Countrywide Option Arms Continue to Deteriorate Significantly

Countrywide Financial, now part of Bank of America, released some rather alarming information about its option arm portfolio, which represents 28% of total mortgage loans it holds for investment.  According to a regulatory filing made yesterday, thousands of borrowers with $25.4 billion in option arms owe as much as their homes are worth.  One in eight is at least 90 days late on payments.  As of June 30th, the typical borrower owed 95% of the value of his home, up from 76% when the loan was made.  The drastic increase in loan-to-value ratios on these loans stems partly from precipitous declines in home values in Southern California, where Countrywide is based.  The fact that 72% of borrowers were making less than full interest payments on their mortgages merely compounds the problem.  This implies that 72% of the borrowers will not be able to afford the inevitable increase in their mortgage payments when they are required to pay the full interest and principal due.  Furthermore, borrowers are adding to their debt burden as the negative amortization causes the principal on their mortgages to increase.  The increase in principal coupled with declining home prices are a lethal combination.  As homeowners face the prospect of owing more on their mortgages than their homes are worth, they are more than likely to hand the keys to the bank.  For more depressing statistics on the looming option arm disaster, you can read my recent post on the topic.  It includes a very handy chart from the Wall Street Journal that is worth my yearly subscription rate.    

Countrywide Sued As Shareholders Vote To Approve Merger With Bank of America

Both the California and Illinois attorney generals' offices plan to sue Countrywide for engaging in deceptive lending practices.  It's unclear how the attorney generals managed to come up with this brilliant plan on the exact same day.  Perhaps it was timed in an effort to attempt to derail Bank of America's proposed merger before it's too late.  However, Countrywide's shareholders just approved the takeover, realizing they would need Bank of America's deep coffers to pay for all the litigation.

The Illinois lawsuit alleges that the company engaged in "unfair and deceptive practices."  Illinois officials say that Countrywide relaxed its underwriting standards, put together loans with risky features and used marketing and sales tactics that motivated employees and brokers to push loans regardless of whether borrowers had the resources to repay them.  Meanwhile, the California attorney general is accusing Countrywide of misleading advertising and other unfair business practices to trick borrowers into taking on risky home loans they didn't fully understand.  

Both the Illinois and California lawsuits fairly accurately describe the entire mortgage industry for the past three years.  Every lender relaxed its underwriting standards, otherwise it would not have been able to compete with all of the bozos pumping no-doc, negative am, interest only and option arms.  Without a doubt, Countrywide was the worst offender, if you're going to base the competition on sheer volume.  But if the attorney generals are attempting to make a statement, they might as well sue them all.  

Why regulators failed to notice the mortgage industry's deceptive practices from 2005-2007, I have yet to understand.  It was constantly reported in the newspapers.  Anecdotal stories about people purchasing homes with no doc loans and option arms were reported nearly every day in the financial press.  Did regulators actually believe back then that people understood negative amortization?  Is it only now becoming clear because default rates are soaring due to falling home prices and the lack of ability to refinance into yet another risky mortgage?  I understand that regulators need to appear vigilant in going after the worst offenders.  And I'm certain that much evidence will be presented that proves that brokers preyed on the financial ignorance of the average American negative amortization mortgage borrower.  What I'm uncertain of is how going after Bank of America, who will own Countrywide on July 1st barring any unexpected events, will help alleviate the foreclosure crisis.  Bank of America is already on the hook for Countrywide's poorly performing mortgage portfolio.  Allowing the bank to remain solvent so that it can provide banking services in this extremely tight lending environment is a much better alternative.  

