Rams hit by rising funding costs

Non-bank lender Rams Home Loans announced yesterday that earnings in the current financial year would be hit by "materially higher spreads" in its funding program.

Market estimates were that Rams would take a 10 to 15 per cent hit to forecast 2008 earnings as a result of its funding problems.

Rams shares were slashed to $1.41 yesterday, reducing the market capitalisation to just under half a billion at $499 million, a far cry from the $2.50 a share and $885 million valuation for the float.
 
The stock opened at a 35 cent or 20 per cent discount to the previous day's close of $1.75, briefly rallying to a day high of $1.58, before being heavily sold to $1.19 as the market digested the morning's ASX funding announcement.
 
Buyers entered the market around lunch and late in the afternoon on massive turnover, providing support from the lows with the day's volume topping 40 million shares, or around 11 per cent of the issued shares.

Rams is unusual among Australian mortgage lenders in that it relies heavily on short-term funding through the US extendible commercial paper market.

That market, a $US140 billion segment of the US$2 trillion commercial paper market, was hit by a liquidity crisis last week.

A distinctive feature of extendible commercial paper is that if the issuer is unable to repay or refinance its notes at maturity (usually 30 days) investors can be obliged to provide liquidity by extending the term, usually up to 180 days.

The Wall Street Journal reported last week that three issuers took advantage of the option to extend their borrowings - a sign that they were not able to issue new paper to replace maturing securities.

The issuers were American Home Mortgage Investment Corp, which has filed for bankruptcy protection, Luminent Mortgage Capital, a property fund with problem mortgage investments, and Aladdin Capital, an asset manager.

Rams chief financial officer Glen Goddard said the company had not invoked provisions to extend its borrowings. He declined to provide details of the higher spreads the company was paying.

He declined to provide any other information about the company's financial arrangements.

Rams has a $14.2 billion loan book, funded by $3.9 billion of warehouse facilities provided by banks, $4.1 billion of residential mortgage backed securities and $6.2 billion in the US extendible CP market.

Most CPs are issued on 30 day terms and are priced against bank bill rates. Rams' prospectus reported that "current average cost of XCP is about 12.5 basis points over the Australian bank bill rate."

A source said yesterday that it would be impossible to say what extra spread Rams was paying. The extendible CP market had shut down and whatever arrangements Rams had made would have been negotiated directly with counterparties.

The source said it would be fair to assume that Rams was paying 10 basis points over its original spread to roll over its paper.

If that estimate can be relied upon Rams faces an earnings outlook about 10 or 15 per cent below the earnings forecast in the prospectus. This is based on a sensitivity analysis in the prospectus that says a one basis point widening of the book-wide funding margin would result in a 1.3 per cent reduction in EBIT.

According to the prospectus Rams will report EBIT of $68.9 million for 2006/07 and $91.1 million in the 2007/08 year.

The current situation is a sharp turnaround from conditions when the prospectus was issued on June 27. At the time the company said: "Overall Rams expects the cost of funding in financial year 2008 to reduce by four basis points compared to financial year 2007."

Credit Suisse issued a report on Rams on August 13 in which it suggested that the company would have to refinance to reduce its exposure to the CP market. It estimated that a switch to higher-cost longer term funding would reduce earnings by 10 to 15 per cent.

The report said spreads for commercial paper had widened by five to 20 basis points. It described Rams as an aggressive user of CP funding, exposing itself to regular re-pricing. This refinancing risk increases as Rams' loan book grows.