Countrywide Financial

Aug 10, 2007

SAN FRANCISCO  Is the largest U.S. home lender down for the count?
Countrywide Financial Corp. spooked investors on Friday after the Calabasas, Calif.-based company said that problems in the U.S. mortgage market pose a serious threat to its earnings and financial condition.
But such drama is nothing new for this company. Shares of Countrywide (CFC
Countrywide Financial Corp
CFC ) have been volatile, often lagging both the broader market and their peers for extended periods.
Its total returns, which count price movement and dividends, are down more than 3% on an average annualized basis during the past three years, according to Morningstar.
Most of those losses before this year came in 2005, when returns dipped 6%. That was an abrupt departure from past cycles. In 2002, while the broader market was diving, Countrywide's star was bright on Wall Street as it racked up gains of 27%. In the next year, those surged to 97% and then tapered to 48% in 2004.
Residential mortgages have been rocky since then, though. "When interest rates were really low and coming off historically high levels, everyone in America wanted to refinance their mortgages," said Frederick Cannon, an analyst at Keefe, Bruyette & Woods. "As the leading mortgage bank in the U.S., Countrywide was one of the biggest benefactors of the refinancing boom."
A key rival is Wells Fargo & Co. (WFC
Wells Fargo & Company
WFC ) Its shares also have been impacted during the recent meltdown, though not nearly as much as Countrywide's, which dropped in Friday's topsy-turvy session as much as 14% before recovering at the close to end down 80 cents, or 2.8%, at $27.86.
But unlike Countrywide, San Francisco-based Wells Fargo is diversified into full-service financial services, ranging from asset management to corporate lending.
Wells Fargo is also less dependent on Wall Street financing than Countrywide, according to Cannon. "While Countrywide has a growing banking operation that's important to its future, it's still predominately a mortgage bank that sells to the secondary markets."
Wells Fargo's mortgage-lending revenue is estimated by analysts to account for anywhere from 15% to 30% of their overall business. It doesn't break out those numbers in its financial statements.
So far in 2007, Countrywide's returns are down more than 30%. Almost all of those losses have come in the past three months.
Meanwhile, Wells Fargo's stock is down less than 2% this year. In the past three months, its shares have lost close to 6%. But over the past three years, the diversified banker has generated total returns of better than 10% on an average annualized basis.
'[Countrywide's] got a strong balance sheet, and market turmoil will diminish in coming weeks and months.'
— Ryan Lentell, Morningstar
"Wells Fargo is a much more diversified play and an extremely well-run bank," said Ryan Lentell, a Morningstar analyst.
But he added that Countrywide is a much better bargain these days than Wells Fargo. Morningstar estimates that Countrywide is trading now at about a 45% discount to its intrinsic value. Its analysts view Wells Fargo selling for 13% less than its $39 "fair value" price.
"There's more risk in Countrywide now," Lentell said. "In the next few months, it's going to be a pretty bumpy road for the company."
Comeback story?
HomeBanc Corp., a smaller mortgage player, filed for bankruptcy Friday. That came after it sold five offices to Countrywide earlier in the week.
"Countrywide is picking up assets from smaller players and gaining market share," according to Lentell. "They're one of the most well-capitalized mortgage originators in the country."
He said that Countrywide should make it through the ongoing unwinding in credit markets. "They've got a strong balance sheet, and market turmoil will diminish in coming weeks and months. As this situation winds down, we think Countrywide will be left standing as an even bigger player in the U.S. mortgage market."
Chart of CFC
Even though it can prosper as smaller competitors falter, Countrywide is subject to the same fundamental issues facing all mortgage lenders.
As an operator focused so heavily on mortgages, the firm has to rely on funding from large brokerages and investment banks. Most of its loans are packaged and resold on Wall Street. During that process of securitization, the lender has to cover its loans before those pools of mortgages can be distributed.
Of Countrywide's $200 billion-plus of liabilities, more than $125 billion came from outside borrowing, according to the company's second-quarter earnings statement.
But the markets' reluctance to buy mortgages right now is causing it to retain a greater proportion of mortgage loans than it sells.
In simple terms, this means that investment banks, the firm's traditional customers, are not buying the company's product. That figures to take a bite out of future earnings or revenues, or both.
The Federal Reserve took action Friday, acknowledging to a large degree the difficulty that Countrywide is talking about, announcing that it pumped $19 billion into the market in an effort to provide liquidity. See related story.
Countrywide's shares fell $5.11, or 17.8%, to $23.55 before the opening bell; the stock recovered somewhat by midday, down about 6% to $26.95.
Despite a slowing from the refinancing boom, Countrywide's stock is coming off a 26.2% return in 2006. In fact, earlier this year, the stock had been on the rise.
Part of that was credited to speculation that Countrywide was ripe for a buyout. One of the candidates talked about was Bank of America Corp. (BAC
Those whispers in the market have all but died as mortgage markets tank and credit tightens. Even though it could be viewed as more reasonably priced, Countrywide would still represent a rather large takeout. The firm still has more than $200 billion in assets and a market capitalization topping $15 billion.
'[Countrywide's] challenge is to get through this liquidity crisis and adjust operations to the new market reality.'
— Frederick Cannon, Keefe, Bruyette & Woods
Hostile takeovers in financials are also hard to pull off, analysts say. Countrywide's chief executive and co-founder, Angelo Mozilo, has said that management is committed to steering the firm through the current downturn.
Keefe, Bruyette & Woods' Cannon commented that uncertainty is so high right now that "it's hard to recommend that investors step into it at this point."
But he said: "We do think Countrywide will get through this and remain a leader. ... Its challenge is to get through this liquidity crisis and adjust operations to the new market reality."
Still, Cannon isn't recommending that new investors climb aboard just yet. He said that he remains neutral on the stock until the impact of a shakeout in mortgage markets becomes clearer.
Analysts at Merrill Lynch said Friday that the firm has the financial strength and management talent to survive what's a difficult market.
Chart of WFC
"We think CFC has the financial strength and management acumen to succeed, and we think Monday's disclosure that it would buy retail branches from a small lender for pennies on the dollar suggests it is not overwhelmed by the secondary-market gymnastics that is wreaking havoc on weaker names," Merrill told clients. See related story.
In a filing Thursday with the Securities and Exchange Commission, Countrywide said that while it plans to retain more loans until investor demand improves, it warned that a prolonged period of poor conditions "could have an adverse impact" on future profits and its financial condition.
"Based on our review of the risk section [of the filing], the aftermarket move seems to be an overreaction and we would recommend investors to accumulate stock on share price weakness," Merrill wrote.
The disclosure was made as part of Countrywide's regular quarterly financial report with the SEC.
When it announced second-quarter results in July, Countrywide indicated that widespread troubles in the subprime-mortgage market had spread to higher-quality loans. See related story.
At that time, Countrywide said that it expected the general slowdown in the housing market to last at least until 2009.
The same concerns are rattling the broader markets as well.
U.S. stock-market futures were pointing to another dark day of trading Friday following the plunge in the previous session, with central banks overseas pumping roughly $100 billion more into the banking system at a time of market worries.

