Countrywide’s confident tone turned to crisis
A year ago, Countrywide Financial Corp. Chairman and Chief Executive Angelo R. Mozilo was boasting that the looming shakeout in home prices and hike in mortgage interest rates would usher in a period of remarkable prosperity for his company.
“I have 53 years of experience. . . and this is nothing compared to 25% prime and 17.5% mortgage rates and 10% unemployment,” he told a conference of bond investors last September, pooh-poohing the effect of rising rates.
He assured his audience that Countrywide’s “proprietary technology” would help it meet its goal “to avoid any foreclosure.” Countrywide invariably kept to “prudent underwriting guidelines,” he said, to ensure that its adjustable-rate borrowers could handle the highest interest rates that might kick in during the life of their mortgage.
“This is when we shine,” he said, calling Calabasas-based Countrywide “an industry leader” and “a role model to others in terms of responsible lending.”
Today, the picture looks much different. Countrywide’s financial reports and recent comments by Mozilo and other executives show that the company, the nation’s largest mortgage lender, has been less a role model in the home-loan market than a prisoner of competitive trends.
Delinquency and foreclosure rates have soared on many Countrywide loans, including mortgages that were thought to be relatively sound, such as home-equity lines of credit.
The tone of executives’ comments has gone from complacent to almost apocalyptic. “We are experiencing home price depreciation almost like never before, with the exception of the Great Depression,” Mozilo said in a July 24 conference call with securities analysts.
The company’s traditional frames of reference for the performance of its loan portfolio, he added, may no longer be “a fair comparison in light of what is happening to real estate values.”
As for his claims that Countrywide’s broad mix of revenue-producing activities would allow it to beat back competition from investment banks and other rivals -- “we had them surrounded,” he said last year -- more recently the company has been in the role of supplicant.
On Aug. 22, it accepted a $2-billion infusion from Bank of America Corp. on terms that will allow the bank to acquire as much as a 16% stake in Countrywide at a cut-rate price of $18 a share. Analysts are still debating whether the investment in preferred stock -- paying BofA a dividend of 7.25% until it is converted into common stock -- is a vote of confidence or a sign of Countrywide’s weakness.
BofA “wasn’t willing to own it now at $18,” said Frederick Cannon, a banking analyst at Keefe, Bruyette & Woods. “That would have been a much greater vote of confidence.” He acknowledged, however, that BofA hadn’t received approval from federal regulators to make such a purchase.
One reason Countrywide finds itself in a predicament is that it needed to offer the same variety and pricing of mortgage products as the overall market.
Asked during the July conference call if Countrywide would have done anything differently had it known a year or two ago what would happen to home prices, Mozilo replied that the firm knew the housing bubble would soon burst, but could not have made different choices.
“Our whole place in the industry would have changed dramatically because we would have arbitrarily made a decision that was contrary to what everything appeared to be,” he said. Among other problems, mortgage brokers would have stopped offering the company high-grade or prime mortgages if it would not also accept lower-quality sub-primes.
Countrywide suggests that mortgage pricing and underwriting standards during the housing boom were set by the most aggressive -- that is, least rigorous -- lenders, and that it was all but powerless to impose its own standards.
“Most of the large bank lenders, as well as Countrywide, were limited, slow, reluctant followers behind the lenders who most aggressively relaxed underwriting guidelines,” the company said in a written response to a question from The Times.
If Countrywide had set its own mortgage rates higher to reflect its judgments of risk, it said, “borrowers would simply have chosen one of a myriad of other lenders offering more competitively priced products.”
Mortgages “are a commodity business,” said Cannon, the banking analyst. “You have to pretty much accept what the market gives you.”
Countrywide, consequently, chased the same kinds of loans as other lenders. Beginning in 2004, it stepped up its origination of two products: sub-prime mortgages (made to borrowers with poor credit, minimal down payments or both) and home-equity lines of credit.
Many of the latter were “piggyback” loans at fixed interest rates to cover all or much of a borrower’s down payment, thus bringing the total mortgage close to 100% of a home’s value. Piggyback home-equity loans, which fall delinquent at as much as twice the rate of conventional floating-rate home-equity lines, accounted for roughly 40% of Countrywide’s $60-billion home-equity loan portfolio as of June 30, the company says.
