In the mortgage industry, no one knows more about balance-sheet management than John M. Robbins Jr., the outspoken entrepreneur who is chairman and chief executive of American Residential Investment Trust Inc. of Del Mar, Calif.
In one incarnation or another, American Residential has been around since 1983, when Mr. Robbins and others founded it as ICA Mortgage.
First Nationwide Bank bought it and then sold it, leaving Mr. Robbins in charge again.
In 1994, when Chase Manhattan Bank bought it, Mr. Robbins left the stage. But Chase sold it 1996, after the Chase-Chemical merger, and the next year Mr. Robbins reinvented the company as a real estate investment trust and took it public.
The IPO took place just before the Russian and Asian financial meltdowns, and Mr. Robbins was better prepared than most in the subprime and REIT markets for the resulting liquidity crisis.
He and his company had been through so many changes that for him the credit squeeze was just another battle -- though a big one. Indeed, by the fall of 1998 he was busy rolling out his current survival formula.
The problems that the Russian crisis let loose on the subprime market are well known: Institutional investors rushed to the safest financial instruments, investment and commercial banks yanked credit to subprime lenders, and consumers' prepayments of mortgages became in a tidal wave.
REITs such as American Residential, heavily invested in the subprime market, were in serious trouble. "Nineteen ninety-eight was quite a year for the REIT industry," Mr. Robbins, 52, said in an interview. "It struggled through this very difficult and mixed market."
At yearend 1998 the company reported a net loss of $1.2 milllion, or 15 cents a share, compared with net income of $2.4 million or 82 cents a share, in 1997. Nevertheless, the company paid shareholders a dividend of 83 cents a share.
To deal with the company's financial difficulties, Mr. Robbins decided that American Residential should sell its AAA-rated Fannie Mae and Freddie Mac securities.
"We sold assets that had become a drain on earnings due to their prepayment characteristics," Mr. Robbins said. "At the same time, the sales gave us the flexibility we needed to invest the resulting proceeds in higher-yielding mortgage assets."
Mr. Robbins also helped the company contain and control a wide variety of risks, including credit, mark-to-market, liquidity, and spread-deterioration risks.
Collectively, the company's risk management techniques provide significant protection against liquidity crunches. For example, seven out of 10 loans that it has purchased this year include prepayment penalties. The company also re-underwrites loans it buys, and appropriately reserves against them, and it obtains committed rather than uncommitted lines of credit -- lines that cannot be withdrawn arbitrarily at the whim of the bankers involved.
By far the most important -- and successful -- component of American Residential's balance sheet fix has been to virtually eliminate mark-to-market risk by quickly securitizing new assets. Through quick securitization, American Residential eliminates the risk of spread deterioration to 60 or fewer days.
So far this year the company has been extraordinarily successful in expanding total assets -- from $632 million at the end of March to $1.3 billion today. In the last nine months American Residential has bought and securitized about $958 million in mortgages.
"All of our assets are now financed by borrowings in the form of securities and are sheltered from some market risk," Mr. Robbins said, "and many of these securities have mortgage insurance, which helps protect us from credit risk."
American Residential's quick response to the liquidity crisis has enabled it to turn its financial fortunes around quickly. In the second quarter the company earned $3.6 million, or 45 cents a share, and, significantly, increased earnings 25% between the first and second quarters.
"I think the company has done a pretty good job of managing through the liquidity crisis, of weathering the storm," said Gary Gordon, an analyst with PaineWebber. "I feel very comfortable with what they're doing. We're forecasting earnings of $1.02 per share this year and $1.20 next year, and they're continuing to sell well below book value, in the area of 60%."
Even while working through the liquidity crunch, Mr. Robbins has been spending a considerable amount of time on strategy. Last year the company had to postpone plans to acquire a mortgage company -- delaying, at least for the moment, its attempt to become directly involved in originating loans.
"American Residential needs to develop some form of origination capability during the foreseeable future," Mr. Robbins said. "We need to acquire mortgage products at a cheaper price rather than purchasing them from another origination source."
In fact, abandoning the brokerage purchase may have been a blessing, Mr. Robbins said. He expressed interest in possibly setting up his own brokerage business so he would not have to worry about merging two different cultures into one.
"In addition," he said, "we've started to change our opinion about what the real value of bricks and mortar is," he says. "If you look five or 10 years into the future and you see where the Internet is going, people are going to be buying anything they want simply by using their television. So you begin to wonder what the value of a nationwide branch network is.
"We're going to want to create a feeling with customers that's similar to the one that they get when shopping at Nordstrom's. You're going to get that feeling, that value, from the ability to produce loans on-line directly."
Mr. Robbins has expressed doubts about the use of REITs as a vehicle for creating shareholder value over the past several months. But he is not abandoning the structure yet, he said.
"REITs are equity vampires," he said, "because the only way you can grow is to create more equity. You can't do it on retained earnings as most companies can, so we've followed Indy Mac's de-REITing and thrift chartering with interest.
"I'm not there yet, because I know if you can create an exciting enough franchise, the equity markets will open to you. When you pay no corporate taxes, as REITs do not, it gives you compelling advantages. So even though REITs have gone through a difficult cycle, you have to take a longer-term perspective."
Mr. Robbins also said servicers will begin cross-selling a broad array of products -- and he said he sees mortgage-related opportunities abroad that have yet to be exploited.
"As the real estate market and mortgage markets become more sophisticated, there are going to be people going into foreign countries, putting together securities, and persuading people that there is enough quality to make those securities viable," he said.
"This is already possible in Europe and Australia. There are going to be great opportunities in the next 10 years where you may even see dollar-based mortgages sold in some of these countries. But these triple-A-rated securities are coming."
Of course, if Mr. Robbins pursues those markets himself, he might want to pick his financiers carefully. "Investment banks are always good partners as long as they're making money," he said, in a single fleeting negative comment about the recent liquidity squeeze. "When markets become more challenging, so do they."