Countrywide Financial, the nation’s largest mortgage lender, said yesterday that more borrowers with good credit were falling behind on their loans and that the housing market might not begin recovering until 2009 because of a decline in house prices that goes beyond anything experienced in decades.
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Stocks & Bonds: Dow Tumbles 226 Points on Weak Profits (July 25, 2007)

The news from Countrywide, widely seen as a bellwether for the mortgage market, initiated a sell-off in the stock market, which is at its most volatile in more than a year. The Standard & Poor’s 500-stock index fell 30.53 points, or 2 percent, to 1,511.04, its biggest one-day drop in nearly five months. The dollar dropped to a new low against the euro, edging closer to $1.40 to 1 euro. Stocks opened sharply lower in Japan this morning.

The slumping housing market has become the biggest worry for the stock market, which just four days ago set records, because of its potential impact on the broader economy and financial system.

Countrywide’s stark assessment signaled a critical change in the substance and tenor of how housing executives are publicly describing the market. Just a couple of months ago, some executives were predicting a relatively quick recovery and saying that most home loans would be fine with the exception of those made to borrowers with weak credit who stretched too far financially.

Executives at Countrywide had for some time been more skeptical than others but the bluntness of their comments yesterday surprised many on Wall Street. In a conference call with analysts that lasted three hours, Countrywide’s chairman and chief executive, Angelo R. Mozilo, said home prices were falling “almost like never before, with the exception of the Great Depression.”

Nationally, home prices have not fallen in the 35 years or so that the government and private services have tracked them. Some researchers like Robert J. Shiller of Yale have compiled data that goes as far back as 1890 and shows that home prices fell for several years during the 1930s.

Mr. Mozilo said that because of a large number of homes on the market, the housing sector would continue to suffer until sometime in 2008 and not begin recovering until 2009.

Shares of Countrywide fell 10.5 percent, or $3.56 yesterday, to $30.50. The stock steadily declined during the conference call, falling as far as $29.50 before recovering.

Countrywide’s earnings were the latest in a series of shocks that have rattled the markets in the last two months. Recently, Bear Stearns said two of its hedge funds were virtually worthless after brash bets on investments backed by risky mortgages with billions in borrowed money.

Last month, the usually optimistic Robert I. Toll, the chairman and chief executive of the luxury home builder Toll Brothers, acknowledged that housing might not rebound before April 2008. In early February, Mr. Toll had told Wall Street analysts the industry was “at the beginning of the comeback trail.”

