Countrywide Financial Corp.

 

Please see disclaimer at bottom of this document

 

 

Countrywide Financial Corp. (CFC)

Investment Notes

 

 

Countrywide Financial Corporation (CFC) is a diversified financial service holding company engaged primarily in residential mortgage banking and related businesses. It operates in five segments: Mortgage Banking, which originates, purchases, securitizes and services mortgage loans; Capital Markets, which operates as an institutional broker-dealer that primarily specializes in trading and underwriting mortgage-backed securities; Insurance, which offers property, casualty, life and credit insurance as an underwriter and as an independent agent; Banking, which operates a federally chartered bank that primarily invests in mortgage loans and home equity lines of credit primarily sourced through its mortgage banking operation, and Global Operations, which provides mortgage loan application processing and mortgage loan servicing. During the year ended December 31, 2005, the Mortgage banking generated 59% of the Company's pre-tax earnings.

 

 

 

September 8, 2007  "Ramblings"

 

Here is some stuff I have been thinking, etc. most of below is about Berkshire and CFC rumors.

I saw a press release yesterday about CFC situation. it appears to be removed from their site. I didn't even notice they "postponed" investors day on 9/5 and 9/6.

Here are some things I came up with in regards to CFC.  I have thought about the CFC case quite a bit with Berkshire. Here are a few ramblings:

1. Mozilo, in my opinion, opted for the short term, and sacrificed business model, models that have existed for 100's of years, and has potentially sacrificed CFC as a going concern in the future. Stanley Kurland left the company a little over a year ago. I questioned if the move had to do with potential ratings discussions, or any type of concern for CFC by Kurland.

2. Mozilo via his compensation, has been raping the shareholders. He has made over $100M in compensation over the last few years. He showers himself with golden rewards of cash.

3. He sells shares in his company religiously and with materiality.

4. He might not be such a straight shooter. Comments such as "I am surprised." or "No one came up to me and told me things would get real bad." How do I know that is not so, because I talked to him, at length, in a public forum in September 2006.

5. What does CFC have that Berkshire would want? Plenty

When rumors were going around about CFC and Buffett, I would often think about it. I knew that Mozilo and Buffett didn't seem right. But, I thought that Berkshire could lay claim to the assets and ownership of CFC , via Wells Fargo, BAC or USB. Ultimately, I think that Berkshire in some fashion will own a bit of CFC (probably indirectly via BAC, or perhaps a future consortium, which could include WFC and USB. I am sure that WEB would be fine with BAC (whom I just am not familiar with, but just think of them like WFC, and I do that with really no knowledge of BAC philosophy etc.)

I think that current balance sheet wise, we could see that CFC is actually insolvent. Yet, couldn't BAC make a deal, say, buy the remaining (80% or > ) of CFC for say $4B. They could do this by negotiating with the creditors, banks, investment houses and investors of the paper that CFC owes. In turn, if BAC or like, were to take over, they do it with an arrangement with current creditors, that gives them some remuneration ( a lot less than planned, and ultimately an awful investment for those investors). Meaning if CFC sold a securitized high rated pool of Alt A Option Arms, for say 1.03, well maybe BAC says, we will pay you as though you paid 0.75. At the same time BAC says, "no problemo securitizer asset loaded to the rim dude, we will just split this scene, and you could get substantially less than what we are offering. Take it of leave it, to be blunt, we don't care."

Hence, I am thinking a BAC type could take over the servicing section of CFC and own the very large and I am sure, when structured conservatively, look to the long term, severe profit streams. They could also absorb the current $200b of assets, but only absorb them at their "mark to market" that buyer ( conduit of Berkshire) is comfortable with. This is where Berkshire comes in. They could probably price these vehicles to own as good as anyone. Yet, they can be generous on their stress factors, which would minimize the price they would buy these "marked down assets." Once they own it, a few years go buy, and the "mark" of distress is lifted, and BAC (Berkshire) would secure a profitable future revenue stream, with the typical Berkshire lower risk profile. What I mean is that on all mortgages and assets bought by BAC (synonymous for Berkshire conduit), there is a certain price, that includes reasonable stress levels. Reasonable stress levels, like hurricane insurance after Katrina and such, would have greater than normal uncertainties, and on the pricing of these assets, conduit buyer take advantage of low prices, and at the same time show reasonable attempt to give a fair price to current owners and creditors of CFC and related debts. Maybe there is a way to deal with the buyers of these "bankruptcy remote qSPE's"