"Liar Loans" Live Up To Expectations

Investors who purchased soured mortgages securities are forcing lenders to repurchase the original loans based on a provision that required lenders to take back loans that defaulted unusually fast if mistakes were made or fraud was committed during the underwriting process. The Wall Street Journal reported yesterday that Countrywide estimated that its liability for such claims rose to nearly $1 billion as of March 31, 2008. Countrywide took a first-quarter charge of $133 million for claims that have already been paid. The loan disputes allege bogus appraisals, inflated borrower incomes, and other misrepresentations made at the time the loans were originated. Demands from loan buyers include Fannie Mae, who claimed in a recent conference call that it was attempting to review every loan that defaults and force lenders to buy back loans that failed to meet promised standards. The bond insurers including Ambac and MBIA which guaranteed investment-grade securities backed by home-equity loans and lines of credit are also getting in the game of scrutinizing the quality of loans in the original pools and taking action where necessary. Even GE, through its subprime mortgage subsidiary WMC Mortgage, is being sued by PMI Group who alleges that WMC misrepresented the quality of loans it included in a pool of subprime loans that were insured by PMI.
Offering further proof that the incidence of misrepresentation was not merely a subprime problem, S&P cut or downgraded its ratings on $34 Billion of Alt-A securities yesterday. Ratings on 1,326 classes of bonds created in the first half of 2007 were reduced. Another 567 similar bonds with AAA ratings were placed on review. A total of 14% of the bond issuance from the period was either cut or placed under review. Late payments of at least 90 days and defaults among Alt-A loans underlying the bonds issued last year rose to 6.64% as of April 2008, up 65% since January of 2008. Clearly the situation is getting worse rather quickly. Alt-A loans were made to borrowers who provided little-to-no documentation of income or assets but had respectable credit scores. Among skeptics they were deemed "liar loans", as it gave borrowers ample opportunity to fabricate their income and assets in order to receive loans to purchase houses they otherwise could not afford. Investors in the securities must've assumed that either borrowers were telling the truth or home prices would never decline. Loans were offloaded by the originators to investors who were more than willing to purchase diversified pools of these loans as they were given AAA ratings by the ratings firms.
Investors are now facing the double whammy of misrepresentations of the borrower's financial condition coupled with declining home prices across the nation. As a consequence, default rates on the loans are surging beyond original estimates when the securities were structured, leaving investors with losses. The ratings agencies are, of course, late to the downgrade party as the securities are already being pummeled in the market. Pissed off investors are now attempting to recoup losses by forcing the originators to repurchase the loans because the quality of the loans was misrepresented. The top four Alt-A lenders in early 2007 were Indymac, Countrywide, GMAC, and Washington Mutual. Clearly these once celebrated lenders have suffered a considerable drubbing. Yet, bottom-fishers have emerged, betting that their fortunes will turn. Given the continuing parade of lousy housing news, I remain a skeptic. Furthermore, I'm disappointed that I never took advantage of the opportunity to purchase a $25 million home using my imaginary bars of gold as a stated asset.

Median Home Prices Continue to Decline, Taking Homeowner Equity With Them

The median price for a single-family home in the US dropped 7.7% in the first quarter to $196,300. The median price for a single-family home fell in 100 of 149 metropolitan areas, with Sacramento posting the largest decline of 29%. The metropolitan area around Riverside and San Bernardino was next with a 28% decline, followed by Lansing, Michigan with a 27% decline. Little surprise then that Bank of America increased its loss estimates on its home-equity loans to 2.5%, up from the 2% it projected just last month. Liam McGee, president of the consumer and small business division said at an investors conference today that Bank of America expects the economy to shrink in the second quarter.
Possibly causing some consternation at the investor conference was MeGee's statement about mistakes made during the housing boom. "We made some mistakes in 2005 and 2006 in how we grew this portfolio." He claimed that the bank has tightened lending standards since then. Although I personally did not have the opportunity to attend the conference, I can only imagine the furious rustling among analysts who jumped at the chance to pepper the banker with the questions:

Analyst I : Mr McGee, are you trying to tell us that the problems in your loan portfolio are the result of actual mistakes your bank made? Are you sure it wasn't linked to the credit crunch?

McGee: Yes, I'm certain we made some mistakes.

Analyst II: But that just doesn't make any sense. The losses in your portfolio had to have been caused by outside market forces that you had no control over.

McGee: No. I'm pretty sure, we lowered our underwriting standards to keep up our market share numbers and now we have to take some losses.

Analyst III: But would you say the worst is over?

