Monday, October 29, 2007
Skepticism Scarce in Countrywide's Rally
By RANDALL W. FORSYTH
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.
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.