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.
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.