McGee: No. As I said before, we just raised our estimates for loan losses just from the prior month based on new data. We'll probably need to raise them again.

Analyst IV: How do you expect us to buy your stock if you don't tell us that the worst is over?

McGee: I'm sorry. Was that a question?

Analyst V: What you are saying then is that you are the only bank that made mistakes, so it must be a terrible investment to buy your stock.

McGee: No, other banks made mistakes too. Possibly even bigger ones than we made

Analyst VI: Who made bigger mistakes than Bank of America?

McGee: Countrywide.

Countrywide's Debt Lowered to Junk, Still Worth More Than Analyst's Opinion

S&P cut Countrywide's debt to junk after Bank of America hinted it may not back all of Countrywide's debt in an SEC filing on May 1st. Meanwhile, FBR's crack analyst Paul Miller said Bank of America should renegotiate its bid for Countrywide, and downgraded the stock to "underperform" from "market perform." Why this analyst's musings are reported as news, I will never understand. First of all, he upgraded Countrywide's stock to "market perform" on August 23, 2007, when the stock was trading around $22. During the entire time that the stock dropped to around $5 before Bank of America's bid, he said nothing. He must've been in hibernation for the credit crunch, and just woken up to realize that he must say something, anything, about a stock that has now lost 90% of its value. He did the same thing with Thornburg, which he downgraded from an "outperform" to "underperform" last week, a full month after the company narrowly avoided bankruptcy by raising a private placement that diluted its stock by 95%. When he issues research notes that have completely missed the boat and come months after the obvious has already been priced into the market, he should also issue an apology. In the meantime, I'm reaffirming my "underperform" rating on Paul Miller's research, and issuing a "junk" rating on his outlook.

Bank Of America May Not Back $38 Billion of Countrywide's Debt

Bank of America has indicated that it may not guarantee $38.1 billion in Countrywide's debt despite its determination to close the acquisition of CFC in the third quarter. The company stated that "There is no assurance that any such debt would be redeemed, assumed, or guaranteed." According to the Bloomberg article, because of BAC's tough language, analysts are expecting the company to put the assets into another company called Red Oak Merger Corp. Red Oak would then file for bankruptcy thus dealing a loud slap across the face to Countrywide bondholders who expected to own BAC debt after completion of the merger. When I say slap, I'm talking Joan-Collins-Dynasty-Style slap. A default on $38 billion in bonds may cause loud ripples throughout the credit markets. It's hard to imagine problems in the credit markets resurfacing given the rabid bullishness on financials lately, but I, for one, am not ruling it out.

Mozilo Convinced Board He Was Grossly Underpaid

Does anyone actually know what corporate boards do?  If so, please explain, because I am perplexed.  While Countrywide Financial (CFC) was busy giving everyone in America a cash-out-refi-interest-only-no-doc-option-arm, what was CFC's Board doing?  They certainly weren't busy scrutinizing the company's moronic lending practices.  Just a quick look at CFC's REO portfolio of homes, which ranges from $40,000 houses in Sacramento to $3 million homes in ritzy parts of California, shows that they did not discriminate when it came to shoddy underwriting.  Well, as it turns out, they were busy hiring compensation consultants to try to figure out how much to pay CEO Angelo Mozilo.  According to the WSJ, the House Committee on Oversight and Government Reform is due to question Mozilo to figure out why, after two compensation consultants told the board to cut back Mozilo's pay, they opted to listen to Mozilo who asked for more.  According to an email Mozilo wrote to the board expressing his disappointment he claimed that "Boards have been placed under enormous pressure by the left wing antibusiness press and the envious leaders of unions..."  So, what did the Board do?  Instead of telling Mozilo to take a hike and hiring my 8 month old baby, who would have only asked for a stuffed frog as compensation, before running the company into the ground, the board opted to pay Mozilo $250m from 1998-2007 (not counting the $406 million from the sale of stock.)  Somehow I doubt that leaders of unions were personally calling the board and pressuring them, and suspect that Mozilo was the one doing the pressuring.  The good news is that Mozilo has been cordially invited to testify in front of the Committee and that might make for some good television...