Description

IVR Preferreds

Mortgage REITs as an industry have essentially gone bankrupt.  Dealers have been eager to margin call anything on the credit side, forcing mREIT’s to pony up cash to meet minimum levels.  The only survivors at the end of the day likely will be the pure Agency players: Annaly NLY, Agency AGNC, and Two Harbors TWO. 

TWO managed a book that was 78% Agency, and 22% credit, and managed to sell off their credit portfolio.  They also sold down their Agency book from $27BB to $20BB. They have survived, although a mortgage servicing rights MSR portfolio could prove problematic.  There is a good write up from a few days ago worth reviewing.

My guess is MFA, RWT, and CIM will eventually be toast.  CIM has staved off margin calls, but their whole loan book is large.  There are lots of other stragglers, MITT, Ellington, ARR but they are small in size and lacking in scale.

Among the larger names, that leaves IVR, which appears to be a hybrid REIT that we think can survive.  They are 74% Agency (not far from TWO), and while so far not able to meet margin calls, has some preferreds outstanding that the risk reward looks to be 5:1.  They closed Friday around $4.70 ($25 par).

Total Pfds:

Here are the slides which review each segment in more detail.

End of March Events

March 17.  IVR declares dividend of 50c for common and all preferreds – which would total $95mm in payments.

March 24.  Press release.  IVR suspends all dividends, and announces it cannot fund margin calls.

March 26.  8K. IVR reports that its wholly owned subsidiary (IAS Asset I LLC) has received notices of an event of default.  This related to the company’s Secured Loans on the balance sheet with FHLBI. The company also refers to certain obligations as “guarantor” and that they may owe certain penalties. This facility finances $600mm of Agency RMBS and $1.3BB of commercial credit MBS, most of which is investment grade.

FHLBI is the Federal Home Loan Bank of Indiana, one of 11 regional banks created by Congress.  They are privately financed but essentially Government Sponsored Entities (GSE’s) to help fund banks.

The company has hired FTI Consulting and Alston Bird as counsel.

So, the preferreds have cratered from $25 to $4.70, around 19c on the dollar.

Different from Two Harbors which managed to sell off its credit portfolio and a chunk of its Agency portfolio to fund margin calls, IVR remains in limbo.

However, while there is a chance that there is a zero recovery here, the case for the preferreds ultimately receiving par appears decent.

Generally, REPO’s are secured against specific assets.  It isn’t hard to figure out that that collateral that has margin calls can be sold in a blink.  In fact, in the March 26th 8-K, the company said exactly that. 

Here is the text:

“Since March 23, 2020, the Company and its wholly-owned subsidiary, IAS Asset I LLC (“IAS”), have received notifications from several financing counterparties of alleged events of default under their financing agreements, and of certain of those counterparties’ intentions to accelerate the Company’s and IAS’s performance obligations under the relevant agreements. The Company and IAS have disputed certain of those notices. However, in the event of a default under one or more of those agreements, IAS’s financial and other obligations under such agreements, and in some cases the Company’s obligations as a guarantor, may be accelerated and the counterparties may take ownership of the securities pledged to secure the financing obligations by the Company or IAS. Certain counterparties have informed the Company that they have sold the securities pledged to secure the financing obligations. IAS also may be subject to penalties under those agreements and may suffer cross-default claims from its other lenders. The Company also previously announced that it was engaged in discussions with its financing counterparties with regard to entering into forbearance agreements pursuant to which each counterparty would agree to forbear from exercising its rights and remedies with respect to an event of default under the applicable financing arrangement for an agreed-upon period, but that the Company cannot predict whether its financing counterparties will enter into a forbearance agreement, the timing of any such agreement, or the terms thereof.”  

Most of the margin calls that we have heard about have been related to the non-credit portfolios.  Dealers who REPO bonds to the mortgage REITs, can and do use their own marks to determine if a margin call is warranted. 

Likely, a big chunk of their credit book is already sold and wiped out.

Here is the balance sheet as of year end.

First of all note that there is a meaningful amount of equity in their 2 agency books, $1211 and $478mm. Simple math suggests that this alone should cover the preferreds by 4x. Of course it is more complicated, as a lot of the cash is gone, and parent guarantees have spooked the preferreds and equity.

In the proforma column, we applied proceeds of the February secondary offering. While in theory we understand equity should go up by the net capital raised, we assumed it was used to fund margin calls essentially.

We do know that IVR repaid $300mm of its Secured Loans with “cash on hand and additional REPO” per the 10K.  That happened February 10th shortly after the equity raise.

But to be extremely punitive, we assumed that the company used the cash to buy residential credit.  That today is worthless.

We also assumed that the $300mm of debt paydown happened on the Agency MBS side, with none applied to the Commercial Credit book.  Then assume $300mm more of REPO on the Agency MBS side, essentially levering up that book.

That would ding equity in the Agency book by $300mm, and adding $300mm of equity to the Commercial Credit book.  The residual cash probably did get used to fund margin calls.

Overall, it is hard not to assume that the credit portfolio is net worthless to the parent.  Restricted cash is held by REPO counterparties, so that also likely is gone. There should have been about $85 of NIM generated in Q1, less $12mm of G&A/management costs.  That $97mm of cash disappeared into margin calls in our assumptions.

But net net, the Agency market appears to be functioning, and SHOULD have a proforma book value of at least $1.1BB assuming that $300mm of repayments ended up funding losing money positions at the Commercial Credit side.

Here is our case for the pfds having some coverage, even if cash/credit books are worthless.

I appears here that coverage is over 100% on the prefs. Note the $439mm of parent guarantor claims.

These are potential guarantees from IAS (related again to the Secured FHLBI Loans).

Below we show how we got the $439mm figure.

We took haircuts to that portfolio to see how much incremental senior unsecured claims there might be ahead of the preferreds, assuming it was fully guaranteed by IVR. There is a good chance that guarantees are limited to specific portfolios, which would be hugely beneficial for the prefs.

At 50c on the dollar for the Commercial Credit book, and assuming guarantor claims at the parent ahead of the preferreds, then there could be $439mm of claims ahead of the preferreds. A 50c mark by the way seems hugely conservative, as this book is generally high quality. Anything approaching 80c on the dollar would result in almost zero incremental parent claims.

Finally, note above we also assumed $50mm of fees, which could be penalties related to the Secured Loans, plus legal/restructuring costs.

Admittedly a lot of this is guesswork, but hopefully on the conservative side. The market seems to be pricing in armeggedon.

Conclusion

We think there is at least $1.1BB of proforma book value at the parent at IVR, assuming their cash and credit portfolios are wiped out. 

Then taking out another $439mm of fees/guarantor claims (using 50c on the dollar for asset sale prices), there remains residual value of $686mm.  With $583mm of preferreds notional, there seems a good shot at getting par back. At 19c, there is known downside, but par plus potential.

Admittedly there are a ton of risk and unknowns. The company has not returned multiple calls to them. If IVR can enter into a forbearance agreement to give them time, then they can let the agency cash accumulate to pay down REPO debt, and de-lever. 

It is admittedly hard to see how this plays out.

If this is a going concern, like TWO, we think the company can reverse split the stock, and perhaps raise equity in the future after a few quarters of de-levering.  The prefs get turned back on and post Covid-19 they trade back to $23-25. In this case the A preferreds look more attractive with its fixed coupon.

Chimera suffered in 2008, and eventually did exactly that.  Going concern book probably looks a lot better than our draconian case of $0.63 per share.  The commercial credit book could recover to par, and would boost book value / share by almost $4 alone right there. The stock doesn't look terribly interesting at $1.95.

If this is a liquidation, the preferreds are cumulative, and the Agency book should continue to perform while in wind down.  Rarely do these end up in Chapter 11 as the collateral will just be seized and sold. But with the Fed backstopping Agencies, they should be able to find a liquid rational market there, and at least legal and restructuring costs would not pile up.

Catalyst

Liquidation, or forbearance agreement to work out out financing agreements