Section 2 - FTSE

PROFILE: COUNTRYWIDE FINANCIAL
54
Kenneth Bruce, a highly regarded analyst at Merrill Lynch
who, for 13 years, worked in the banking industry (including
two years at Countrywide), agreed and reiterated a buy rating.
Two days later, in mid-August, Bruce reversed himself and
issued a sell rating, warning that Countrywide could go
bankrupt if it could not continue borrowing money to fund
its portfolio. Neither his upbeat note nor sell rating was
intended for the public. “Those notes were proprietary for
our clients,”says a Merrill Lynch spokeswoman. “We did not
send them to any media.”Bruce’s alarm triggered a sell-off in
not only Countrywide stock, which fell 13% one day and
then 11% the next, but in mortgage-related securities of all
kinds. There was a
week-long run on
Countrywide Bank,
CFC’s wholly owned
thrift that has about 100
offices across the US.
The $50bn in ready
credit that Mozilo
touted had evaporated.
He scrambled to pull
together a financing
package. One report
said he was offered 30day
money at 12.5%,
the financial equivalent
of hara-kiri. Pundits
opined that CFC was
too big to fail — after
all, it originated one in six home mortgages in the US. The
stock traded as low as $15. On August 17 Mozilo
announced he had secured a financing of $11.5bn from a
consortium of 40 banks. This failed to ease market fears.
Every month Countrywide made $41bn in mortgage loans,
and to finance these it relied upon turning over $13bn in
commercial paper. The new funding fell short of
Countrywide’s needs. Paul J Miller, an analyst at Friedman,
Billings, Ramsey & Co., predicted that if the liquidity crunch
lasted more than a month, Countrywide would be forced to
sell assets at a deep discount to remain in business.
As we’ll see, he was right. First though, Mozilo announced
that Countrywide Bank—the company’s wholly owned
federal savings bank—would speed its expansion in order to
fund home loans with deposits. As McMahon notes, this is
relatively easy because Countrywide Bank branches are just
kiosks inside Countrywide Home Loan offices, not branches
as defined by the Fed. By this time, according to one source,
examiners from the Office of Thrift Supervision (which
regulates federally chartered savings banks) had set up shop
inside of Countrywide’s headquarters and were monitoring
events on a real-time basis. Countrywide had staunched the
outflow of funds with newspaper ads offering above-average
interest rates. By the end of September, Countrywide Bank
was attracting $50m in deposits each day. As the industry
continued to deteriorate, Mozilo made a surprise
announcement: Bank of America (BofA) had agreed to invest
In March, New Century—second only to CFC
in making sub prime loans—suddenly
suspended operations, just a week after a
favourable analyst’s report from Bear Stearns.
By this time, more than two dozen sub prime
lenders had either failed or closed up shop.
However, there were signs that the mortgage
industry’s problems were not confined to sub
prime loans. CFC, for example, reported that
during 2006 the delinquency rate on its prime
loans rose to 2.93% from 1.57% in 2005.
$2bn in CFC. BofA, the nation’s leading consumer bank with
assets of $1.46trn, had romanced CFC for six years or more,
according to reports. In return for BofA’s ready cash, CFC gave
up 20,000 shares of preferred stock, which pay an annual
dividend of 7.25% (more than double the rate similar CFC
securities paid just a month before) and are convertible into
111m shares of common at $18. BofA CEO Kenneth Lewis
had secured the right to buy 16% of Countrywide for not only
less than market price but for 20% less than book value. BofA
cannot sell the preferred shares for 18 months, but in return
gets the right of first refusal on any offer to acquire all of CFC.
An enigmatic phrase in the agreement says that the
conversion price “may be
adjusted upon the
occurrence of certain
events.” Neither
company would
elaborate, but reasonably
translated it means that if
CFC’s financial condition
declines beyond a certain
point, the conversion
price also declines.
Analyst Paul Miller’s
prediction had come to
pass. An analyst at S&P
says the preferred stock
sale signaled distress on
the part of Countrywide,
and Frederick Cannon of
Keefe, Bruyette & Woods (KBW) agrees. “From a
shareholder’s viewpoint, it was very expensive, but it would
appear that it was also extremely necessary.”
Mozilo put forward the best face possible, calling it a vote
of confidence and portraying the transaction as a win-win
deal for both companies. BofA’s Lewis was more detached.
“We hope this investment will be a step toward a return to
a more normal liquidity in the mortgage market,”he said.
Alas, investors weren’t persuaded that Countrywide had
been saved.They concluded that the $2bn BofA investment
was really too small to make a real difference. Interest rates
were rising, home values were falling, and an
undetermined number of CFC borrowers would be unable
to continue making payments as the interest rates on their
loans reset to market rates. One clue: fully 60% of CFC’s
sub prime loans made in 2005 and 2006 and scheduled to
reset in 2008 have not been refinanced. Mozilo himself
spoke despairingly of a “sudden and severe and deep
deterioration”in home values.
In August Mozilo announced that 500 jobs would be cut.
In early September he announced that an additional 900
employees would be let go. Two days later he said the total
would reach 10,000 to 12,000 over the next three months, up
to 20% of Countrywide’s total headcount. A week later,
almost buried in a press release, was news of a new financing
of $12bn secured by liens against mortgages held in
Countrywide’s own portfolio. Over 30 days, Countrywide
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS