Wall St. balked at Mozilo’s optimism
All last year, Countrywide Financial Corp. Chief Executive Angelo R. Mozilo insisted that the lender would survive the mortgage crunch.
If he believed what he was saying, he grossly underestimated the market forces that were driving the company either into bankruptcy or, as happened Friday, into the arms of a deep-pocketed suitor: Bank of America Corp.
Instead of listening to Mozilo, investors would have been better off paying attention to the actions of “short sellers” -- traders who were betting heavily that Countrywide wouldn’t make it.
First up, there is a cold fact of life for any financial company that has lost investors’ confidence: If Wall Street begins to think you’re gone, you’re gone, because you won’t get the funding you need to keep your business going day to day. Or even if you can get it, you won’t be able to afford it.
Countrywide, already shut off from the easy Wall Street credit that had fueled its growth during the housing market’s boom times, has $15.5 billion in debt maturing this year.
Maybe it could have refinanced those borrowings, but at what cost?
MBIA Inc., the big bond insurance firm that is reeling from losses on mortgage debt it has guaranteed, on Friday sought to bolster its balance sheet by raising $1 billion in capital via the sale of notes.
The investors who bought the notes demanded a whopping 14% annual interest rate on their money, at least through 2013. That is far above the average corporate junk bond yield of 9.11%, according to bond tracker KDP Investment Advisors -- and a sign of how risky MBIA is perceived to be.
Apart from underestimating market concerns about how Countrywide would finance itself, Mozilo apparently didn’t foresee how vicious the selling of his stock would become.
Right or wrong, a company’s stock price shows investors’ second-by-second judgment of how the business is going and what it is worth. In Countrywide’s case, the market in the first three days of this week marked down the value of the business by an average of 15% a day. The stock reached an 11-year low of $4.43 at one point on Wednesday.
You can’t have too many 15% down days before a company’s market value nears zero. That message had to be coming over loud and clear at Countrywide’s Calabasas headquarters.
What was driving the selling?
On Tuesday, rumors swept the market that the company was on the verge of a bankruptcy filing. Countrywide issued a statement saying there was “no substance” to the rumors, but that didn’t help the stock.
Some investors and traders may have been selling on Tuesday ahead of the company’s report Wednesday on its lending operations in December.
The report showed that the delinquency rate on the $1.5-trillion mortgage portfolio the company services had risen to 7.2% at the end of December from 6.5% a month earlier.
But why should any investor in a mortgage lending firm be surprised that delinquency rates still are rising? No one with a working brain believes that delinquencies will peak before sometime later this year -- at the earliest.
Besides, Countrywide stock already should have reflected the bad news. The price had been hammered mercilessly since mid-October, falling in 10 of the 13 weeks through Jan. 4.
Two groups of investors would have had a good reason to sell this week as the stock continued to sink: those who believed the bankruptcy rumor and feared the shares would become worthless; and short sellers who would profit mightily if, in fact, the stock went to zero.
Short sellers are traders who borrow stock, usually from a brokerage’s inventory, and sell it, pocketing the sale proceeds. Their bet is that the market price of the stock will drop in a matter of weeks or months, in which case they would buy shares at a lower price to replace the ones they borrowed.
If the bet is correct, the short seller’s profit is the difference between the sale price and the repurchase price.
Countrywide, which has 580 million shares outstanding, became a major target of short sellers last year as the mortgage market deteriorated. The number of Countrywide shares sold short reached 134 million as of Dec. 31, more than five times the 25.6 million shorted as of mid-February, according to New York Stock Exchange data.
When professional short sellers smell blood -- or bankruptcy -- they have been known to gang up on a stock. They’re often accused of spreading bankruptcy rumors or other bad news to try to encourage other investors to bail out and push a stock lower.
But short selling also is a strategy used by investors who aren’t necessarily hoping that a stock drops in price. Some short sales are made as part of hedging strategies: An investor shorts a stock with the idea that, if other bets in his or her portfolio fail to rise because the market turns down, the shorted stock will fall and offset the losing bets.
It’s impossible to tell what percentage of the short sales in Countrywide stock was by traders who wanted the price to collapse and what percentage was part of hedging strategies.
Either way, short selling has the same effect, adding to downward pressure on a struggling stock.
From Bank of America’s point of view, however, the short sellers turned out to be allies: The lower the stock went, the lower the price the bank had to offer to rescue Countrywide.
Six weeks ago, with Countrywide shares at $10.82, Bank of America might have had to offer about $6 billion for the business.
Thanks to traders and investors who scoffed at Mozilo’s sunny view of the company’s future, the bank is paying one-third less.
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