Bond ratings agencies have begun to downgrade and re-evaluate mortgage securities, which has virtually shut down the market for certain debt offerings that specialize in home loans. That, in turn, has made it harder for some private equity firms to finance buyouts.

Countrywide, Wells Fargo and other lenders have also stopped offering a popular subprime loan that carried a fixed rate for 2 years and an adjustable rate for 28 years.

Investors are demanding more in return for holding junk bonds and yesterday pushed the yields on the securities to 8.4 percent, the highest they have been in nearly two years, according to KDP Investment Advisors, a research firm.

What was added to the worries yesterday was the idea that even credit-worthy homeowners would default on mortgages at higher rates as home prices fall — and that even a well-run company like Countrywide could be hit by big losses.

At the end of April, home prices were down 2.1 percent from a year ago, according to an index that tracks 20 large metropolitan areas compiled by the research firm Case-Shiller. That compares with an 11.2 percent increase from April 2005 to April 2006.

Countrywide said about 5.4 percent of the home equity loans to customers with good credit that it held an interest in were past due at the end of June, up from 2.2 percent at the end of June 2006. By comparison, more than a fifth of subprime loans were past due at the end of June, up from 13.4 percent a year ago.

“Where you will see prime borrowers have trouble is where they took the riskiest of adjustable-rate mortgages and put nothing down with a first and second combined,” Thomas Lawler, a housing economist, said.

Many of Countrywide’s home equity loans were second mortgages made to people who were financing the full or nearly full cost of their homes. These loans are particularly risky because when house prices are falling and a home is foreclosed and resold, the holder of the first lien is paid off and often there is little left to apply to the second mortgage.

“Countrywide is highlighting what is an industrywide problem,” said Christopher C. Brendler, an analyst with Stifel Nicolaus, an investment firm in St. Louis. A second mortgage “is really an unsecured loan like a credit card.”

Countrywide said its customers who are falling behind on payments appear to have lost jobs, had a divorce or fallen ill. Many are living in homes that are no longer worth what they were when the loan was made and cannot refinance because lenders have become stricter.

The company reported second-quarter earnings fell 33 percent, to $485 million, largely because it had to write down the value of loans and other assets by $923 million.

Another problem is how Countrywide pays Mr. Mozilo, 68, and one of the company’s two founders. Though he is considered a pioneer in the mortgage business, he has become a target for shareholder activists as more attention has focused on executive pay in general and on the lucrative rewards reaped by mortgage executives in particular during the housing boom.

On the conference call yesterday, one investor asked Mr. Mozilo how he could justify selling stock while Countrywide was buying shares, which have fallen.

In the last five years, Mr. Mozilo has exercised options and sold shares for a profit of nearly $380 million, according to data compiled by Thomson Financial. Starting last fall, Mr. Mozilo significantly increased the number of shares he was selling on a regular basis for profits of more than $130 million.

“The decision to buy back stock is a collective decision that emanates from the financial operation of the company and is based on what is in the best interests for the shareholders,” he said, noting that he has all the shares he received when he started the company nearly 40 years ago. “It’s totally unrelated to the issue of my sale of stocks.”

Cars make their way amid thick smoke and haze in Beijing, July 17, 2007. The affects of greenhouse gas ozone, which has been increasing near Earth's surface since 1850, could seriously cut into crop yields and spur global warming this century, scientists reported on Wednesday.

The affects of greenhouse gas ozone, which has been increasing near Earth's surface since 1850, could seriously cut into crop yields and spur global warming this century, scientists reported on Wednesday.
 

Ozone in the troposphere -- the lowest level of the atmosphere -- damages plants and affects their ability to absorb carbon dioxide, another global warming gas whose release into the atmosphere accelerates climate change, the researchers wrote in the journal Nature.

While carbon dioxide is blamed for global warming, it also has a beneficial effect on plant growth, and ozone counteracts this effect, said Stephen Sitch, a climate researcher at Britain's Met Office, which deals with meteorology.

"As CO2 (carbon dioxide) increases in the atmosphere, that stimulates plant growth," Sitch said by telephone. He noted that many scientific simulations that predict the impact of global warming have included this effect but "they haven't included the other effect, the negative effect of ozone damaging productivity."

Plants and soil currently slow down global warming by storing about a quarter of human carbon dioxide emissions, but that could change if near-surface ozone increases, the researchers said.

Projections of this rise in ozone "could lead to significant reductions in regional plant production and crop yields," they said in a statement.

Carbon dioxide's fertilizing effect can be powerful, Sitch and his colleagues reported, pushing global plant productivity by 88.4 billion tons a year.

This figure does not take into account the depressing effect of ozone; with that factored in, the fertilizing power of carbon dioxide is 58.4 billion tons, the scientists wrote.

Without accounting for increased ozone, earlier simulations have underestimated the amount of carbon dioxide that will remain in the atmosphere, Sitch said.

