There Goes Delta Financial, Now How Safe is Countrywide?

Includes: CFC, DFC
by: Andy Abraham

Delta Financial (DFC) the ninth largest sub prime leader imploded last week due to a bankruptcy announcement. Delta said in its announcement, "The Company has been unable to complete such a securitization transaction upon satisfactory terms." Delta Financial announced that it has stopped accepting new loan applications, and that talks are underway with potential buyers for its assets. Many value investors were exposed to Delta Financial and the losses could be staggering to those with concentrated portfolios.

Delta Financial's issues bring to mind Countrywide (CFC). Due to the fact that the latter's stock is trading at about 53% of its Sept. 30 book value of $23 a share, many value investors are intrigued. The company's bonds are selling at "junk" levels. For example, the 5.8% bonds maturing in June 2012 are trading at about 76 cents on the dollar, for a yield of 13.16%. Since the recent lows, Countrywide has rebounded approximately 11%. The question is: Has Countrywide bottomed or is it possible that Countrywide could suffer the same fate as Delta Financial? One big difference between Delta Financial and Countrywide is that Countrywide was able to increase its borrowings from both the Federal Home Loan Bank of Atlanta as well as receiving $2 billion from Bank of America Corp. (NYSE:BAC) for preferred stock convertible into a stake of about 16%. Even though Countrywide has received this source of funding, many depositors are scared to deposit funds with them even at higher rates.

Value investors need to be aware that the housing crisis has not been resolved, and potentially there exists much more downside. If the prices of houses continue to fall, the mortgages that Countrywide holds become less valuable; not to mention all the second mortgages that Countrywide holds, which will become even less valuable or worthless. As every good value investor knows, it is important to watch the insiders, and unfortunately none of the insiders of Countrywide has stepped up to the plate and started purchasing shares. If the insiders are not showing any confidence, how can we as value investors show confidence?

Another problem facing Countrywide is the recourse agreements that it signed when it sold off loans. The recourse agreements force Countrywide to repurchase numerous loans from its investors, including those that went into default. This could be a major source of liquidity drawdown. To make matters worse, how many investors have an appetite for mortgage loans considering the current situation? Over the next year Countrywide needs to pay approximately $27 billion in borrowing costs. Where is this money supposed to come from?

One needs to ask: Would the government bail out Countrywide in a worst case scenario? The last time the government came in to bail out financial institutions was in the early 1990s. Investing is not an emotion game but rather a marathon in which we investors need to pace ourselves and stay out of trouble. Cheap can get cheaper or, in Delta Financial's case, cheap can become bankrupt.