Anthracite Capital (AHR) – Part 3 - Outlook

Anthracite Capital’s ratio of exposure to commercial and residential mortgage backed securities was 2:1 in 2003. Since then they have brought down the residential exposure to zero, and diversified within the commercial mortgage asset class. Below is a summary of Anthracite’s percentage investments by asset class over the last five years taken from their annual report:

Year	2007	2006	2005	2004	2003
Commercial Real Estate Securities	49.3	53	49.7	44.6	62.8
Commercial Mortgage Loan Pools	26.9	27	32	36	-
Commercial Real Estate Loans	23.5	11.8	10.6	9.1	4.4
Commercial Real Estate Equity	0.2	2.3	1.3	-	-
Residential Mortgage Backed Security (RMBS)	0.1	5.9	6.4	10.2	32.8

Anthracite investments are well diversified by property type both globally and within the US as detailed in the below tables taken from their annual report:

Property Type	Percentage
Office	32.8
Retail	28.8
Multifamily	22.7
Industrial	7.5
Lodging	6.7
Healthcare	0.7
Other	0.8

Geographic Location	Percentage
California	16.8
New York	12.2
Texas	9.6
Florida	8.6
Other	52.8

Anthracite is trading well below Net Asset Value (NAV) and book Value of $10.87 as indicated in their latest quarterly report. This discount partly reflects the negative sentiment harbored by the market towards companies that have credit exposure and partly the anticipation of margin calls as 21% of the company’s assets are exposed to mark-to-market adjustments and margin calls. Alternative financing in lieu of short-term borrowings can reduce such exposure but in a tight credit environment, such restructurings calls for substantial associated costs. YTD margin calls to May 14, 2008 already stand at $91.7M and that compares to just over $82M for the whole of 2007. This explains the rapid decline in the market value of Anthracite’s assets as a result of the credit crunch. Anthracite responded to margin calls adequately by raising liquidity – issued common and preferred stock resulting in net proceeds close to $100M and renewed certain credit facilities. Although the terms of these deals make it expensive, the company could use some of that cash to fund the purchase of distressed assets, which should provide handsome returns when the credit situation eases.

Outstanding yield, BlackRock’s management expertise, and the discount to NAV make an investment in Anthracite a compelling proposition. However, the risks are very real and because of the 3:1 leverage, one can visualize scenarios where the company’s assets can end up being valued less than its outstanding borrowings thereby making the equity worthless. This risk should be weighed against the positives before making an investment decision on Anthracite. In a diversified portfolio, Anthracite is a fit as a small position in the small-cap portion.

Related Posts:

1. Anthracite Capital (AHR) - Part 1 - Introduction.
2. Anthracite Capital (AHR) - Part 2 - Business Issues.
3. Anthracite Capital (AHR) - Part 3 - Outlook.

Anthracite Capital (AHR) – Part 2 – Business Issues

Anthracite Capital is managed by BlackRock Financial Management Inc – a subsidiary of BlackRock, Inc. (BLK) a publicly traded asset management company with $1.37T in assets. With this structure the company can afford to have NO employees. BlackRock Financial Management provides the operating platform for Anthracite’s CMBS operations as well as the expertise with asset originations and risk management. Investments in mezzanine level debt and preferred-equity is managed through Carbon Capital Funds, a private real-estate debt fund management by BlackRock.

Anthracite’s board of directors has adopted an indebtedness policy that limits the company’s recourse debt-to-equity ratio at 3:1. This is consistent with the financial covenants in the company’s credit facilities and the strategy helps with limiting risk.