Summing it up Mozilo and Buffett,  do not seem like a fit. CFC is better off without the leaders (even the founder) that pay such great personal compensation packages, used incompetent judgment in their business model, etc, etc. But, BAC and WFC have that expertise, and we could see a means where indirectly WEB takes over an entity, by use of a conduit subsidiary or material investment where they have an influence on (WFC), BAC or USB , for now). Buffett wouldn't come in and run the place ala Solomon, but he could have a company that already is a leader in the industry do it.

They can save the world ;-)

 

August 21, 2007  "Note of mine to NY Times"

I would like to talk with you about Countrywide's ALT A and Option Arm situation. I brought the advertisement in from NY Times today and Countrywide had a full page.  I found the following odd:

 

 1. CFC mentioned investment grade credit rating...... my response...they have for a long time bragged about their high credit rating. they didn't mention "oh, just last week, most rating agencies downgraded us, two (2) full notches." If you go to the www.nasdbondinfo.com you will see that Moody's does not rate them investment grade. I think they rate them Ba2 , which I think is, 'spec" could be wrong. I think all ratings agencies also have them on credit watch negative.

 

2. The ad mentioned that they have over $100 billion in assets. They didn't mention the quality of the assets. option arm mortgages, lots of non FNMA stuff.  They  didn't mention that they have assets / equity in excess of 15X. 

 

3. If gain on sale disappears, earnings  turns into material loss.

 

4. If assets marked to market, decrease 5%, then CFC would lose about $6 bil in stockholders equity.

 

Question for you. Do you think fed lowered the window, to stop a run on CFC on Friday. Feel free to call me, day or
night

 

August 16, 2007 -  quick thoughts and note to NY Times in regards to their call to me on Countrywide
 

 

 

July 28, 2007 -  quick thoughts

 

1.     I do suspect that securitizers are requiring a materially higher OC, retained interest now.
 

2.    with such a slow down, and with wider spreads, etc, how are Gain on Sale so large in 2Q07, for many of the banks, at least the ones I was (am) short, being DSL and CFC. I materially reduced those shorts, and did fully cover FED.  I suspect Gain on Sale margins will soon materially reduce.

 

3.   CFC  in my view is not suffering from a 6 sigma event. One issue for them is sub prime, for sure. The other is that they are holding these marked to market (or marked to model) assets, and these assets are at around (going from memory here) about 10X shareholder equity. hence, a little disruption on the mark, goes a long way. Also, the seasoning of Pay option loans next year, might cause some increased defaults, and I am not so certain the reserve is proper.
 

4.    I am thinking is that based on not only the environment for loans, but also the potential concern of CFC's leverage, quality of assets and so forth, that securitizers are requiring a step down on how much they will pay for bonds, and some type of mechanism that puts CFC more at risk in a similar fashion as over-collateralization (OC).

 

5.    CFC, with their leverage, and what I consider to be a potential quality of assets and reserve issue, would feel stress, exacerbated by their leverage if they have been "marking to high" and/or "reserving to little."

 

6.    5 years ago, CFC assets (and liabilities ) looked so much different. I mentioned previously that a major ratings agency and I spoke, and I was surprised they weren't modeling potential future distress in Alt A Option Arm loans for CFC. This type of loan is huge for CFC and a huge Marked to Market asset. (yet, they now might move to investment and then "lower of Cost or Market" takes over, but that is a whole different story). Anyway, the ratings agency said, "we monitor by timely payments in our daily tapes." what I think they were missing, was the fact that option arms, can for 4 years (+/- a year or so), will continue with very low payments, and default would be difficult. So, it is a live and learn, even for the best in the business.

 

 

July 26, 2007 - further research on CFC results

Further research was warranted by comment received about our concern of MSR's affecting the gain on sale. Upon further review, our thesis was correct that CFC was retaining more of the securitized loans. However, we were looking for capitalized MSR's. This terminology is incorrect and we should have been calling it retained interests. Reviewed the 1Q07 10q (2nd qtr not yet released) for retained interest and found that the retained interests did increase $548M over 1Q06 (224%).

