Section 2 - FTSE

PROFILE: COUNTRYWIDE FINANCIAL
56
Typically, executives file a plan and stick with it for years.
But Mozilo filed plans that allowed him to sell stock at an
ever-increasing rate even though his options did not expire
until June 2011. Mozilo also began selling shares he had
held for years. As October drew to a close, it appeared that
soon Mozilo would own no shares of his company, a
remarkable situation for a CEO. Because Mozilo is ultimately
the responsible officer for the company’s pension plan, and
because he sold so much stock within the past two years,
litigants may demand he give up some of those gains.
Kravitz goes further than simply alleging that CFC stock
was an unlucky investment for the pension plan.
“Countrywide stock became an imprudent investment
based in part on the misconduct going on in the company
that, once disclosed, could lead to a drop in the price of the
stock.” This alleged misconduct has been reported in
various news articles, which describe a variety of practices
that exploited Countrywide borrowers by charging them
interest rates that were higher than their credit scores
merited and overcharging them for a variety of fee-based
services, such as appraisals and credit reports. Mozilo has
angrily denied the allegations, although he has not
specifically rebutted any particular one.
Meanwhile, the state treasurer of North Carolina wrote
to the SEC complaining that Mozilo “apparently
manipulated his trading plans to cash in” even as the sub
prime debacle was unfolding. And the Louisiana
Municipal Police Employees’Retirement System persuaded
the Delaware Chancery Court to order Countrywide to
provide confidential information about the operation of its
stock-option program. Countrywide was also told to
provide any related information that it may have already
given to the SEC, the New York Stock Exchange, or the US
Department of Justice.
Clearly, both actions lay the foundation for lawsuits.
Kravitz expects that at some point all the suits will be
consolidated into a single action and a lead attorney will be
appointed by the court to prosecute the action.The lawsuits
present a possible impediment to what is likely the most
logical solution to the problems facing Countrywide, which
would be its acquisition by Bank of America. BofA now
holds nearly 10% of all US bank deposits, which is the limit
set by the government. If BofA is to grow, the mortgage
market presents a natural path. Already BofA ranks fifth,
with a 7% market share, but experts say that its mortgage
operation is not managed nearly as well as Wells Fargo’s
(the number two mortgage company) or CFC’s.
Mozilo has proposed that BofA outsource its entire
mortgage business to Countrywide, which presumably
would put its own people at home mortgage desks in BofA
branches and which certainly would act as BofA’s back
office for all mortgage transactions. BofA CEO Lewis has
not publicly responded directly to this idea, but he has said
that he has never been involved in a successful joint
venture. Indeed, suppose that BofA had hired
Countrywide to run its mortgage business, and then
Countrywide was hit with these lawsuits, unfavorable press
articles, and equally unfavorable comments by various
politicians. Lewis would have little if any control over the
situation, hardly the position a conscientious (or
ambitious) CEO wants to find himself in.
Mike McMahon, the former banker, notes one potential
downside. Mortgage banking is a volatile, cyclical and
seasonal business, and therefore mortgage banks
command a low price/earnings multiple. CFC, for
example, traded below 10 times earnings (recently, the p/e
ratio was 5). Even so, CFC might still make sense for BofA.
Like other commercial banks, BofA expects to cross-sell
services to its mortgage customers. Besides, even with the
book of CFC mortgage business, BofA would not be
primarily a mortgage bank but rather a consumer bank
with a big mortgage business.
Will it happen? It might, provided that Mozilo and Lewis
find a way to settle the lawsuits quickly and at a reasonable
cost. But there is still another potential problem. Generally,
institutional investors who buy mortgage-backed securities
have no recourse if those mortgages default. The exception is
fraud — whether it is committed by the mortgage originator
or the borrower. Here lies the rub: it is an unquantifiable
hazard for CFC or any company that acquires it. In the
freewheeling days of 2003 to 2005, it was easy for loan officers
and borrowers to bend the facts to their advantage. If an
institutional investor can substantiate enough such instances,
it may force Countrywide to take back an entire package of
loans — a potentially devastating event.
Meanwhile, the housing market continues to deteriorate
and so does Countrywide’s financial results. For
September, the company reported that total loan fundings
fell 44% from September 2006. Delinquencies as a
percentage of unpaid principal balances rose to 5.85%, up
from 4.04%, and pending foreclosures climbed to 1.27%,
up from 0.51%. A few days later CFC announced that
layoffs and office closings will require a pretax charge of
$125m to $150m. Analysts projected third quarter losses of
as much as $1.3bn after loan loss provisions.
What does Mozilo have to say about his company’s
predicament? Very little (phone calls from the press,
including FTSE Global Markets, are rarely returned).
However, in an effort to combat an increasingly poor public
image, Mozilo hired a major public relations agency with
substantial experience in crisis management. Now,
employees are provided with rubber wristbands that
proclaim “Protect Our House.” In a meeting with
employees, a senior executive reportedly told them that “it’s
gotten to the point where our integrity is being attacked.
NOW IT’S PERSONAL! . . . And, WE’RE NOT GOING TO
TAKE IT!” In other words, if anyone has suffered during
the recent mortgage lending crash, it is Countrywide, not
its customers or shareholders.
The events of the past two years have resulted in a grim
outlook for nearly every aspect of the US housing industry. But
the industry will bounce back and once again the American
housing market will be robust and growing. For now, it’s too
soon to say the same about Countrywide Financial.
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS