What is Countrywide Worth?

Last summer I wrote two posts on Countrywide: Absurd CFC Rumor Presents Shorting Opportunity (August 21, 2007 with CFC at $21.79) and Why Countrywide is Done (August 28, 2007; $19.31).

My view then and now is that CFC is a zero barring a government intervention/giveaway like the Bear Stearns deal:

I just saw something that makes me much more confident in my Countrywide short and put options position. The manager of Second Curve Capital appears to be a Countrywide sympathizer.

Today in the WSJ I see that this viewpoint is continuing to take hold:

Investors remain skeptical that Bank of America Inc. will end up acquiring Countrywide Financial Corp. at the estimated $7.16 a share price agreed to months ago, and the company’s stock is continuing to sink in trading today.

Wednesday, Standard & Poor’s equity analysts chimed in, saying they believe Bank of America “will renegotiate a lower price due to large losses in CFC’s loan portfolio.” They value shares at $6 a share, on the expectations that the deal will be reworked.

In their research note An Involuntary Transaction: Why BAC + CFC May Never Close, Institutional Risk Analytics writes, "Given the outline above, our view is that the equity of CFC is worth $0."

I have no position in CFC but I own puts on a number of other lenders: BKUNA, CNB, COF, DSL, and SOV.

Two Funds Dump Countrywide; Legg Mason Catches Falling Knife

Two of Countrywide Financial Corp.'s largest shareholders said in regulatory filings Monday that they have cut their stakes in the mortgage lender...

AllianceBernstein LP had been the largest stakeholder in Countrywide, but it dumped 40 million shares in August.

Barclays Global Investors NA dumped almost 25 million shares.

Meanwhile Legg Mason is buying. They liked it at $30 and they like it even more under $20. They will probably get really excited about buying at $10.

You know you're subprime when...

A classic from Broker Outpost: "You know you're subprime when,"

• When the lender I used for your purchase is now out of business and now we cant get out of your 80/20 that is about to adjust to 12%?

• When you need a stated income letter from the borrower stating what they do for a living (ameriquest) and they fax you "I HAVE A JOB. Signed Joe Borrower."

• Your borrower walks in to your office in his Waffle House uniform and wants a stated income loan.(happened)

The Loan Officer Forum at Broker Outpost is a gold mine for finding out what was going on in the mortgage business during the bubble. You can find out that Countrywide would allegedly loan 95% LTV to a 590 FICO with no tradelines.

Why Countrywide is Done

First of all, the rumor about Buffett buying Countrywide turned out to be wrong, as usual.

Second, the Bank of America investment produced a huge pop that instantly faded once people realized what a desperate move it represented for Countrywide.

An article in today's New York Times: Inside the Countrywide Lending Spree.

Countrywide has a huge presence in California: 46 percent of the loans it holds on its books were made there, and 28 percent of the loans it services are there.

But Countrywide documents show that it, too, was a lax lender. For example, it wasn’t until March 16 that Countrywide eliminated so-called piggyback loans from its product list, loans that permitted borrowers to buy a house without putting down any of their own money. And Countrywide waited until Feb. 23 to stop peddling another risky product, loans that were worth more than 95 percent of a home’s appraised value and required no documentation of a borrower’s income.

As recently as July 27, Countrywide’s product list showed that it would lend $500,000 to a borrower rated C-minus, the second-riskiest grade. As long as the loan represented no more than 70 percent of the underlying property’s value, Countrywide would lend to a borrower even if the person had a credit score as low as 500. (The top score is 850.)

You can bet that any loans like this are underwater and the borrower is going to default. If you read the "If Only I Waited" posts from Bubble Markets Inventory Tracking, you can see that a 30% equity cushion based on the 2005 price of a California house is now no cushion at all.

That is why default rates and recovery rates are inversely correlated. Countrywide has so much Real Estate Owned that they will have to accept terrible prices to get rid of it.

The company would lend even if the borrower had been 90 days late on a current mortgage payment twice in the last 12 months, if the borrower had filed for personal bankruptcy protection, or if the borrower had faced foreclosure or default notices on his or her property.

...Countrywide was willing to underwrite loans that left little disposable income for borrowers’ food, clothing and other living expenses. A different manual states that loans could be written for borrowers even if, in a family of four, they had just $1,000 in disposable income after paying their mortgage bill. A loan to a single borrower could be made even if the person had just $550 left each month to live on, the manual said.

The bullish argument on Countrywide goes: Countrywide is so big that they will be the only lender left standing and will gain huge market share.

Mortgage lending is a commodity business. Lenders don't have valuable brands. They attract business by offering a competitive rate (the prime model) and/or by not asking borrowers very many questions (the Alt-A model).

In fact, many people hate Countrywide. And the NY Times article suggests that their business model was to abuse their customers.

When Congress holds hearings about the housing collapse, which they will but only well after the horse is out of the barn, they will be looking for companies to pillory.

If Countrywide is still around, it will be a perfect target.

Edit: I just saw something that makes me much more confident in my Countrywide short and put options position. The manager of Second Curve Capital, appears to be a Countrywide sympathizer. That article is a straw-man argument that knocks down the least damning elements from the New York Times article.

Second Curve gets fawned over for its "branch hunts" where the hedge fund staffers go around to bank branches to examine their customer service. Good idea, except that if you ignore what the bank is investing its deposits in, you make mistakes. After all, Second Curve owned New Century stock.

Tom Brown quote:

"Given the level of investor panic surrounding the subprime borrower lately, I'm feeling very greedy regarding subprime lenders these days, and am especially greedy over subprime-mortgage lenders," Brown wrote on Feb. 27. "This is one of those times in investing, I believe, when it will pay to be very, very aggressive."

Absurd CFC Rumor Presents Shorting Opportunity

This rumor was printed in the WSJ and hyped to death all day long on CNBC. The actual wording was "Some investors speculate Berkshire could be a buyer for parts of mortgage lender Countrywide Financial Corp..."

There is no substance to this story. Unnamed people are speculating that something could happen. So this is just a rehash of the rumor that Buffet was going to buy HOV. Look how that turned out.

WB likes to buy companies with strong, trustworthy management and leave them in place.

Meanwhile, "Examiners from the Office of Thrift Supervision, which regulates Countrywide Bank, recently set up a full-time presence in a conference room at the Calabasas, Calif., headquarters of Countrywide Financial..."

Incentive Incompatibility at Mortgage Brokers

From a recent Washington Post:

"Maggie Hardiman cringed as she heard the salesmen knocking the sides of desks with a baseball bat as they walked through her office. Bang! Bang!

'You cut my [expletive] deal!' she recalls one man yelling at her. 'You can't do that.' Bang! The bat whacked the top of her desk. As an appraiser for a company called New Century Financial, Hardiman was supposed to weed out bad mortgage applications. Most of the mortgage applications Hardiman reviewed had problems, she said.

But 'you didn't want to turn away a loan because all hell would break loose,' she recounted in interviews. When she did, her bosses often overruled her and found another appraiser to sign off on it.

'There was instant notification to everyone as soon as you rejected a loan. And you dreaded doing it because you paid for it. Two guys would come with a bat, and they were all [ticked] off because you cut their deals.'

This sounds like something out of The Sopranos, except it was happening at the nation's third largest subprime lender, which wrote tens of billions in loans.

It's really not that surprising. This story could have come from a book about S&L Crisis I.

Savings & Loan Crisis I

New Century's financing was provided by its warehouse lenders: big investment banks. They pulled the plug once the subprime problem became obvious.

In contrast, the banks and S&L's mortgage portfolios are financed by depositors - owners of savings accounts or CDs. And these depositors needn't worry about what management is doing with their money, since the federal government guarantees that they will be made whole.

"The major indirect cost of deposit insurance comes from its potential to subsidize inefficient types of bank risk-taking. Deposit insurance undermines the incentives of depositors to monitor and police bank risk-taking. This is the problem of moral hazard..." (Kane 2002[pdf])

This problem of moral hazard has occured before:

"Back in the early 1980s when Ronald Reagan deregulated the savings and loan industry, Texas became the nation's biggest cesspool of S&L crookery. At the core of their thieving strategy was a little trick they described thusly: 'A rolling loan gathers no loss.'

"These wily Texas coyotes had figured out a win/win situation. S&L operators could help their buddies "borrow" money from their S&Ls, not pay it back, and still allow the S&L to book loan fees and other profits, upon which the S&L executives based their salaries and bonuses.

"Ah, you say, but wouldn't bank regulators notice that the loans were in default? No. Because each time a loan came due the S&L would "roll it over" -- renew it -- adding all interest due into the new loan and booking it as income. The loans got bigger and bigger, and never got paid off. The bankers got rich, the borrowers got rich, American taxpayers got the bill. A classic Texas "win/win" business deal."

This is from Stephen Pizzo's blog. He is the author of Inside Job: The Looting of America's Savings and Loans. There are a couple of choice pieces from the book:

"Of the 56 banks that failed in the U.S. between 1959 and 1971, 34 had passed their most recent examination in a 'no-problem' category, and 17 of the 34 had been given an 'excellent' rating." (Rep. St Germain, qtd in Pizzo p. 475)

"Buttoned-down appraisers, plugging along in boring jobs... learned that by simply raising their opinion of a property's value to match a borrower's needs or desires, they could raise their own standard of living as well - and the higher the opinion, the bigger the paycheck."

The parallels here are too numerous to count. Decades from now, it will be difficult to remember the difference between S&L Crises I and II.

Meanwhile, while I was on a long road trip and hence not posting, Cramer was pounding the table about these garbage stocks. Anyone who doesn't already know about his track record can look at this previous post.

I didn't make any trades as a result of the rally in these Alt-A stocks. You can look at the data coming in at the Crucial Credit/Housing Sites and see what is really going on.