Any creation of a retained interest appears to resulted in a gain on sale. These retained interests are to be valued at FMV and should regularly re-valued for Marked to Market. Bear Stearns recently received no bids when they attempted to sell mortgage obligations. Interesting to see impairment, if any, recognized by CFC in the 2nd qtr.


 

July 25, 2007  -  Business Week claims Ronald Redfield has "Gumption."

 

I was concerned as I first fell upon this article.  Then I looked up the word, "Gumption", and found out it means, "Boldness of enterprise; initiative or aggressiveness. Guts; spunk. Common sense."    Here is a cut and paste from an article at www.businessweek.com  from July 25, 2007

 

 Cashing In at Countrywide

"Posted by: Dean Foust on July 25

For all the buzz over Countrywide’s poor earnings report on Tuesday and CEO Angelo Mozilo’s bearish comments about the housing market, I think we’d be remiss if we didn’t discuss the elephant in the room: The fact that Mozilo was an aggressive seller of Countrywide’s stock during the past year: By the count of New York Post writer Paul Tharp, Mozilo has sold $118 million in options since last December.

That’s notable because during the same period, Countrywide was buying back its own stock (which critics argue could have had the effect of providing a cushion under the stock during the period that Mozilo was selling. If you want to see a list of all of Mozilo’s stock sales, click here at BusinessWeek’s new Company Insight Center, which (shameless plug alert) provides a wealth of information about public companies and the executives who run them.

I don’t often put much stock in the so-called “earnings calls” that companies hold with Wall Street analysts immediately after each quarterly earnings report, given that the majority of analysts are terrified of asking tough questions lest they offend the CEO and lose their access. But one investor, Ronald Redfield of Redfield, Blonsky & Co., a small New Jersey CPA and investment firm that appears to be short Countrywide’s stock (see commentary here that Redfield posted on his web site a week before Countrywide reported earnings), had the gumption to question Mozilo about the sales. It was an interesting exchange. Mozilo briefly defended the sales, but you could tell the question was eating at him because at the end of the earnings call, he brought it up again. Here’s the exchange:

Ronald Redfield - Redfield, Blonsky & Co.: Were there any buybacks during the quarter? Do you find, Angelo, with all respect, you selling a material amount of shares into buybacks? You previously mentioned you own 10 million shares. How many shares do you currently own, not including options?

Angelo Mozilo: I don't know the answer to that question. I own -- including options, I think around -- I think it is around 11, 12 million, something like that. The sales of the stock had nothing to do with buybacks because that 10b5-1 agreement was made well over a year ago.

Ronald Redfield - Redfield, Blonsky & Co.: No, the legality is fine, but one can think that perhaps the price is being held up the buybacks creating a demand.

Angelo Mozilo: Yes, well, if you think like that it's -- I don't think like that. The buybacks were done because we thought it was in the best interest of shareholders. I have -- as somebody pointed out, I'm 68 years old, I own a lot of shares, and I have 10b5-1 that is in process right now. That is selling into this market when the buybacks are not holding it up.

So it is an independent issue that is not relevant to buybacks or not buybacks. It is a personal situation that I'm selling into a market no matter where the price of the stock is.

The call continues as other analysts ask questions, and at the conclusion, Mozilo says this:

Angelo Mozilo: Okay, some final comments. One to the individual who asked about my sale of stock. The decision to buy back stock is a collective decision, really emanates from the financial operations of the Company as to what is the best return for the investment of the shareholders, invested capital for the shareholders. So it is totally unrelated to any of my issues relative to the sale of stock.

Secondly, as I said, I don't know the exact amount of shares that I have. But the shares that I have, actual stock I have, I have retained for 39 and a half years. Not sold a share of the initial stock that I got when Dave and I started this Company that I got, that I purchased.
The only thing that is being sold under the 10b5-1 are options with expiration dates.

END OF CALL"
 

 

 

July 25, 2007 - notes reviewing 2Q07 8k and conf call

Neg am income about the same vs. 1Q07-6.33% of total interest income and 7% in 1Q.

Delinquencies and loan losses continue to increase. Loan losses increased to $103,475 from $38,649 in 1Q07.

