Edition: U.S. / Global

Market Place; Realty Concern's Rapid Collapse

By Floyd Norris
Published: January 12, 1989

IT may be a record for speed. In just 201 days, the Residential Resources Mortgage Investment Corporation went from being an initial public offering to a Chapter 11 case in bankruptcy court.

The rapid plunge of Residential Resources stunned many in its industry and served to point up both the risks of such companies and the flexibility of the accounting standards they use.

''These things are insanely difficult to analyze,'' said John Higgins, an analyst with Audit Investments, who had been negative both on Residential Resources and on other stocks in what is called the C.M.O.-REIT industry. That stands for real estate investment trusts that invest in collateralized mortgage obligations, and despite the complex name, they have been popular with investors. Mr. Higgins said they represented about a third of the equity in the entire REIT industry.

Shares in such companies were sold primarily to individuals attracted by high promised yields of 18 percent or more. But few understood how those yields were obtained, and even those who took the trouble to pore through financial reports could not learn how well they were really doing.

There were indications that all was not completely well at Residential Resources, but none that Chapter 11 was nearing. In October, when it paid its first quarterly dividend, of 48 cents a share, the company said it expected to pay that rate on a consistent basis. But on Dec. 20, when it declared its second dividend, it was down to 40 cents. The drop was attributed to rising short-term interest rates, which it said had put pressure on profits. Now that dividend is not likely to be paid.

The stock came under pressure when the dividend was cut, but the shares were still trading at $7.50 on Friday, down from an initial price of $10.

The American Stock Exchange did not allow trading to open on Monday, pending news, and has not resumed it. But over-the-counter trading resumed yesterday. Dick Newberg, a trader at Vanderbilt Securities, said quotes early in the day began at $2 bid, but slid to a low of 37.5 cents. The final quote was 50 cents bid, $1.25 asked.

Collateralized mortgage obligations are, in essence, securities backed by the cash flow from mortgages. Several different securities will be backed by the same pool of mortgages, with buyers of the first security getting all the early principal payments and a relatively low rate of interest. When that security is paid off, the principal payments will go to the second security, which usually has a higher rate of interest. Other securities follow in priority, and details often vary. Interest rates on the securities can be fixed or variable.

What is left over, after all the other securities have been paid off, is the residual, and it can be quite substantial if all goes well. It is those residuals that Residential Resources owned.

The risks for such companies include changing interest rates, which can cause homeowners to speed up or slow down mortgage payments and can raise or lower the required payments on some of the C.M.O. securities that stand ahead of the residual payments they are to receive. Given that, any evaluation of Residential Resources or its competitors would depend on the market value of its assets, which can vary sharply with changes in interest rates. Banks that lent money to Residential Resources based those loans on market value, and when that turned down, they called the loans, precipitating the bankruptcy.

But for investors there is no way to learn that market value. Residential Resources, along with others in the industry, bases its accounting reports on what it paid for assets, not on what they are worth. Thus it was able to report a profit of 49 cents a share for the quarter that ended Sept. 30, the last report it made before it filed for bankruptcy.

Whether it was just rising interest rates that led to the collapse is not clear. The company's three top executives resigned on Tuesday, and the announcement referred, without explanation, to the ''submission of inaccurate'' documents in arranging some loans. The outside directors, who have taken control of the company, did not return phone calls yesterday.

Shares of other companies in the business have been shaken by the episode, but while it is equally hard to evaluate their assets, it is clear that they are better capitalized and thus more likely to be able to withstand higher interest rates. Mr. Higgins pointed out that the Asset Investor Corporation had short-term bank debt equal to just 27 percent of shareholder equity, a relatively small amount of leverage. Residential Resources, by contrast, reported that at the end of September its bank debt came to 272 percent of shareholder equity. On the New York Stock Exchange yesterday, Asset Investor shares fell 12.5 cents, to $11.50, after dropping 25 cents on Tuesday.