Could Housing Panic Actually Save Countrywide?

Countrywide Financial CORP. (NYSE:CFC) is offering investors the opportunity to buy a quality Fortune 500 company cheap, very cheap. Buying low and selling high is a strategy most covet, nevertheless never truly understand how to accomplish. When the market creates buying opportunities most investors shy away, scarred off by the prospect of continued loss in the investment. The art of buying low and selling high is finding a quality company that has been beaten up buy the market and ripe for a comeback. Countrywide is presenting investors this opportunity.

I know your first reaction is "yeah right, there is no way I am going to put my money into the mortgage meltdown", a valid feeling. The problem is feelings and emotions have nothing to do with investing. Investing is about buying quality companies cheap (unless you're a day trader, we are talking about investing). Warren Buffett has created an empire on this principle. There are three factors driving the stock down

1. Their exposure to the subprime mess
2. Third quarter losses the company reported, and
3. An overall panic in the housing market.

The question is, do these factors support the low valuation?

Right now CFC is trading at $13.60 per share off a $41.00 May price and a 52 week high of $45.26. The stock is trading at nearly a third off their yearly high and more then half off their value since May. The current valuations are not valid when looking at Countrywide's overall position in the housing market. Countrywide is the largest mortgage lender in the country, originating 3 trillion in mortgage loans since 1969. This quarter, Countrywide's mortgage loan portfolio continued to grow, reaching $1.47 trillion in October 2007, an increase of $202 billion, or 16%, from October 2006. Only 1% of all loans originated in Countrywide's history have completed foreclosure.

Of subprime loans, the driving force behind the housing "crisis", less then 4% are currently in default. This percentage truly puts Countrywide's exposure into perspective. Really beating down Countrywide's stock is the reported net loss of 1.2 billion in the 3rd quarter of 2007. The loss was their first quarter loss in 25 years, safe to say an anomaly supplied by subprime woes. The troubles affecting Countrywide are industry broad, not a specific operating mistake of Countrywide itself. The troubles seem to be part of a correction in the overall housing market. Looking forward losses accrued in the 3rd quarter are not re-accruing as the company projects a profit in the fourth quarter of 2007 and through 2008. Countrywide is trading at a P/E ration of 3.81, while Bank of America (BAC) is trading at a P/E of 10.46 and Fannie Mae (FNM) at 13.26 .

Obviously Countrywide is trading at a considerable discount to their direct competitors. Countrywide has great management and they are not sitting back waiting for the storm to blow over, management is taking proactive actions to right the ship. In order to deal with the subprime issues, Countrywide has embarked on several ventures to help home borrowers maintain their payments and avoid default. They currently have 33.6 billion of "highly reliable liquidity" to help deal with housing defaults and assigned 2700 staff to mitigate default losses. Countrywide expects to cut foreclosure by 35% in 2007 from 2006. The company has shown consistent quality growth over the years and I do not believe the management completely lost their ability to manage based on one quarter. 25 years with out a quarter of losses is pretty amazing and a signal the company will rebound. Federal inquiries into Countrywide's lending practices do not appear validated. The company has been lending since 1969 and embarked on a "we house America program" to fund 1 trillion in home loans to help lower income and minority individuals buy homes and acquire mortgages. In this program Countrywide loaned 789 billion as of August 2007.

Countrywide is the leading lender in home mortgages to all minorities including African Americans, Asians and Hispanics. The company once championed for their efforts is now being demonized for their lending practices. In order to protect themselves going forward, Countrywide will "tighten underwriting guidelines and enhance controls" requiring higher FICA scores from perspective borrowers. Tightening restrictions is a bad sign for lower income and minority homebuyers. Nevertheless, stricter mortgage criteria is a positive sign for investors as Countrywide will have substantially less subprime mortgages to worry about going forward.