Gain on sale remained strong and represented 300% of net income. From the call, CFC was only able to sell the prime loans. Contradicted each other several times at various times during call as to credit spreads tightening or widening. Sense that they are not quite sure where the credit market stands and how long the difficulty in selling loans will last. The gain on sale may have been influenced by the increase MSRs during the quarter. we are speculating that in order to get the sale done, more loans had to be retained.

Mozilo noted in call that increased delinquencies were due to economic reasons (unemployment, price decline, etc.), and not resetting of variable rates. Later in the call, David Sambol mentioned that delinquencies could have been worse if not for the economy. Later, the delinquencies and foreclosures were due to different situations in various regions.

Mozilo noted that the tough environment would last thru the end of 07 and stabilize in 08. That was his estimate. Take away is that the end of the tough period is not in sight but CFC did provide a big dose of reality for the industry outlook and I was surprised that so many analysts seemed to be taken aback by the difficulties.
 

 

 

 

July 18, 2007 (34.94) Notes from http://www.fpafunds.com/news_070703_absense_of_fear.asp

“There have been several studies as to how inflated housing prices had become prior to the present correction. According to the work done by Gary Shilling’s firm, home prices would have to correct between 22% and 28% to return to the equivalent of the median asking rent or to the trend line of the CPI. Prior to 1996, both of these measures approximated the rate of increase in home prices. According to Robert Shiller of Yale University, his real quality-adjusted existing house price index would have to correct nearly 45% to bring it back into alignment. My initial reaction to this estimate was one of disbelief and that it appears excessive; however, home prices would appear to have a considerable way to fall, given the high level of total homes available for sale. With nearly 4.5 million homes for sale in 2007, this compares to an average of approximately 2.5 million homes since 1990 or an excess of approximately 2 million homes. Since 1965, the median dollar volume of single-family homes sales as a percentage of nominal GDP has averaged 8.4% versus 16.3% at the 2005 peak, according to Northern Trust Global Economic Research.”

“Two years ago, we noticed a problem developing in our bond portfolios involving Alt-A securities. Despite having average FICO scores of 718 on the underlying loans, these securities experienced rapidly escalating delinquencies and defaults after just nine months. We sold them since we did not want to wait around to find out the reason why this was happening. Our worst fears were recently confirmed in a study by First American Financial entitled, “First American Real Estate Solutions Report, Alt-A Credit—The Other Shoe Drops?” This report shows the following changes in underwriting standards between 1998 and 2006, with the major changes occurring in the last two or three years:

· ARM % of originations rose from 0.7% to 69.5%
· Negative Amortization rose from 0% to 42.2%
· Interest Only rose from 0.1% to 35.6%
· Silent Seconds rose from 0.1% to 38.7%
· Low Documentation rose from 57% to 79.8%
· FICO scores were essentially unchanged at an average of 706.

What is interesting is that the origination volumes for the last two years, when the most egregious deterioration in underwriting standards occurred, total more than the previous seven years of originations combined. Of further interest, Dale Westoff, senior managing director of Bear Stearns, Inc., estimates that 25.8% of sub-prime and 41.2% of Alt-A originations were in California; the combination of these total 33.7% of the total sub-prime/Alt-A universe. For 2006, sub-prime/Alt-A represented approximately 40% of total mortgage originations. I reference this Alt-A underwriting data because I believe it reflects the wider trend of underwriting deterioration throughout the entire mortgage universe. Because of a laxness in credit underwriting standards, along with an accommodative Fed, the housing price bubble was magnified and, thus, it has spread into the asset-backed securitizations market. “

“A recent example of the flawed nature of this market came to my attention when my associate, Julian Mann, showed me a very garden variety LIBOR sub-prime floating rate security. A major pricing service valued this bond at par, while on March 19, 2007, one of the major rating agencies rated this bond A3. To affirm the accuracy of this bond’s pricing, we went to two brokerage firms that traffic in this type of security and requested what their bid might be, if we owned this security. One responded with a $7 bid. In other words, a 7% of par bid, a difference of 93% to the pricing service. The other firm declined to bid, but they did indicate that, if they were to, their bid would have probably been around this level. Julian has found several other similar examples, so this one does not represent the proverbial “needle in the haystack.””

