Thornburg's Mortgage Migraine

It seemed like a great idea at the time.

Thornburg Mortgage (NYSE: TMA  ) was one of many mortgage originators dealing with so-called alt-A loans. It loaned money to borrowers with decent credit ratings, but allowed them to avoid fully documenting income and assets when applying for a mortgage

That worked well for a while, as long as interest rates stayed low and home prices marched skyward. But with real estate now taking a breather, and interest rates on ARM loans starting to reset, the reality of Thornburg's lax lending habits is taking its toll.

Check, please
On Thursday, Thornburg announced that it received a margin call -- a demand to repay loans immediately -- which forced the company to fork over an additional $300 million of its $2.9 billion alt-A portfolio. The margin call came after Thornburg's alt-A portfolio declined as much as 15% in just the past two weeks.

Thornburg isn't a stranger to liquidity woes. Last summer, it had to dump $21.9 billion in assets to keep its balance sheet healthy enough to fend off bankers. That raised chatter of possible bankruptcy, sending shares into a precipitous plunge, and presenting one of the first tangible news stories that would end up scaring the pants off the entire mortgage market.

Thornburg was quick to explain the latest declines, telling investors that the drops resulted not from actual losses on the loans, but simply from falling confidence and market demand for such loans. Manaagement also called the drops "not a credit performance issue, but a securities price issue."

That's possible. But digging a little deeper, I find that investors' waning demand for alt-A loans may in fact be well-justified.

The numbers might be the only thing not lying
Last year, the FBI Mortgage Fraud Report discovered that as much as 70% of the borrowers who defaulted soon after their loans were made had falsely stated information on their mortgage applications. Another report by the Mortgage Asset Research Institute found that 60% these loans were made to borrowers who inflated their actual income by at least 50%.

That puts holders of alt-A mortgages in a sticky situation. Since borrowers were able to apply without fully disclosing their true financial health, it's entirely possible that the underlying value of alt-A loans is significantly less than it initially appears. Even though many of these mortgage troughs hold top-notch credit ratings from agencies like Moody's (NYSE: MCO  ) , those ratings may have been granted using less-than-accurate data. The only surefire way to discover lenders' true viability is to wait and see exactly how many homeowners end up defaulting. And you know how much investors hate waiting.

Even worse for Thornburg, its business model focused on originating jumbo loans -- those too big to be sold to government-sponsored titans Freddie Mac (NYSE: FRE  ) and Fannie Mae (NYSE: FNM  ) . Since so much uncertainty remains in the mortgage backed securities market, it's nearly impossible to sell packaged loans to outside investors. Mortgage shops like Thornburg and competitors IndyMac (NYSE: IMB  ) and Countrywide (NYSE: CFC  ) are left holding a bag of investments nobody in their right mind wants, which makes shareholders quiver.

Please, oh please, just reveal yourself
It's hard to tell right now whether alt-A mortgages as a whole will go up in smoke. That's most of the problem. Nobody, including the companies and investors who hold these CDOs, has much of an idea exactly what they contain, or what their future holds. There's so much uncertainty plaguing the market that the de facto choice right now is to wait until the fog clears, making it next to impossible to accurately value many mortgage products.

Unfortunately for Thornburg, waiting's exactly what it'll have to do. During last summer's balance-sheet cleansing, it was forced to raise $500 million via stock sales, and halt a dividend payment, to keep its balance sheet sufficiently liquid. It hasn't yet sold any assets this time around, but with every bit of bad news sending investors deeper into the trenches, Thornburg certainly can't rule out further waves of liquidity pain in the future.

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