Aside from their mortgage business Countrywide has large revenue streams from other services and subsidiaries. For example, Countrywide is the third largest Federal Reserve Bank in the nation. Banking Operations' assets were $106 billion in October 2007, compared to $83 billion in October 2006. Countrywide's mortgage refinance division is sure to see an increase in business as the Fed lowers interest rates. Panic in the housing market which helped pummel Countrywide's stock, may also be a catalyst for their comeback. Lower interest rates in the end benefit refinancing and new mortgages going forward, especially for the nations largest mortgage lender Countrywide Financial.

Of course in the short term Countrywide's stock could remain volatile. I am not saying this is the lowest point to come, but the stock is cheap for a company of this quality. Countrywide may trade to $10 even $9 in the short term, although from a technical standpoint the stock does appear to have bottomed out. In the medium term (1 to 2 years) the stock could trade up to $26 easily, still $20 off the 52 week high. It takes a lot of guts to buy a stock getting hammered in bear industry. The market presents opportunities, leaving it up to the sharp investor to have the guts to take advantage.

Disclosure: Author has a long position in CFC

Comments

[Sean Olender:]

Yes, it would take the same "guts" as jumping out of a plane without a parachute. Well, maybe not that bad. But anyone closely following this could tell you that we are almost certain to lose at least one major bank in the next twelve months.

This untested financial architecture is crumbling before the recession. Now it appears that a contraction of credit, a likely recession, the flight of foreign investors to escape their mounting exchange rate losses, and the exhaustion of the American consumer are coming together at a single point that might cause enough pressure and heat to create a fission reaction.

If it was just Countrywide, I'd say yes. But here most banks are fighting to stay afloat with fraudulent accounting right now and loans from the Fed and FHLB (which gave out something like $170 billion over the past few months).

I disagree for three reasons. First, I don't know that big banks are going to be looking for acquisitions when they are only able to maintain themselves by pretending in accounting obfuscations that their losses aren't as big as they really are (ala Japan's bank strategy in the 1990s). Second, there are many banks on the brink of failure, so CFC is just one of many cheap options. Third, it seems to me that mortgage lending is dead in America. CFC and Wall Street ruined it for everyone. When this is over, I wouldn't be surprised if the only place to get a mortgage is the US government. Home prices will be falling for several years and investors are not going to buy mortgage securities secured by depreciating assets.

The only way these jerks at the Fed and Treasury can keep housing from deflating fast is by inflating everything else with big "injections" of freshly printed money. Well, guess what, when you print money and "inject" it into your friendly conspiratorial banker's account balance, you DEVALUE all of the other dollars circulating here and around the world. Americans are too foolish to get mad about that. They think PRICES are going up and can't understand that it's the fresh palates of money being handed out that drive up prices. Foreign investors are signaling that they've had enough of this counterfeiting. They are threatening to bail. We can't get on without them. We need $2 billion a day flowing into this place. When they debase the currency, they hurt foreign investors. if their American stocks or bonds are "up" 8% this year, they still lost money because the dollar plunged against their currency by more than 10%. Without some responsible management of the money supply, foreigners are going to bail and then it's going to get ugly.

The Fed is stuck between bailing out its Wall Street friends and bringing on the apocalypse of the dollar losing reserve currency status. Let's hope they understand what's at stake.

2007 Nov 16 11:16 AM

[W.C. Varones:]

"Right now CFC is trading at $13.60 per share..."

That was yesterday. Today it is $12.12. I don't think you understand how horrible CFC's loan portfolio is, or the risk that loans it sold will be put back to it as fraudulent originations.

Enjoy your long. I'm still short.

2007 Nov 16 11:55 AM

[W.C. Varones:]

"Right now CFC is trading at $13.60 per share..."

That was yesterday. Today it is $12.12. I don't think you understand how horrible CFC's loan portfolio is, or the risk that loans it sold will be put back to it as fraudulent originations.

Enjoy your long. I'm still short.

