently suffering fear and loathing, volatility and weakness in equity markets is because Thornburg represents the minority when it comes to disclosure. If every institution were to mark to market its distressed securities then the world would be able to see what the damage really is and move on. Until this happens, the market will be susceptible to further sharp down days that seem overblown to many. The credit market needs to J-curve its way back to pricing reality. Then, and only then, can there be confidence that now may be the time to buy.
The Dow fell 207 points or 1.6% last night. It was mostly one-way traffic. The S&P fell 1.8% and the Nasdaq 1.7%.
Thornburg was not the only market driver last night. Early in the day, leading US retailer Wal-Mart lowered its profit forecast, citing weaker economic conditions affecting customers globally. Customers were straining under pressures which include higher oil prices, the company said. Home Depot also announced an expected slide in second half earnings due to the sluggish housing market. Both stocks fell 5%.
This was not the news the market wanted to hear. The bulls are still putting their faith in the strength of the global economy and the resilience of the American consumer.
Another large hedge fund, Sentinel Management, which oversees US$1.6 billion in funds, was the latest to announce a freeze on redemptions last night.
The Dow is now down 6.9% from its high and up 4.5% for 2007. The broad market S&P 500 is down 8.3% from its high and is up only 0.6% for 2007.
In other markets it was a very “red” day, with the exception of oil which rose 1% to US$72.38/bbl. For once, base metal markets decided it was time to sell in unison on credit market and economic uncertainty, and despite reports of reduced inventories. Tin lead the charge in London, falling 7%. Copper and nickel fell 2%. Aluminium 1.6% to its lowest level since January 8. Lead managed to rally in London, but fell heavily again in New York. Copper was also hit heavily in New York.
Gold continued what traders described as lacklustre trading in the face of uncertainty. The US dollar edged up against the euro and pound as US Treasuries were once again sought, but gold barely moved. The precious metal is currently stuck in a no man’s land between potential liquidation from leveraged holders of stocks and other assets and value as a safe haven currency. Most players have moved to the sidelines.
While the US dollar was up against most currencies, it was once again lower against the yen. This implies further carry trade unwinding, borne out by the fact that the Aussie had another bad night, falling to US$0.8347.
Not helping the situation for Australia was the significant down-tick in the spot uranium price yesterday as marked by both Trade Tech and Ux Consulting. The market-watchers announced US$105/lb as the latest traded price, down US$15 and US$5 respectively from last week’s measures, and now down some 22% from the high.
The SPI Overnight fell 77 points.
