Friday, 26 October 2007

Countywide's 3Q shocker


Countrywide reports $1.2 billion loss

Beleaguered mortgage lender Countrywide Financial Corp. reported Friday its first quarterly loss in 25 years, a reflection of the turmoil in the credit markets that's roiled financial-services companies in the U.S. and elsewhere.

The company maintained its dividend payout and said it has also negotiated $18 billion in additional liquidity that it characterized as "highly reliable." Countrywide also said it expects to turn a profit in the fourth quarter and in 2008.

The Calabasas, Calif.-based company (CFC) reported a third-quarter net loss of $1.2 billion, or $2.85 a share. In the year-ago period, Countrywide saw net income of $648 million, or $1.03 a share.

Its mortgage-banking business suffered a $1.3 billion loss in the latest quarter.
Countrywide's ability to pay its dividend to shareholders was in doubt with the company under so much strain. However, the company on Friday declared a 15-cents-a-share regular quarterly dividend.

The company said third-quarter results included a loss of 73 cents a share to reflect the impact of the below-market strike price of convertible preferred issued during the quarter.

"Countrywide's results for the third quarter of 2007 reflect the impact of unprecedented disruptions in the U.S. mortgage market and the global capital markets, as well as continued weakening in the housing market," said Chief Executive Angelo Mozilo in a statement.

Chief Operating Officer David Sambol blamed the loss on inventory write-downs driven by the credit crunch, higher credit costs as a result of the housing downturn, and restructuring charges.

"We view the third quarter of 2007 as an earnings trough, and anticipate that the company will be profitable in the fourth quarter and in 2008," Sambol said.

Countrywide said it took losses and write-downs of about $1 billion on non-agency loans and mortgage-backed securities. Moreover, The company increased its loan-loss provisions on its held-for-investment portfolio to $934 million, up from $293 million in the second quarter.

The lender also raised its estimates of future defaults and charge-offs due to a worsening housing market, higher delinquencies and tighter credit. Countrywide plans to cut between 10,000 and 12,000 workers by the end of the year as a result of plunging origination volume.

Countrywide took a $57 million restructuring charge in the third quarter. It expects to see between $70 million and $90 million of additional restructuring charges, primarily in the fourth quarter.

The company said it expects the housing market to continue to weaken in the near term, and unless interest rates head lower, it sees lower mortgage originations through 2008.

Countrywide forecast consolidated earnings in the range of 25 cents to 75 cents a share for the fourth quarter.

I've been saying this a lot lately but I'll say it again. Truly ugly stuff. Well the good news they maintained their dividend, got an additional $18 billion in funding and will return a profit in fourth quarter. Before we get carried away, as the market has, sending the stock up more than 32% today, let's take a closer look at these so-called positives.

In CFC- just another $12 billion to tide us over I reported that CFC had obtained $25.5 billion of extra funding since the end of July. Now you can make that $43.5 billion. That's a lot of funding, some of which will go towards paying their $0.15 dividend. That the company may need to source another $18 billlion in funding should send alarm bells.

Then there is the exciting news that CFC will return to profitability in 4Q07. The company gave a range of between $0.25 - $0.75 a share for the fourth quarter.

Let's take the middle of that range $0.50, and see what that gives for the full year. CFC reported earnings per share of $1.57 for the first half of the year. Now you can add a loss of -$2.12 and a final quarter of $0.50. That means that CFC will post a net loss of -$0.05 per share or approximately -$28m. So CFC is on target to at best break even this year as opposed to Net Income of $2,674m or $4.42 a share in 2006.

The company also said they will make a profit next year and buried down in the bottom of their 8-K said they would post a Return on Equity of between 10 - 15% in 2008. Taking the middle of that range would give Net Income of around $2.0 billion in FY08 still approximately 25% lower than what they earned in 2006.

Discounting at my required rate of return of 15% I get a valuation of $21.24 per share. So if you believe CFC's forecasts you can understand the rally in the stock price.

However I think it requires a leap of faith on the part of investors to believe CFC's forecasts. The company said it expects the housing market to weaken in 2008 and as such to expect lower loan origination volumes. At the same time delinquencies are rising and the company is raising it's expected estimates for future charge offs.

In 'A closer look at Countrywide (CFC)' I noted that their provisions for loan losses was going exponential. As the chart above shows the third quarter accelerated that trend.

As the company admits, the outlook for housing is going to get worse. Also remember that in 2006 45% of mortgages originated by CFC carried adjustable rates. Thus we can expect, despite CFC's plan to help renegotiate some $16 billion of loans that high credit provisioning will persist through 2008.

There is no compelling reason to buy this stock other than the belief it has been drastically oversold and the forecasts the company has given are accurate. That's a lot of believing in a company that said on August 2nd of this year:

It is important to note that the Company has experienced no disruption in financing its ongoing daily operations, including placement of commercial paper.

A company that can go from that statement to completely wiping out any profit for the year in 2 months does get my benefit of the doubt on forecasts for 12 months in advance. Not to mention the fact that the CEO has been selling his stock like crazy.