2007 Nov 16 11:56 AM

[User 123270:]

Normally I'm the last to play English teacher but how can anyone take this writer seriously? I was intrigued by some good points here and then the writer loses credibility by referring to people's 'FICA' scores, and error after error. FICA is social security withholding FICO refers to someone's credit score. After about three of four errors I start to question the credibility of an author. The writer also seems to ignore the market is always looking forward and cites a low foreclosure rate. While that might be sound, it ignores the huge wave of resets coming, and ignores the net loss on loans which are renegotiated in order to keep that lower foreclosure rate. The author then goes on to say how diversified Countrywide is by not just lending directly but through others. That is a completely bad basis to tout how sound their business is since earlier in the article the author states that the meltdown is industrywide, and Countrywide is more responsible than the others.

2007 Nov 16 01:03 PM

[Homeowner:]

This opinion has very little depth of analysis and demonstrates a lack of understanding of basic concepts.

CFC's historical foreclosure rate is nice, but does that have anything to do with their near-term rate given recent conditions and actions?

The stock is cheap - relative to what? Historical 52-week high? So what. That doesn't mean a thing relative to future prices.

CFC projects a profit in Q4? And you believe them? Do you have any analysis to back this up?

What is the point of highlighting CFC's leadership in minority lending? To then talk about how its getting rolled back? I don't get it. It's many of those loans that are going to bite them in the butt in the coming quarters!

It takes more than a few superficial points predicated on a relative price drop to say that CFC is a viable investment. I agree with the author that it takes a sharp investor to spot gems through the media and industry bluster. I'm still waiting for a sharp investor to make a case for CFC though.

2007 Nov 16 04:06 PM

[Homeowner:]

This opinion has very little depth of analysis and demonstrates a lack of understanding of basic concepts.

CFC's historical foreclosure rate is nice, but does that have anything to do with their near-term rate given recent conditions and actions?

The stock is cheap - relative to what? Historical 52-week high? So what. That doesn't mean a thing relative to future prices.

CFC projects a profit in Q4? And you believe them? Do you have any analysis to back this up?

What is the point of highlighting CFC's leadership in minority lending? To then talk about how its getting rolled back? I don't get it. It's many of those loans that are going to bite them in the butt in the coming quarters!

It takes more than a few superficial points predicated on a relative price drop to say that CFC is a viable investment. I agree with the author that it takes a sharp investor to spot gems through the media and industry bluster. I'm still waiting for a sharp investor to make a case for CFC though.

2007 Nov 16 04:06 PM

[User 123351:]

I have to agree with "User 123270", this analysis is weak, at best, totally uninformed at worst. Countrywide is not a "federal reserve bank" (there are 12 federal reserve banks, and they are not publically held). In fact, Countrywide is not even a bank. It is a federally chartered thrift, regulated by the OTS. Nevertheless, the current stock price of a company as compared to its price in the past is not indicative of unrecognized intrinsic value. All you need to do is look at their webpage and check what they are offering for rates on deposits. There is no clearer indication that the institution is having liquidity problems than the rates it is offering. If you borrow at 5.3%, and lend at 7%, it does not take much in the way of overhead (salaries, rent, etc.) to consume the anemic NIM. This institution is in trouble in so many ways. The author cites to declining foreclosures; are you kidding me? Their non-performs are approaching 6% and are rising. There is no precedential history this company can point to as evidence of its ability to survive this "cycle." There has never been a national real estate correction such as the one we are in, driven apparently by credit, rather than a consumer based recession. I think the author is punch drunk from all the cool-aid he has been drinking. At the least, he has been reading too many of Mozillo's press releases.

2007 Nov 16 06:32 PM

[W.C. Varones:]

Nice resume:

seekingalpha.com/autho...

2007 Nov 17 08:56 PM

[Sean Olender:]

Well, it's been a few months and this author was shown to lack foresight. Anyone who bought into this "bargain" in November 2007 is down 50% now.

2008 Feb 13 11:56 PM