Thornburg Mortgage Asset Corp. said its second-quarter earnings were $7.48 million, or 27 cents a common share, down 46% from a year earlier.

Larry A. Goldstone, president of the Santa Fe-based real estate investment trust, said the slide was "not an unexpected result." He said the drop could be attributed to the increase in adjustable-rate loan prepayments in Thornburg's portfolio caused by low interest rates and the flat yield curve.

Thornburg's net interest margin fell to 0.63%, from 1.41%. Return on average equity was 6.83%, down from 13.45%.

The constant prepayment rate on the portion of the portfolio subject to prepayment activity averaged 34%, up from 27% in the first quarter. But the rate fell in June to 31%, the first improvement since the middle of 1997, the company said.

This summer may have seasonally high prepayments because of the strong housing market and low interest rates, Mr. Goldstone said. He said he thinks there will be some "significant declines" in prepayments in the fall and winter.

Operating expenses declined to 0.10% on average assets because of the elimination of the management performance fee, the company said.

Thornburg sold close to $140 million of assets in the quarter, mostly cost-of-funds-based adjustable-rate mortgage securities. These sales resulted in $1.5 million in earnings.

"REITs are essentially a spread-income business-the difference between the spread on the assets and the borrowing costs," said Jim Fowler, principal with NationsBanc Montgomery Securities.

In the past six weeks REITs have sold a tremendous amount of adjustable- rate mortgages, Mr. Fowler said. He said REITs now have to decide whether to sell them and take a capital loss to generate cash that can be reinvested into other assets, or hold them and earn nominal spreads, if any, in the hope that prepayments will slow down.

Most REITs have an outlook that "prepayments are not likely to slow down over the next couple of quarters and so they're selling the ARMs, taking the losses, and redeploying the cash into hybrids or pass-throughs," Mr. Fowler said.

Mr. Goldstone said Thornburg's situation was "all Asia-related."

"This is a typical flight to quality. This has got nothing to do with the domestic economy as far as I can tell," he said.

This is the most difficult interest rate scenario for REITs to operate in, Mr. Goldstone said.

"This environment is probably more disappointing and irritating because our results aren't as good as we'd like them to be," Mr. Goldstone said. "But this environment does not threaten the viability of our business."

Thornburg's total assets increased to $5.1 billion at the end of June, up from $4.9 billion at the end of March, and it has increased its whole loan position. In the second quarter it had $833 million of new purchases, 35% whole loans, many of which are hybrids that are fixed for five years. It has four-year liabilities matched against them, Mr. Goldstone said.

This year Thornburg has bought more than $1.6 billion of adjustable-rate mortgage securities and loans. Its whole loan portfolio has increased to $578 million as of June 30, and it plans to turn many of them into AAA securities to reduce its cost of funding, Mr. Goldstone said.

Thornburg's investment policy allows for it to have total exposure of 20% of assets, or about $1 billion, in hybrids; it is now at about the $275 million mark, he said.

Securitization would probably add up to 20 basis points of incremental expense, but the cost of funds would be reduced by up to 45 basis points, he said.

To further securitization initiatives, Thornburg has hired Deborah Burns as vice president of whole loan securitization. She will establish a program and evaluate securitization alternatives, the company said.

Ms. Burns was the former director of project finance at the Teacher's Insurance and Annuity Association-TIAA-CREF.

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