Friday, December 7, 2007

Countrywide still sux

The Wall Street Journal

December 7, 2007


Countrywide Isn't Out of Woods Yet

December 7, 2007; Page C1

Since a credit crunch engulfed mortgage lenders in mid-August, analysts and investors have had nearly four months to think about whether Countrywide Financial Corp. can survive. Their conclusion? It is too early to tell.

So far, the nation's largest mortgage lender has managed to limp along, largely by increasing its borrowings from the Federal Home Loan Bank of Atlanta and receiving $2 billion from Bank of America Corp. for preferred stock convertible into a stake of about 16% in Countrywide. Its executives have vowed to return to profitability this quarter after a $1.2 billion loss in the third quarter.

"I'd rather be breathing than dead," Countrywide's chief executive, Angelo Mozilo, quipped at a conference Monday in Washington.


The company's stock and bond prices, however, suggest that investors see a serious risk that Countrywide eventually could seek bankruptcy protection or resort to huge sales of new stock that would slash the value of existing shares.

In 4 p.m. composite trading yesterday on the New York Stock Exchange, Countrywide's shares were up $1.68 to $12.10 amid a generally upbeat trading session in the financial sector sparked by falling lending rates. So far this month, Countrywide's share price is up 11.8%, but down 71.5% for the year.

The stock is trading at about 53% of the Sept. 30 book value of $23 a share. The company's bonds are selling at "junk" levels. For example, the 5.8% bonds maturing in June 2012 are trading at about 76 cents on the dollar, for a yield of 13.16%

"The market is really concerned about the possibility of default," says Steven Persky, chief executive of Dalton Investments LLC, a Los Angeles fund-management firm with $1.3 billion in assets. Mr. Persky, whose firm doesn't have any exposure to Countrywide, has been thinking of buying some of the bonds.

He thinks the company is so big and important to the economy that regulators wouldn't let it fail.

Still, he says, buying Countrywide bonds now would be "a dangerous game to play. Lots of people didn't believe Russia would default, but it did. On the other hand, in the U.S., when was the last time a large financial institution failed?"

Here are some sobering thoughts for people tempted to buy Countrywide stock now:

The company's fate hinges on how much worse the housing slump gets. Falling house prices cut the value of collateral backing the $83.56 billion of loans held by Countrywide as investments. Some economists say a recovery may be several years away. "I don't know where we are in the cycle," Mr. Mozilo said at the conference. "I wish I did."

Countrywide's savings bank holds $26.84 billion of option adjustable-rate mortgages, which allow borrowers to start with minimal payments and face far higher ones later, and $32.47 billion of second-lien "home equity" loans, potentially worthless in a default because the first-lien holder gets first dibs on the home. These two categories of high-risk loans account for three-quarters of the bank's loan holdings.

Countrywide says some of that risk is covered by mortgage insurance. As of Sept. 30, the company carried mortgage insurance on $23.05 billion of its bank's residential loan portfolio, which totaled $79.46 billion. But it isn't certain that mortgage insurers will have enough capital to meet all claims if the housing slump worsens. Countrywide's bank portfolio doesn't include subprime mortgages of the type subject to a rate-freeze program announced by the Bush administration yesterday.

More bad news, such as ratings downgrades, could scare away depositors. Countrywide managed to halt a run on its savings bank in August by bringing in Bank of America as a big shareholder. But the company still has to offer premium rates on certificates of deposit to attract funds needed to support further lending. The high rates it must pay for funds will squeeze Countrywide's profit margins on loans.

Insiders aren't showing obvious confidence. The company hasn't reported any purchases of shares by its senior executives in recent weeks, even though the stock recently touched an intraday low last month of $8.21. By contrast, executives of another big mortgage company with a drooping stock price, Fannie Mae, have bought shares over the past two weeks.

Countrywide needs to repay a total of $26.38 billion in borrowings over the 12 months ending Sept. 30, according to the latest quarterly filing. Countrywide officials have said they can meet these payments -- a point that Moody's Investors Service affirmed -- but may have to sell some mortgages or related securities to do so. Investors are so wary of mortgages that it is impossible to know how much of a discount Countrywide would have to offer to find buyers for these assets.

Investors will be looking for chances to force Countrywide to repurchase many of the loans it sold in recent years. Provisions of those sales require repurchases in some cases, such as when loans default early or otherwise don't live up to the "representations and warranties" provided by Countrywide at the time of the sale. "It is our intention to defend our positions vigorously," the company said in a recent securities filing.

Loan losses are likely to be a huge drag on earnings for years, and the more-conservative loans being made now don't produce huge immediate gains when they are sold, as many of the more aggressive loans did during the housing boom

As if it didn't have enough exposure to mortgages already, Countrywide's insurance arm has sold reinsurance to insurers that cover mortgage-default risk, taking on a portion of their potential liabilities. Countrywide has said its maximum potential losses on these reinsurance contracts were about $1 billion as of Sept. 30.

There are some bright spots, however. The company's loan-servicing business, which gets fees for collecting payments and handling foreclosure cases, produces about $1 billion of cash flow each quarter, says Craig Emrick, an analyst at Moody's. Distressed borrowers often end up paying hefty fees. For example, Countrywide says it collected $93.6 million of late-payment charges in the third quarter, up 27% from a year earlier.


Linus said...

Wow. Mozillo unloads all of his shares and no other exec wants to purchase any. That's confidence in your product!

Kenneth said...

Any thoughts on how the anticipated rate cut from the fed is going to affect the stock price? Also, what is your feeling on how the Dec earnings report is going to look?

Gerard said...

Assuming nothing else happens, stocks will continue to go up and volatility will decrease in anticipation of a rate cut. I'm waiting until right before the cut to add to my shorts.

The Dec earnings report will be audited. Expect the auditor and/or board members to leave. Caution: The report will probably not come out until after the Jan options expire.

Good Luck