David confirmed today that margin requirements in the repo market have doubled -- that removes the cushion from DFR in terms of that unencumbered cash they talked about on the last call.
They do not have a repo refunding to do until the end of August and it will only be on a portion of their repo base but that is the next risk point -- will be interesting to see if they decide not to pay the dividend to conserve cash and increase their cushion of unencumbered cash. Assuming the deal for the management company closes, that might provide another source of liquidity -- or even a value even if the REIT portfolio becomes insolvent.
One interesting aspect, in addition to the potential for the management company to help, is that if the mortgages get wiped out in a margin call (see below on the math), then what happens to the alternatives portfolio? does that disappear too or does that survive. must admit to not knowing.
If DFR does go under, it will be a shame that they didn't react quick enough or didn't take survival seriously enough. Its always best to know the right question to ask -- they said it on the call and I am hoping they meant it -- they are focused on liquidity and will do yield optimization in the future. Right now I am standing pat -- hard to say what the right call is here.
Best way to think about it is would I buy it now if I didn't own it? no way too risky. Why not sell? I like David's comment on real money today -- there are stocks left for dead -- best to ignore those and focus on the walking wounded. To me DFR is in that situation. I won't commit new capital to it but rather than sell it, I will take the chance that they make it because the rewards will be great.
How does this work? If before they borrowed $985 mill to buy $1 bill in agency mortgages, now they can only borrow $970 mill to buy agencies. For AAA prime mortgages the borrowed levels would be $950 mill and now $900 mill. So to own the same level of mortgages going forward that they did at the end of July, they will need an extra $ 50 mill in capital for each $1 bill in AAA mortgages (they owned about $2.3 bill at that time) and an extra $15 mill in capital for each $1 bill in agency (they had around $5.5 bill end July). So as you can see that $229 mill they had then will be encumbered as the repos get refunded over the next couple of months. Will they pay the dividend -- can't know for sure until the money is in the account. if they are able to line up the next repo without any more issues, then yes I think they will.
A smaller cushion means almost any decline in the value of the mortgages and they will have trouble meeting margin calls.
I must admit fixed income trading is not my specialty so I'm somewhat flying blind.
I will lay out some thoughts on the market in the next note.
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