 

Just Some Ramblings

 

 

Certain banks make loans, using non traditional financing, and giving loans to individuals which typically would not have gotten loans in past. This is not merely sub prime, but also Alt A. (Alt A is formerly sub-prime, but changed name for a new tier). Reserves are at an all time low, where as risks seem higher.  Entities (builders and developers) also, I suspect are getting loans, based on "what will be after project is completed, rented or sold. Reserves are at an all time low, where as risks seem higher.

We are short FED, DSL and CFC, all for the same reasons. They all have a material part of their net income tied into income recognized in mortgages, and cash not being collected. CFC also makes a lot of money on securitizing their loans. Our thesis is this securitization  will materially slowdown, and that stress of option arm mortgages (payment optional kind of) will be greater than modeled. Balance sheet write downs of loans held for sale and for investment. I think CFC has 12:1 Assets to Equity.

 

Historically, banks have made money by getting your money, paying less interest, and loaning it out for longer periods of time, and collecting greater interest. CFC it appears, in recent years,  has deviated from  that history. CFC  now reports earnings, yet  not necessarily are they collecting money and at the same time, their reserves are lower than historical. They also make a ton on selling their loans, this is called "Gain on Sale" via securitizations. Now that credit spreads have widened, this "Gain on Sale, should be less. Once sold, they have forfeited future interest income. If loan defaults or prepays, they may have to reverse gain on sale previously picked up. They also carry a huge amount, compared to equity, of Mortgages as investment, which are reported quarterly at "lower of cost or market" and Mortgages held for sale, which is "marked to market." I theorize that many are not liquid, hence mark to market is suspect. Playing devils advocate, even if liquid, markets have dropped, and I think that will be evident on many banks reportings for  June 30 , 2007 (due 8/15/07).

Watch the total assets on the banks and brokerages. If they start dropping, does American liquidity start to get tighter? Now liquidity is great, when he goes home, it could be great as well.

 

You could look at our notes on that and see the following:

1. Gain on Sale income has been on average, from F2003 - F2006, around 200%. In theory, that ratio looks like it could drop in F2007, even though is is 284% at 1Q07. Nevertheless, something to watch, especially as we know credit spreads have widened.

2. If you look at negative amortization you will see " % Non Cash Interest Income / Total Net Interest Income", in 2003 was not material (0.00%) and is now 27.5% of NI before taxes. In 1Q07 that amount rose to 41%.

3. Insider selling has been brisk. For most of the insider selling period, you have had company buybacks in the ratio "buybacks/insider selling) of about 3:1. Just mentioning and not insinuating a thing.

4. As of May 31, 2007, nearly 1% of all cfc serviced loans are in foreclosure.

 

5. Insurance division seems to be much more profitable than traditional insurance companies.  When I mention this, I am not at all focusing on mortgage insurance, but focusing on Balboa.  The potential exists that they are being too aggressive with their assumptions.

 

 

I think we are all starting to realize that the analysis of CFC is  real difficult. If it weren't that difficult, the ratings agencies would have gotten it correct. I don't blame them one bit for their lack of correctly modeling the increased stress on the system. . This was new to them. Look at the velocity since 2004. I was at a securitization conference in February. A major securitization and banking analyst for one of the major agencies, told me they were not at all stress testing negative amortization  loans.  If the loan was current, they were modeling all was okay.   The data they were using in my opinion, was skewing the loans to look more favorable than actual, more favorable than history. Why is that? My guess is that the loans were performing, because one will not default till seasoned. Why would you stop paying on the negative amortization loan . In a negative amortization home, you can live super comfortable for 53 months, and hope things work out before them.  So, I think the major agencies are now modeling negative amortization. The ratings agencies are evolving. It's just natural. Yet, we see some recent Countrywide securitizations (as recent as Friday) be rewarded Aaa. One thing is for certain,  every ratings agency and most banking analysts, know a lot more about this stuff than me.

I do think CFC will feel some balance sheet stress. I think CFC will at a minimum feel pressure from their ratings agencies.

 

None of above is recommendation for any investment, just sharing some thoughts. sorry if errors.

 

 

 

 

 

 

June 21, 2007  (37.66)

 

Review of 2006 10K and March 2007 10Q

 

1. CFC sells 85%-90% of originated loans and has benefited from gain on sale of those loans. This % is very high compared to DSL and FED. 1Q07 gain on sale represented 284% of net income for CFC while DSL was 19% and FED was 9%. See #6 below.

