Wednesday, October 31, 2007

Rate Cut Unlikely to Fix Housing Woes

Wednesday October 31, 12:49 am ET
By Alan Zibel, AP Business Writer

Fed Rate Cut Sought by Wall Street Would Have Only Limited Impact on Housing, Banking Sectors
WASHINGTON (AP) -- The interest rate cut that Wall Street believes will buffer the economy from housing market woes is unlikely to give much of a boost to suffering banks and homebuilders in the near term, analysts say.

The Federal Reserve policymaking committee is expected to approve cutting a key short-term rate at least a quarter percentage point Wednesday to help the economy get through a deeper-than-expected housing slump and credit crunch that accelerated in August.

Investors are betting the central bank will reduce the federal funds rate, the rate banks charge each other for overnight loans, to 4.5 percent. Over the next 12 to 18 months, lower short-term rates will aid the overall economy because many equity credit lines and some credit card rates are pegged to short-term market rates.

Yet the Fed's efforts now, on top of a half-percentage-point rate cut in September, won't change the outlook much, if at all, for companies on the front lines of surging mortgage defaults and a dried-up market for complex securities backed by home loans.

"The problems in the housing market, the problems in the credit markets are not easily solved by the Fed cutting rates," said Steve East, chief economist for investment bank Friedman Billings, Ramsey & Co. in Arlington, Va., who sees the Fed making three quarter-point cuts by January and puts the odds of a recession in 2008 at 60 percent.

The thinking is that lenders can improve battered balance sheets if they have to pay less for money they borrow short-term while the rate they charge borrowers for long-term loans holds steady or moves higher. Yet analysts say problems in the credit markets extend beyond the benefits of small rate cuts.

Struggling homebuilders, such as D.R. Horton Inc., Lennar Corp. and Pulte Homes Inc., are faced with tightened lending standards and severely limited demand. Many would-be buyers are unable to qualify for loan approvals, even if rates move lower.

Lower interest rates are "certainly not the panacea" for getting the housing market back on track, said UBS homebuilding analyst David Goldberg.

The median U.S. home price nationwide fell for the eighth consecutive month in August, according to the S&P/Case-Shiller index released Tuesday. Fifteen of 20 metropolitan areas included in the index declined. Many experts predict housing prices will fall further before demand rebounds.

Jefferson Harralson, a banking analyst with Keefe, Bruyette & Woods Inc. who follows banks such as Bank of America Corp. and Wachovia Corp., said an acceleration in losses from defaults "seems to be a given, whether or not a rate cut occurs."

He says home equity lines of credit will be less likely to default if rates are lower. But that's hardly a revenue cure for banks in an environment in which housing prices continue to fall and foreclosures continue to rise.

"The home equity business isn't going to be a growth business," Harralson said.

Tuesday, October 30, 2007

Skepticism Scarce in Countrywide's Rally

Barron's Online

Monday, October 29, 2007



Skepticism Scarce in Countrywide's Rally


IN A TOUCHING DISPLAY OF FAITH-BASED investing, Countrywide Financial's debt and equity securities soared Friday despite dramatic evidence of mortgage- credit deterioration severe enough to induce the Federal Reserve to cut short-term interest rates again.

Even though the company reported a $1.2 billion loss for the third quarter as a result of $3 billion of credit-related losses, its securities exploded higher. In the debt markets, the cost of insuring against default by the nation's largest mortgage lender plunged an astounding 100 basis points, or one percentage point, to 377.5 basis points for its credit-default swaps. Yields on Countrywide's bonds plunged as much as 40 basis points on the earnings news.

Among equity securities, the common (ticker: CFC) soared 32% while Countrywide Capital preferred's (CFCpfdA and CFCpfdB) jumped 22%. And the Calabas, Calif., company also declared its regular 15-cent dividend on the common, which might have been in jeopardy given its scramble to raise cash during the quarter. That, of course, featured the placement of $2 billion of convertible preferred with Bank of America (BAC) during August's dire days

Still, the rebound in all these securities and derivatives was not spurred by the dismal results but by Countrywide's declaration that the third quarter marked the trough and profitability would return in the current quarter.

But given the many premature calls in the past year that the bottom of the housing and mortgage markets had been reached, Countrywide's declaration that the worst is over might be worthy of more skepticism, not least because of Chief Executive Anthony Mozilo's huge sales of stock, which the Securities and Exchange Commission is investigating.

More likely, the recovery in all of Countrywide's securities Friday reflected a monster short-covering rally.

But the green-eyeshade types in the credit market took a more jaundiced view of Countrywide's results. Standard & Poor's lowered its credit rating to triple-B-plus, the third investment grade from the bottom, from single-A-minus.

Egan-Jones carries a triple-B-minus rating, a notch above junk. This independent rating company noted "a disconnect" in the Countrywide report. "CFC has $209 billion of assets and took charges of $1 billion; a 5% charge equates to $11 billion compared to equity of $15 billion."

Even a 5% haircut would be modest, based on the plunge in prices in the ABX index of credit-default swaps on asset-backed securities. The price of the ABX triple-B-minus tranche (backed mainly by subprime mortgages), originated in the first half of 2007, hit a record low of 18.57% of par, extending its headlong plunge of the past two weeks. At the start of the year it was in the high 90s, which shows how much the low end of the mortgage market has sunk.

