Countrywide Skeptics

As most readers probably know, subprime mortgage broker/lender Countrywide Financial’s CEO Angelo Mozilo, which posted a massive loss for its third quarter, predicted a return to profit this quarter. Not only did the stock rise 32% that day, but CFC’s announcement was perceived to be such good news that it gave the stock market a boost.

I will confess to not having given the Countrywide forecast much thought beyond considering it to be not credible. Now CFC could have deliberately over-reserved, and it therefore relying on being able to reverse those reserves if results don’t meet its cheery prediction. However, the ABX indexes are continuing on as close as you can get to a vertical trajectory downward, so it looks pretty likely that any cushion will be consumed by increases in delinquencies and foreclosures (remember, a foreclosure puts an end to servicing revenues). CFC has announced a borrower salvage program that is unlikely to help its profits. I don’t see much factual underpinning for the idea that CFC has turned the corner.

Now my view is based simply on the continuing-to-deteriorate fundamentals for housing and my belief that anything that comes out of Mozilo’s mouth has to be taken with a handful of salt. But Michael Shedlock and Accrued Interest, who have thought about CFC more deeply, are also dubious.

Shedlock points out that the spike-up in the stock price was due to a short squeeze and then turns to substantive matters. First he gives us some juicy bits from Mozilo’s pronouncement that I somehow missed:

Countrywide said borrowers were behind in payments on 29.08 percent of subprime loans it services as of September 30, up from 23.71 percent in June. The delinquency rate rose to 5.76 percent from 4.56 percent on prime home equity loans, and to 4.41 percent from 3.35 percent on conventional first mortgages.

That trajectory does not speak well for capital returning to the market. When losses start piling up, lenders tend to over-learn their lessons and become stringent often at precisely the time when reducing credit availability can have knock-on effects.

Shedlock’s comments:

It appears that Countrywide attempted to throw in everything but the kitchen sink into those “one time losses“. But even with that strategy it is premature for Countrywide to be acting as if the “perfect storm” is over. Those increases in delinquencies are going to translate into increased foreclosures and increased REOs (Real Estate Owned) sometime down the line.

One has to laugh at the statement that the third quarter represented an “earnings trough.” After all, a $2.85 per share loss is quite a “trough”. The estimate was a loss of $1.65 per share. It’s quite amazing to see a $1.20 per share earnings miss be treated as such magnificent news.

In addition, Countrywide appears to be bragging about securing another $18 billion in “highly reliable” credit lines. Instead investors ought to be worried about the possibility that Countrywide will again need those credit lines.

Accrued Interest, by contrast, was willing to consider the possibility that Countrywide was correct and might show profits soon, and the tone of the post was neutral. However, the arguments do not bode well for CFC.

AI posits that mortgage lending could become more profitable by virtue of a shift in the supply/demand balance. Continuing demand for mortgages versus a withdrawal of lenders and investors suddenly means more pricing latitude on the part of lenders, and almost certainly margin improvement. He also points out that most salvageable of the current subprime borrowers facing resets will be refinanced, either by CFC itself, or Wamu, the FHA, or various state-sponsored programs. His conclusion:

So back to Countrywide. I don’t think they are in a good position to take advantage of higher loan margins. I think actual banks with actual balance sheets and better access to emergency liquidity are in stronger position to realize new opportunities in mortgage lending. On the other hand, if we assume that Countrywide underwrites nothing other than easily securitized stuff, and has indeed written down all its assets (including both loans and servicing rights) to their true value, then there is no reason why they shouldn’t be profitable to some degree in the near future.

The big IF in the previous paragraph is the true value of their assets. By that I mean not the market value, but what those assets really turn out to be worth. We are living in a world where determining the value of mortgage assets is extremely difficult. We know that there are assets currently priced at 50 cents on the dollar which will eventually pay off in full. And we know there are assets similarly priced which will turn out to be worthless. If Countrywide has written down all their risky assets to x cents on the dollar, and on average, that’s what those assets eventually pay out, then everything will be fine. If they realize x-y, then it may be several quarters before they’re back in the black.

Finally, the thing that I don’t like about Countrywide is their access to non-market capital. A bank can go to the Fed or to the Home Loan Banks and get emergency capital. So if WaMu or Fifth Third or US Bank or some other large retail bank were to have sudden trouble with securitization, they’d have options. Countrywide Bank is too small to consider it a realistic option to fund Countrywide’s overall operation, and as we saw in August, Countrywide is subject to liquidity problems.

In terms of the market overall, both in credit and stocks, you’d hope that Countrywide delivers on their promise. If not, I think there will be a very negative reaction in both markets.

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  1. weichristineliao

    an article from the Barron’s on ctrywide:

    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%.”

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