Sub-prime loans constituted 4.6% of Countrywide’s total originations in 2003 by dollar volume. That jumped to 10.9% in 2004 before slipping to 8.9% in 2005 and 8.7% last year. Home-equity loans rose from 4.2% of volume in 2003 to 8.5% in 2004, 9% in 2005 and 10.2% in 2006.
Conventional conforming loans -- those under $417,000, which can be sold to the government-sponsored mortgage agencies Fannie Mae and Freddie Mac and therefore are regarded as the safest mortgages for investors -- dropped from 53.9% of Countryside’s total production in 2003 to 37.1% in 2004. By last year, they had fallen to 31.9%.
These changes in Countrywide’s portfolio occurred just before delinquency and foreclosure rates on lower-quality loans began to rise. Just over 13% of sub-prime loans were delinquent or facing foreclosure in 2004, but that rate climbed to 22.56% in 2006 and 24.11% by June 30 of this year. In the home-equity category, the combined delinquency and foreclosure rate was 0.82% in 2004, 3.05% in 2006, and 3.82% on June 30.
Countrywide executives say the deterioration of the home-equity portfolio is one of their biggest surprises and has caused an unexpectedly high share of charge-offs and delinquencies among their borrowers.
However, they say they anticipated that these would be troublesome loans, and to cover the risk, they charged borrowers as much as 2 percentage points over the prime rate. (Conventional revolving home-equity lines are often made at less than prime.) Of course, that high interest burden has only intensified the financial pressure on some strapped borrowers.
Mozilo said in July that it was traditionally “very common” to make home-equity loans, piggyback and otherwise, that brought a homeowner’s indebtedness close to 100% of the property’s value, “and in an ordinary market, it worked fine.”
But the “sudden and severe and deep deterioration” in home values has thrown many borrowers into delinquency because homeowners with little or no equity have been unable to refinance their mortgages to reduce their rates.
Countrywide pursued other lending practices typical in the industry and has suffered the same financial problems as a result. In a letter to federal bank regulators in May, the company acknowledged that it often judged its customers’ creditworthiness for sub-prime adjustable mortgages on whether they could afford payments at a loan’s low initial “teaser” rate, not at the much higher rates that might kick in two or three years after the loan was made.
The letter appears to contradict Mozilo’s claim last September that the company’s underwriting standards required borrowers of adjustable loans to qualify at the higher rate.
The letter from Mary Jane M. Seebach, Countrywide’s managing director for public affairs, said that in the fourth quarter of 2006, about 60% of its borrowers of sub-prime adjustable mortgages would not have qualified for their mortgages based on the higher rate. Nearly 25%, she said, would not have qualified for any other mortgage offered by Countrywide.
Seebach acknowledged that Countrywide, like the rest of the industry, had cut back sharply on the most default-prone mortgages -- loans to borrowers with poor credit histories and no income documentation and minimal or no down payments.
“The market,” she wrote, “once again realizes that it is reasonable to expect a down payment from borrowers who have not proven their ability to manage their credit.”
Countrywide says it has taken steps to tighten lending standards, along with the rest of the mortgage industry. Among other things, it has eliminated piggyback home-equity lines and no-down-payment mortgages and requires income verification from borrowers with down payments of 10% or less.
But those steps may have come too late, as loans already on the books threaten to bring greater losses. Countrywide says it expects its 2006 crop of sub-prime loans to be “one of the worst performing vintages ever.” Many such loans reset at higher interest rates two or three years after they are made. In the past, such borrowers customarily would refinance before the rates reset, often at fixed rates.
The company says that 60% of the sub-prime loans scheduled to reset in 2008 -- meaning loans made in 2006 and 2005 -- have not been refinanced. Given the tighter standards facing sub-prime borrowers today, refinancings are likely to be harder to come by.
That’s troubling, because sub-prime loans that can’t be refinanced before the reset tend to have “much higher delinquency rates,” Countrywide says, than those that are refinanced.
As for loans that the company has packaged and sold to investors in the bond market and on which it retains some liability for defaults, executives said in July that it was too early to say what those losses will be. David Sambol, the company’s president, told analysts in July that it was “providing for future losses [in its mortgage portfolio] at a level that is greater than anything that we have ever seen.”
Countrywide also concedes that its vaunted proprietary system for estimating loss probabilities and delinquency rates was bamboozled by real-world conditions in 2006 and 2007.
“There really had not been for our models. . . very much in the way of historical empiricals” to help Countrywide compile accurate predictions, Sambol said in July. At the same meeting, the company said its automated underwriting system had been “recalibrated.”