KKR loan sale welcomed; Commerce's Bay exits residential mortgages; Countrywide cut by Merrill

By Sheri Kasprzak

New York, Aug. 15 - Continued woes in the mortgage-lending sector have forced KKR Financial Holdings LLC to sell off $5.1 billion in residential mortgage loans and leave the residential-mortgage business.

Another company getting out of the residential-mortgage game is Bay Finance Co., a subsidiary of Commerce Group Inc.

In other mortgage-related news, Countrywide Financial Corp. was downgraded to sell from buy by Merrill Lynch on Wednesday.

Merrill said Wednesday it made its decision to downgrade based on liquidity concerns in the broader mortgage sector.

"Should a liquidity event occur, for which the likelihood is increasing, Countrywide shares would probably witness further selling pressure," Merrill said in its report.

"That's the case for a lot of mortgage lenders," noted one sell-side trader on Wednesday. "I don't think Countrywide is alone here. But investors are jumpy when it comes to mortgage lenders."

Countrywide stock (NYSE: CFC) was down $3.17, or 12.96%, to $21.29 in trading Wednesday.

Investors should hold KKR

Even on news that KKR was selling off its residential mortgage loans, sell-side traders said investors shouldn't be too eager to sell just yet.

"It's going to be a shock to the system for them," said one sell-side trader. "But really it was probably the best move for them."

"In terms of whether it was a good move or not, I would say it probably doesn't matter," said another sell-side trader. "It was probably the only choice they had. I don't think investors should be too eager to get out just yet but it seems like a lot of folks are selling this morning."

Volume of KKR shares was way up on Wednesday with 17,267,117 shares traded compared with the average 1,262,340 shares.

The stock gave up $4.75, or 31.11%, to close at $10.52 (NYSE: KFN).

REIT generates 75% of income

"As a REIT, at least 75% of the company's gross income had to be generated by real estate assets, which for the company consisted of its investments in residential mortgage assets," said the KKR statement released Wednesday morning.

"In order to meet this requirement, the company sought to limit its exposure to both interest rate risk and credit risk by investing in floating-rate and hybrid-rate assets that were hedged with interest-rate derivatives and by investing in residential mortgage assets with high-credit quality due to the underlying collateral having a weighted average [Fair Isaac Corp.] FICO score of 728 and a weighted average loan-to-value ratio of 71%."

On Wednesday, Lehman Brothers downgraded KKR to equal weight from overweight and Friedman Billings Ramsey downgraded the company to market perform from outperform.

KKR said in a news release Wednesday that, in addition to the sale of residential mortgage assets, it will no longer invest in residential real estate assets and plans to dispose of the remainder of its portfolio through a runoff of the assets through principal payments and prepayments or through a strategic alternative, possibly the sale of its REIT subsidiary.

According to the statement, KKR finances $5.3 billion in residential mortgage-backed securities and has a net equity investment in those facilities totaling $200 million.

San Francisco-based KKR's statement said it may need to record a charge of up to $200 million in the net equity investments in asset-backed liquidity note facilities.

Bay Finance bails out

In other news, Bay Finance, the mortgage-lending arm of Commerce Group, said Wednesday it is getting out of the mortgage-lending business.

The move, said one sell-side trader, is really not that surprising.

"So many of them [mortgage companies] have gotten out of the business this year," he said. "For CGI, it's probably a good move. They can go on with their insurance lines and get out of a business that is not going to do anything but hurt them in the long run."

Commerce Group said it plans to retain the existing loan portfolio, valued at about $20 million, according to a statement.

"Over the last year, we have made a concerted effort to focus our energy and resources on our core property and casualty insurance business," said Gerald Fels, Commerce's chief executive officer, in a news release.

Bay, according to the release, will complete its pending loan applications.

Following the announcement, shares of Commerce were down by 9 cents on Wednesday to close at $29.78 (NYSE: CGI).

BFC drops Levitt merger

News that BFC Financial Corp. is backpedaling on its planned merger with Levitt Corp. sent Levitt's stock down by more than 20% on Wednesday.

After receiving word from BFC that the merger would not be proceeding, Levitt said in a statement that it would move on with its planned rights offering - and BFC will participate.

Fort Lauderdale, Fla.-based Levitt, a builder of planned communities, will offer up to $200 million in stock in the offering to its current shareholders.

Levitt's stock ended the day down 21.07%, or 79 cents, to close at $2.96 (NYSE: LEV). In after-hours trading, the stock gained 2.25 cents.

Thornburg's stock jumps

An optimistic statement from Thornburg Mortgage, Inc.'s chief executive officer helped push the stock back up on Wednesday, a day after the company said it has delayed second-quarter dividend payments.

CEO Larry Goldstone said in a statement that that company expects its mortgage business's profitability to be "far superior to what we've experience over the last several years, as this environment has eliminated substantial market competition from numerous mortgage originators and investors."

Although Goldstone said the company's performance has been good, it is still being impacted by the liquidity crunch being felt elsewhere in the market.

"Unfortunately, we cannot predict when stability and rational behavior will be restored in the mortgage market," Goldstone said. "Our credit quality is among the highest in the industry, our assets among the most liquid of any financial institution, and our client orientation is without parallel in the mortgage industry."

The stock soared by 38.76%, or $2.95, to close at $10.56, gaining another 18 cents in after-hours trading (NYSE: TMA), despite major drops in the broader stock market and despite troubles in the broader mortgage-lending market.

"He's telling everyone what they want to hear," said one sell-side trader. "That's not a bad thing, I don't mean it in a derogatory way but you have to have confident investors."

On Tuesday, Thornburg said it would be moving the payment date of its second-quarter dividends to Sept. 17 from Aug. 15. The move was made because of disruptions in the mortgage market that resulted in the sudden and unprecedented decline in the market prices of its mortgage securities. Particularly, the company has experienced disruptions in its ability to fund its mortgage assets in the commercial paper and asset-backed securities markets.

In the statement released Tuesday, Thornburg said it will have received, by Sept. 17, its scheduled monthly mortgage payments for August.

Thornburg, based in Santa Fe, N.M., is a single-family prime residential mortgage lender.

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