Ozone's damaging effect on plants means they will suck up less carbon dioxide from the atmosphere, leaving more of this chemical to contribute to greenhouse warming, he said.

"Carbon dioxide is the largest greenhouse warming gas but ... (ozone) is reducing plant productivity by an appreciable amount," Sitch said.

Ozone has doubled since the mid-19th century due to chemical emissions from vehicles, industrial processes and the burning of forests, the British climate researchers wrote. Carbon dioxide has also risen over that period.

Unlike carbon dioxide, which is directly caused by these human-spawned emissions, ozone is a so-called secondary air pollutant, produced by reactions with other chemicals like nitrogen oxide and carbon monoxide.

Tropospheric ozone is different from stratospheric ozone, which contributes to a protective layer high above Earth's surface that guards against harmful solar radiation.

Suspended in laser light, thousands of atoms pair up and dance, each moving in perfect counterpoint to its partner.

They are the building blocks of what may one day become an enormously powerful quantum computer capable of solving in seconds problems that take today's fastest machines years to crack, U.S. physicists said on Wednesday.

"You can do the equivalent of multiple classical calculations at the same time in the quantum world," said Trey Porto, a researcher with the U.S. Commerce Department's National Institute of Standards and Technology or NIST, whose work appears in the journal Nature.

Porto and colleagues have coaxed pairs of super-cold rubidium atoms to repeatedly swap positions, a feat that could make them useful for storing and processing data in quantum computers.

In today's computers, the smallest unit of storage is a binary digit or bit, which can only have two values -- zero or one. These form the basis of information storage in digital computing. When combined into groups of eight on a typical PC, these bits become bytes.

"In the quantum world, instead of just the possibilities of zeros and ones, you have a range of possibilities," Porto said in a telephone interview.

Quantum bits or qubits can also oscillate between the zero and one positions, like a half-flipped light switch. This flexibility could allow for many calculations to be carried out simultaneously, Porto said.

Porto's team isolated pairs of atoms in a lattice of light formed by six laser beams all fixed on one point, suspending the atoms in a uniform pattern. "There is no container. It is levitated by the laser beams."

They trapped these pairs in wells or dips formed by ripples in the light. When forced together in tight spaces, the atom pairs began to oscillate between zero and one, passing in and out of a state of entanglement.

Porto describes it in terms of two magic coins spinning in the air. "While they are spinning, these coins are correlated so that if one is heads up, the other is always heads down," he said.

So far, all the pairs are dancing the same tango. To be useful in a quantum computer, he and his team will need to figure out how to get different pairs to dance and spin independent of the neighboring atom pairs.

Porto's team is one of several around the globe working to develop a system that could support quantum computing.

"We're just demonstrating the most fundamental, basic unit of what you would need," he said.

The Food and Drug Administration on Wednesday said the rising number of cosmetics, drugs and other products made using nanotechnology do not require special regulations or labeling.
 

The recommendations come as the agency looks at the oversight of products that employ the design and use of particles as small as one-billionth of a meter. There are fears by consumer groups and others that these tiny particles are unpredictable, could be toxic and therefore have unforeseen health impacts.

A task force within the FDA concluded that although nano-sized materials may have completely different properties than their bigger counterparts, there is no evidence that they pose any major safety risks at this time.

"We believe we do not have scientific evidence about nano-sized materials posing safety questions that merit being mentioned on the label," said Dr. Randall Lutter, FDA's associate commissioner for policy and planning, during a briefing with reporters.

As least 300 consumers products, including sunscreen, toothpaste and shampoo are now made using nanotechnology, according to a Woodrow Wilson International Center for Scholars report.

The technology is also being used in medicine, where scientists are developing tiny sensors that detect disease markers in the body, and in the food industry, which is using it to extend shelf life in food packaging.

The FDA now treats products made with nanotechnology the same way it handles all products -- requiring companies to prove safety and efficacy before their product can come to market.

But some product categories, such as cosmetics, foods and dietary supplements are not subject to FDA oversight before they are sold, which already worries some advocates. Producing them with nanotechnology adds another layer of concern.

The International Center for Technology Assessment, a nonprofit policy group that is suing the FDA calling for more oversight over the technology, said the recommendations lack teeth.

"Nano means more than just tiny. It means these materials can be fundamentally different, exhibiting chemical and physical properties that are drastically different," said George Kimbrell, staff attorney at the group. "The consumer is being made the guinea pig."

The group sites studies showing certain types of the particles can cause inflammatory and immune system responses in animals as an example of possible dangers.

The FDA said it will soon issue guidance documents for industries using nanotechnology, which include pharmaceutical companies, medical device makers and consumer products firms.

Lutter said the task force concluded that nanotechnology is not substantially different from earlier emerging technologies such as biotechnology or irradiation.