Trading in REIT stocks Impacted by Liquidity Concerns

Tumultuous days of trading in the REITs are a result of the liquidity panic in residential loans, replaced by hopeful buying today in response to the Federal Reserve's discount rate cut to 5.75% from 6.25%. Investors know that this Federal Reserve rate reduction adds liquidity to the market, enticing borrowers to the Fed's discount window to access capital to take advantage of market opportunities.

We think additional government response to the funding panic should be expected next week. Now that foreign banks are feeling the crisis, central bank administrators in all nations are crying out for assistance. Investment banks are also feeling the impact of the funding crisis. We expect the Bush administration to respond with some proposals to calm the markets. We note that the Federal Home Loan Banks provide a potential source of liquidity for the mortgage market, with over-funded balance sheets authorized, but not traditionally used, to invest in mortgage backed securities.

Still, even as liquidity returns to the market, there has been permanent adjustment to the Financial Mortgage REIT sector, with mortgage originators, previously the most stable of these REITs, driven to financial ruin by inability to fund their loans in the repo market.

Bankruptcy liquidation is in process for American Home Mortgage, HomeBanc Corp., and NewCentury Financial. Late filings of 10-Q reports for 2Q 2007 were announced by Hanover Capital, Impac Mortgage, and Opteum. Thornburg Mortgage delayed payment of the dividend for 3Q 2007. NovaStar Financial expects to terminate REIT status at the end of 2007 and will pay the 3Q 2007 dividend with a preferred security. Anworth Mortgage is concerned over margin calls for its Belvedere Trust subsidiary. Even Redwood Trust, with its exposure to jumbo loans in California, has seen deteriorating profitability.

A few of these Financial Mortgage REIT originators will weather the storm to gain market share and investor appreciation. We view Thornburg Mortgage as clearly a survivor, with the highest credit quality of any of the Financial Mortgage REITs. Redwood Trust also has enough capital to survive. NovaStar Financial and Anworth Mortgage are likely to steer through these times with enough capital and sufficient portfolio depth to maintain liquidity on lower origination volume.

As the average REIT is now down (18%) for 3Q 2007, with Financial Mortage REITs down (50%), and Financial Commercial REITs down (30%), we think the tape has seen enough destruction for now.