Below is a recap of the company’s borrowings by maturity, type, and cost taken from their annual report:

Borrowing Type	Within 30 days	31 to 59 days	60 days to 1 year	1 year to 3 years	3 years to 5 years	over 5 years	Total, Cost
Reverse Repurchase Agreements	$80.12M						$80.12M, 5.44
Credit Facilities			$261.89M	$409.71M			$671.60M, 6.06
Commercial Mortgage Loan Pools		$17.93M	$44.27M	$368.43M	$130.68M	$657.78M	$1.22B, 3.99
CDOs		$16.74M	$16.43M	$149.54M	$548.80M	$1.09B	$1.82B, 6.11
Senior Unsecured Notes						162.50M	$162.50M, 7.59
Senior Convertible Notes						$80M	$80M, 11.75
Junior Unsecured Notes						$73.1M	$73.1M, 6.56
Junior Subordinated Notes						$180.48M	$180.48M, 7.64
Totals	$80.12M	$34.67M	$322.60M	$927.69M	$679.68M	$2.25B	$4.29B, 5.72

* Weighted Average Maturity – 6.5 years.

Below is a summary of the company’s investments by maturity, type, and cost taken from their annual report:

Commercial real estate securities outside CDOs	Estimated Fair Value	Adjusted Purchase Price	Loss Adjusted Yield
Investment Grade CMBS	$149.86M	$158.22M	6.56
Investment Grade REIT Debt	$20.03M	$23M	5.49
CMBS rated BB+ to B	$316.21M	$417.20M	8.71
CMBS rated B- or lower	$144.80M	$166.38M	10.73
CDO Investments	$46.24M	$63.99M	20.56
CMBS Interest Only (IO) securities	$15.92M	$14.73M	8.80
Multifamily Agency Securities	$37.12M	$36.82M	5.37
Sub Total	$730.18M	$880.32M	9.34
Commercial real estate loans and equity outside CDOs
Commercial real estate loans	$618.33M	$601.14M
Commercial mortgage loan pools	$1.24B	$1.24B	4.15
Commercial real estate	$9.35M	$9.35M
Sub Total	$1.87B	$1.85B	4.15
Commercial real estate assets included in CDOs
Investment grade CMBS	$768.67M	$759.52M	7.09
Investment grade REIT debt	$226.06M	$224.61M	5.85
CMBS rated BB+ to B	$466.56M	$486.16M	10.01
CMBS rated B- or lower	$54.34M	$68.69M	14.98
CDO investments	$3.39M	$3.48M	7.79
Credit Tenant Lease	$24.95M	$23.87M	5.66
Commercial Real Estate Loans	$464.46M	$434.36M	8.73
Sub Total	$2B	$2B	8.28
Total	$4.61B*	$4.73B	6.57

* Face Value - $6.53B

Anthracite is exposed to losses resulting from fluctuations in interest rates. Specifically, changes in the level of LIBOR money market rates affect the company’s net interest income – Anthracite’s short-term collaterized liabilities outside of CDOs are floating rate based on a market spread to LIBOR. As the level of LIBOR increases or decreases, Anthracite interest expense moves in the same direction. Below is a look at the company’s quantification of the risk, taken from their annual report:

Change in LIBOR +/- basis points	Projected Change in Earnings Per Share*
-200	$(0.03)
-100	$(0.02)
-50	$(0.01)
Base Case	None
+50	$0.01
+100	$0.02
+200	$0.03

*Their 5/15 quarterly report states a significant change to this with a 50 basis point LIBOR resulting in an adjustment of $0.04.

There are also risks associated with the treasury/credit yield curves/levels:

• When treasuries are priced to a higher yield, Anthracite’s portfolio becomes less valuable and vice-versa.
• Treasury yield curve changes affect Anthracite’s portfolio valuation, as the prepayment assumptions have to be adjusted.
• Anthracite’s portfolio valuation is dependent on the market’s perception of how valuable the company’s assets are as reflected by the credit curve and relation to the treasury yield curve. Specifically, as supply increases, the assets become less valuable as yield needs to increase.

Changes in portfolio valuation affect the company’s ability to borrow. While the interest rate sensitivity is quantifiable as indicated above, the yield curve risks are somewhat less so. Anthracite uses a hedging strategy to limit risks.