 

2. Efficiency ratio reported in q much lower than calculated—why? CFC reported efficiency ratio includes banking operations only. The 22% reported is very good by industry standards-someone at Ryan class told me Hudson City Savings Bank was around 19% and that was thought to be excellent and as low as he had seen. Maybe overhead costs not being allocated to banking divisions fairly so the efficiency ratio might not be reliable.

 

 

3. Pre-tax earnings decline 37% March 07 vs. March 06. Divisional allocation of pre-tax earnings also reflected significant changes:

 

Division	March 2007 % of pre-tax earnings	March 2006 % of pre-tax earnings
Mortgage Banking	14.3%	49.6%
Banking operations	41.1%	30.5%
Capital Markets	18.9%	13.9%
Insurance	25.6%	05.8%
Other	00.1%	00.2%

 

 

 

4. CFC gain on sale of loans accounted for 285% of net income in March 07 versus 199% of net income in March 06 and 212% for year end Dec 2006.

 

5. Negative amortization included in loan totals was $815.8M as of March 07 and $654.0M in Dec 06, an increase of 20%. DSL and FED analysis showed a greater negative amortization  % as % of interest income. 1Q07 CFC negative amortization income represented 40% of net interest income (17% in 1Q06) while DSL negative amortization was 62% of net interest  income and FED was 46% of net interest income.

 

6. American Banker chart (6/25/07) showed CFC foreclosure rate was up to .9% as of May 2007. The 6/25/07 issue also had an article detailing recent bond market problems and noted that the likely outcome would be tighter margins and higher securitization costs. Investors will demand higher yields leading to “pressured gain-on-sale margins and more residual write-downs for originators”. Need to watch how this affected (or will affect) CFC in the 2^nd and possibly the 3^rd quarters of 07.

 

7. 46% of CFC loans held for investment are for California properties. This could be an area of concern if CA economy falters. Recent unemployment report showed an increase in CA unemployment from 4.8% to 5.2%.

 

8. Being so large will possibly give CFC an opportunity to pick up market share as other lenders falter.

 

Reporting: hard to get a handle on the $ amount of delinquencies. CFC reports on option arms and negative amortization but not sure about total portfolio.

 

Annual CFC Metrics

 

	2006	2005	2004	2003
Conventional Loans  % $ Volume	77.10%	79.20%	76.90%	84.10%
Nonprime Loans  % $ Volume	8.70%	8.90%	10.90%	4.60%
FHA/VA Loans % $ Volume	2.80%	2.10%	3.60%	5.60%
Non Purchase Transactions % $ Volume	55.00%	53.00%	51.00%	72.00%
Adjustable Rate Loans % $ Volume	45%	52.00%	52.00%	21.00%
% Loans Pending Foreclosure	0.65%	0.44%	0.42%	0.43%
	2006	2005	2004	2003
Average FICO Scores	718	720	730	not avail
Negative Amort / Net Interest Income	27.31%	5.25%	0.07%	0.00%
Negative Amort / Gross Interest Income	6.09%	1.55%	0.03%	0.00%
Average Loan To Value At Inception	75.00%	75.00%	73.00%	not avail
Average Loan To Value Current
Total Assets	199,946,230	175,085,370	128,495,705	97,977,673
Average Assets (presented in K)	80,763,154	61,324,821
Average Earning Assets  (avg. total loans from K)	79,748,333	60,686,976
Stockholders Equity	14,317,846	12,815,860	10,310,076	8,084,716
Average Equity (presented in K)	5,505,439	3,989,372
Stockholders Equity to Total  Assets	7.16%	7.32%	8.02%	8.25%
Average Equity to Average Assets	6.82%	6.51%	#DIV/0!	#DIV/0!
Average Assets to Average Equity	14.67	15.37	#DIV/0!	#DIV/0!
Negative Amortization on All Loans	$653,974	$74,748	$29
Negative Amortization loans  as % of all single family homes	????	????	????	????
	2006	2005	2004	2003
Total Interest Income	$12,056,043	$7,970,045	$4,645,654	$3,342,200
Total Net Interest Income	$2,688,514	$2,353,620