Tuesday, October 30, 2007

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”.

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