There are also a few other risks that can have an impact on Anthracite’s business:

• Credit Risk: This is the exposure to loss from loan defaults. The risk is mitigated by the fact that most of these assets are financed on a non-recourse basis in the company’s CDOs, where a significant portion of the risk of loss is transferred to the CDO bondholders.
• Asset and Liability Management: The risk is associated with the timing and magnitude of the re-pricing and/or maturing of assets and liabilities. The risk is mitigated by matching the term of the liabilities as closely as possible to the holding period of assets. Exact matching is however not possible because different kinds of assets and liabilities react differently to market conditions.
• Currency Risk: Certain of Anthracite’s CMBS and loans are in Euro, British Pounds, Canadian dollars, and other currencies. Fair-values of assets and earnings can both be impacted by currency fluctuations. The risk is mitigated by using local-currency denominated financings and foreign currency forward commitments and swaps.

Related Posts:

1. Anthracite Capital (AHR) - Part 1 - Introduction.
2. Anthracite Capital (AHR) - Part 2 - Business Issues.
3. Anthracite Capital (AHR) - Part 3 - Outlook.

Anthracite Capital (AHR) – Part 1 - Introduction

Anthracite Capital (AHR), is a Real-Estate-Investment Trust (REIT) focused in the Commercial Mortgage area. The REIT structure permits companies to minimize or eliminate corporate taxes and requires them to distribute 90% of their income to shareholders as dividends. The shareholders are taxed for the amount. REIT allows shareholders a more liquid way to participate in the real-estate market, albeit with far less leverage. The invested enterprises may choose to use leverage on their investments, however risk increases as the amount of leverage increases.

REIT primer:

The REIT structure parallels closely the concept of stock mutual funds – similar to allowing investors to own a basket of securities without having to buy each one of them – REIT provides a way to own a basket of real-estate assets without having to actually purchase any real-estate.
REIT structuring varies across countries. In the US, the major requirements to qualify as an REIT are:

• Distribute at least 90% of their taxable income as dividends.
• Dividends, interests, and property rental income should form 95% of income earned.
• At least 75% of income should be derived by rents or mortgage income.
• Cannot be a financial institution or an insurance company.
• Ownership in taxable REIT subsidiaries cannot be more than 20% of assets.

There are also a number of other restrictions that regulates REIT, the primary aim being to limit abuse – without such regulations in place, one could structure personal assets as REIT and gain tax benefits, especially when pooling assets from like-minded individuals.

REIT is classified under three different types:

• Equity REIT: They have ownership interest in real-estate properties. Rents form the primary source of revenue for such REIT.
• Mortgage REIT: They have ownership interest in real-estate property mortgages. Interest earned on the mortgages owned form the primary source of revenue for such REIT.
• Hybrid REIT: They combine the characteristics of an Equity and Mortgage REIT by owning both real-estate properties and mortgages.

There are a number of sub-categories under each of these broad REIT categories. Anthracite Capital (AHR) is a specialized firm focused on investing in high-yield commercial real-estate debt and equity. The company purchases pools of mortgages in the form of Commercial Mortgage Backed Securities (CMBS) and provides strategic capital to commercial real-estate industry in the form of mezzanine loans and purchase of an equity stake. To fund these purchases and to issue mezzanine loans, the company issues equity and/or debt backed by CMBS. As with most REIT, there are a couple of other factors that affect returns of Anthracite Capital’s (AHR) investments:

1. Spread: It represents the difference between the interests paid by the company for debt issued vs the realized returns on investments.
2. Leverage: It represents the ratio of the company’s debt-to-equity.

Below is an overly simplified example of how the use of Leverage can affect total returns:

Spread	Realized Investment Return % (=No Leverage)	Projected Return at 3:1 leverage	Projected Return at 6:1 leverage
2%	6%	12%	18%
0%	6%	6%	6%
-2%	6%	0%	-6%

Related Posts:

1. Anthracite Capital (AHR) - Part 1 - Introduction.
2. Anthracite Capital (AHR) - Part 2 - Business Issues.
3. Anthracite Capital (AHR) - Part 3 - Outlook.