Egan-Jones further observes:

"A core issue is whether BAC will continue to support CFC. The $2 billion preferred share investment helps, but unless conditions improve, more will be needed."

On that score, Bank of America so far is likely showing a loss on that preferred. Even with the rebound in Countrywide common, to 17.30, it ended below the $18 conversion price on the converts -- which, it might be recalled, was a discount to the market at the time, a highly unusual concession for an issuer of such securities.

"On the liquidity side, the high cost (over 5%) for short-term paper is unsustainable," Egan-Jones adds. "[Countrywide's] business is built on short-term rates below 3%."

WHICH IS ONLY ONE REASON that this week's two-day meeting of the Federal Open Market Committee looms larger than any other such gathering since, well, the one last month. At the Chicago Board of Trade, the futures market decided it was an absolute certainty that the policy-setting panel would lower its federal-funds target, currently 4.75%, by at least 25 basis points. The probability of a surprise 50-basis-point cut, as in September, is just 8%. The futures market currently is projecting a rerun at the Dec. 11 FOMC meeting. A cut in the funds-rate target to at least 4.25% is a lock, then, with a 32% chance of a 4% overnight money rate.


Anticipating the Fed: Treasury yields continued their slide ahead of the Oc. 30-31 FOMC meeting, at which the panel is expected to cut its fed-funds target by at least another quarter point, from 4.75% currently.

Those expectations of Fed rate cuts are based mainly on the parlous state of the housing and mortgage markets, evidenced by September data showing a sharp drop in sales of occupied homes and weak new-home sales. The impact also was apparent in Merrill Lynch's (MER) massive $8 billion write-down of mortgage-related investments in the third quarter.

In the Treasury market, yields were little changed as the market sold off late in the week when equities rallied. The two-year note wound up at 3.772%, while the 10-year benchmark wound up at 4.403%.

The effects of the credit problems and the likely Fed response were more evident in the currency market. The dollar touched a new low against the euro and in terms of the Fed's dollar index. And it hit a 27-year low against the currency that counts, gold.

Conference call

I just finished reading the grueling 3 hour conference call that the market seemed to get so warm and fuzzy over. Here is my rebuttal:

Because the credit markets are frozen, CFC can no longer fund loans using money from “Commercial Paper” at 3.5%. Instead, they are funding loans using 5.5% CDs issued by Countrywide Bank. As they move operations to the more heavily regulated bank, they are going to be subject to scrutiny by government auditors and regulators, who may call foul on the poor quality junk they transferred into the bank.

They are assuming they will lose about $1.4 Billion on $8 Billion in home loans. To put that in perspective, the TOTAL damage from the southern CA fires is estimated to be about $1 Billion. Reasonable estimates for CFCs loss is anywhere from $1 Billion - $4 Billion. The problem is the market for re-sale of mortgages has collapsed so it’s hard to say how much they are worth. Personally, I estimate they’ll lose about $2 Billion because many people will continue to pay their mortgages out of a sense of honor, even if their house prices have gone down and it’s more rational to default.

They talked a lot about how the “speed” of mortgage prepayment (usually due to sale or refinancing) is decreasing which has a positive effect on return on capital. However at this point in the game, I’d be less concerned about return ON capital and more concerned with return OF capital. The default rate has gone up seven fold! The fact that people cannot sell or refinance IS NOT A GOOD THING, despite their positive spin on it.

They talk about getting more revenue from late fees. You’ve got to be kidding me! They are talking about collecting an extra ½ of 1 percent, when in reality they are in serious danger of eating ½ of the loan!

They say that they have enough money to fund all their debts through 2008, but their debt can increase if their creditors demand more collateral. That has been the trigger for most of their competitors going bankrupt.

They are assuming that house prices will start to go up by the end of 2008. The census bureau just said that there are over 2 MILLION unoccupied homes in the U.S. That is a huge inventory that needs to be cleared out before prices will appreciate. Home prices are also still way out of line with rent prices in most of the country, especially CA, FL and NV where countrywide makes most of it’s loans.

Riiiiiiiiiiiiiiiight. Even the REALTORS and other housing bubble cheerleaders don’t see a recovery until 2010. In Japan, house prices went down FOR FIFTEEN STRAIGHT YEARS.

After hours on Friday, S&P lowered CFCs credit rating to just above junk. This is HUGE news. It will further increase their cost of borrowing money and could trigger deadly margin calls for more collateral. Unbelievably a credit rating reduction can result in a profit thought standard creative accounting. It works like this: Bonds you sold are suddenly worth less and they people who bought them must register a loss, conversely as the seller you can post the profit. If that doesn’t make sense to you, that’s because it doesn’t make sense. Last quarter major investment banks posted 2/3 of their gross “income” due to this effect when their credit ratings got slashed. Perhaps this is how CFC really intends to be “profitable” next quarter.

I don’t think CFC common shareholders will benefit from any “bailout” if there is one, mostly because CFC has been accused of so much wrong doing, I think the government is more likely to use them as a scapegoat. And like Enron, they aren’t “too big to fail”.