LUM Balance Sheet

In this section we will describe LUM’s balance sheet. Although some of the entries will be similar to what is contained in other balance sheet, there are many differences which will need to be explained. Differences will exist in both entry and outlook to other financial statements. We will highlight the important differences and avoid discussing entries that are in generic statements.



Assets



Cash and cash equivalent: This is an entry which is in most balance sheets and contains the liquid investments where the company can convert into cash very easily.



Restricted cash: This is cash held by a third party trustees. In most cases it will be the cash used to pay off dividends.



Mortgage backed securities available for sale: These are securities that the company owns as investment or collateral. As we can see from the balance sheet (see cell B14) they are a significant proportion of assets. These are the securities that the company invests in and expects to receive mortgage income to pay off its dividends as well as capital appreciation of the value of the mortgage backed securities (MBS). MBS’s are complicated securities which are not always so simple to value as there are many out there by different issuers and a liquid market does not always exist. Furthermore complicated models need to be built to price them. LUM calculates the value of the MBS portfolio based on a fair value approach, where assumptions are made on prepayment speeds and fair value (see a forthcoming article on MBS securities). Furthermore if liquidity exists they can receive prices from different pricing providers (MBS’s are not traded on an active exchange).



Equity securities available-for-sale, at fair value: As can be seen from the balance sheet, this is a small quantity compared to MBS assets. It is possible that for regulation or hedging purposes they invest in a small amount of equities (see cell B15).



Loans held-for-investment, net of allowance for loan losses: These are the actual pools of mortgages bought which were not securitized into MBS’s. The company acquires these mortgages for the sake of investment and not to sell them as a principal trade. The company maintains an allowance for loan losses. The value is used to take into account default on mortgages. This is calculated by taking into account the current state in the economy, historical default rates as well as other actuarial factors.



Derivatives at fair value: The Company invested in certain types of derivatives for hedging purposes.



Other Assets: This includes real estate properties owned at the lower of its carrying value or fair value.



Liabilities



Mortgage backed notes: Just like it buys securitized mortgages loans converted into MBS’s, LUM can also originate and structure loans into MBS’s and then sell them to investors. This becomes a liability and LUM has to pay the mortgage interest to investors.



Repurchase Agreements: When a company needs to borrow money, one way it can do this is by entering into a repurchase agreement or “repo”. They will give the securities as collateral but have to buy it back. Furthermore they have to pay the interest.



Commercial Paper: LUM will issue short term commercial paper to fund its MBS portfolio. By the end of 2006 the outstanding balance on commercial papers was $637.7 million at a weighted average rate of interest of 5.36%.



Warehouse lending facility: By the end of 2006 the company established a warehouse lending facility with Greenwich Capital Financing Products Inc and Barclays Bank plc. These facilities are the companies’ primary source of short term funding for acquiring mortgage backed loans. These are all short term borrowings that are secured by loans. They are structured as repurchase agreements. In general warehouse lending facilities provide financing for loans for a maximum of 120 days. There are two parts to the warehouse lending facilities 1. Mortgage loans financing – which finances actual pooled mortgage loans which have not been securitized and 2. Asset backed securities financing which are actual tradable MBS securities rated below AAA.



Junior Subordinated Notes: These notes are issued by the company and have a maturity of 30 years, they are issued to two trusts DST I and DST II, The total amount outstanding in the two notes is $92.788 million or which 51.550 million is part of DST I and $41,238 is part of DSTII. The difference in structure between DSTI and II bonds are that DST I have a fixed coupon until 2010 and there after the coupon will be referenced to 3 month Libor + 3.16% until maturity. DST II interest payment will be referenced to 3 month Libor +3.75% throughout the life of the bond.