Countrywide Rebounds Despite Big Losses

Shares of the mortgage lender shot up 32% Friday after the company issued a rosy forecast

by David Bogoslaw

Countrywide Chairman and Chief Executive Angelo Mozilo

It's fair to wonder whether the 32% gain in Countrywide Financial's (CFC) shares on Oct. 26 was just a dead-cat bounce or a reflection of a more enduring turnaround in investor confidence. After all, this was the first quarterly loss the nation's largest mortgage lender has recorded in 25 years and it's not as if anyone, including the company's top executives, expects deterioration in home values to end anytime soon.

But given the nervous speculation in recent weeks about whether Countrywide would remain solvent, the news that it has secured ample capital and liquidity to continue originating and selling mortgage loans and to meet its debt obligations through next year was greeted with a big sigh of relief by investors.

Countrywide Financial reported a net loss of $1.2 billion, or $2.85 a share, vs. a profit of $648 million, or $1.03 a share, a year ago. Excluding the impact of the below-market strike price of convertible preferred shares issued in the third quarter of 2007, which amounted to 73¢ a share, the company had a loss of $2.12 per share.

Three major factors contributed to the net loss: reduction of inventory valuations caused by the seizing up of the credit markets and the inability to sell their nonagency loans and securities; higher credit costs due to ongoing deterioration in housing prices; and restructuring charges stemming from the company's efforts to cut expenses.

The Calabasas (Calif.) company recorded writedowns of $830.9 million in the value of mortgage servicing rights, $716.7 million in mortgages and mortgage-backed securities and $718.6 million for a loss on the sale of loans and securities. These were partly offset by hedging gains of $1.18 billion.

Countrywide also boosted its reserves for loan losses to $934 million from $38 million on a bet that mortgage delinquencies will continue to expand. Restructuring charges of $57 million stemmed from its move in September to cut between 10,000 and 12,000 jobs, or 20% of its workforce, by the end of 2007 due to the deepening housing slump.

In an earnings release, Countrywide said it considers the charges nonrecurring and predicted it would return to profitability in the fourth quarter from what it called an earnings trough in the third quarter. Countrywide expects to earn between 25¢ and 75¢ a share in the fourth quarter and to achieve return-on-equity of 10% to 15%.

The shares jumped 17% at the start of trading on Oct. 26 and were up 31% by the time money managers and analysts had finished listening to a detailed rundown of liquidity-boosting and business model improvement measures, as well as housing market forecasts, during a conference call that lasted nearly three hours. The shares closed 32.2% higher at $17.29.

But those gains merely returned the shares to the level that they were trading at a week ago, before nervous investors began to assume the worst for Countrywide's quarterly results after seeing the magnitude of loan loss provisions and other charge-offs taken by other financial firms, says Chris Fortune, an analyst at T. Rowe Price. At the end of June, T. Rowe Price owned 18.6 million shares of Countrywide across multiple investment portfolios.

To shore up its liquidity, the company borrowed $11.5 billion against commercial paper-backed facilities and negotiated $18 billion in additional, highly-reliable secured borrowing capacity, as well as selling a $2 billion equity interest to Bank of America (BAC).

"What Countrywide did today was they took a lot of fear related to their capital and liquidity out of the story," Fortune says. "Their capital's strong and the liquidity looks strong, and that's despite the fact that they took significant impairments in building their loan loss provision."

Countrywide seems to be looking at the harsh realities of the housing market by putting aside a large reserve for loan losses, ahead of anticipated further deterioration in home prices, he says.