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Friday, March 21, 2008

The Cayne Mutiny and the Thornburg Carry

by Tanta on 3/21/2008 08:17:00 AM

This, via Felix via Yves, is funny.

Floyd Norris ruminates on the the Bear business as well as the curious details of the Thornburg Mortgage deal:

The deal negotiated by Thornburg got the banks to promise there would be no more margin calls for a year, by which time, it is hoped, the securities would have regained value. The cost to Thornburg of getting that concession was to give warrants to the banks to buy a lot of stock at a penny a share, and to promise to raise at least $1 billion in cash within days. That cash would provide a margin of safety for the banks even if the mortgage securities market continues to decline.

To borrow that money, Thornburg is offering convertible bonds paying 12 percent annual interest. Add in some extra warrants, and buyers of the bonds will be able to get stock for less than 72 cents a share. If they convert, they will own 86 percent of the company, while the bankers will have an additional 3 percent — for which they will pay 1 cent a share. Existing shareholders will have an 11 percent stake.

If, that is, the bonds sell. On Thursday night, the bond offering was delayed until Monday, a sign that the underwriters may be having trouble rounding up buyers.

Logically, the shares should trade for 50 cents or less if these are the terms Thornburg must pay to borrow, but the price has stayed well above that level. So why did the shares not collapse?

Perhaps shareholders hope to vote the deal down, but that would remove only the conversion privilege from the bonds. Bondholders would still get warrants, and their interest rate would go up to 25 percent. It is hard to explain rationally, but perhaps some buyers heard the company had a plan to stay afloat, and ignored the details.

Thornburg officials would not talk to me, but it is not easy to understand how they expect to make this deal work for very long. Thornburg’s longtime strategy was to borrow at low rates to finance mortgage securities paying higher rates. Now it will pay 12 percent to help support securities paying a much lower rate of interest.
That negative carry trade thingy hurts.