Countrywide, Markets On The Ropes
Liz Moyer, 08.16.07, 1:53 PM ET
The credit crisis is threatening to take down one of the biggest U.S. mortgage lenders, Countrywide Financial, which Thursday rocked financial markets by disclosing that it had to tap all of an $11.5 billion credit line because of ongoing funding problems.
Countrywide (nyse: CFC - news - people ), with $216 billion of assets (enough to make it among the 20 largest financial holding companies), said it had drawn on that credit line, arranged by some 40 banks, and added it was going to speed up plans to move mortgage production operations into its federal savings bank affiliate.
That move would allow the Calabasas, Calif., lender to rely less on funding its activities from the debt and credit markets and more on its own deposits, as well as borrowing from the network of Federal Home Loan Banks.
As a result, Countrywide shares plunged nearly 30% to $15 before recovering slightly. They've lost nearly three-quarters of their value since February. The Dow shed more than 300 points.
"Along with reduced liquidity in the secondary market, funding liquidity for the mortgage industry has also become constrained," said Savid Sambol, Countrywide's president and chief operating officer. "With these changes, we believe we are well positioned to leverage opportunities presented by a consolidating industry."
If they make it that far. Two major credit ratings agencies, Fitch and Moody's (nyse: MCO - news - people ), downgraded their ratings for Countrywide sharply on Thursday. Standard & Poor's had not acted as of noon, but some said they would not be surprised to see it change either its ratings or its view on Countrywide.
Fitch said its downgrades reflect the "unprecedented disruption in the capital markets, which has severely reduced liquidity for mortgage-centric entities." Fitch downgraded Countrywide two notches, to BBB+ from A, putting it just two notches above junk grade. The ratings firm lowered Residential Capital to BB+ from BBB, making it officially junk grade.
Moody's put the rating one notch above junk, a perilous perch. "These difficult financial markets create potential challenges to Countrywide's franchise and leadership in the mortgage banking business," wrote Moody's analyst Philip Kibel, "and further disruptions in the U.S. single-family mortgage markets."
Moody's also said on a conference call Thursday that market turmoil, which has dragged down the Dow Jones industrial average almost 1,400 points since mid-July, could lead to the blowup of a big hedge fund along the lines of the 1998 demise of Long-Term Capital Management. Hedge funds have been heavy buyers of derivative products linked to mortgages and mortgage-related assets, but the market for trading those securities has all but dried up.
"A possible consequence of the repricing of risk assets would be the failure and disorderly liquidation of a hedge fun or other institution of sufficient size as to disrupt markets," said Chris Mahoney, vice chairman of Moody's, on Thursday.
Financial firms like Countrywide are particularly sensitive to their credit ratings because they have to constantly tap the capital markets to secure their funding. The lower the rating, the harder it is to get cheap funding through debt or credit agreements.
"If enough financial pressure is placed on Countrywide, or if the market loses confidence in its ability to function properly, then the model can break, leading to an effective insolvency," wrote Merrill Lynch research analyst Kenneth Bruce in a report Wednesday that brought up the "b" word in the context of Countrywide. "If liquidations occur in a weak market, then it is possible" for Countrywide "to go bankrupt."
Others raised that possibility again on Thursday. "We do believe there is a scenario in which the current liquidity crises last for longer than three months and CFC is forced into bankruptcy," said Friedman Billings Ramsey analyst Paul Miller. "It will be ugly, but it can happen!"
Countrywide's problems come from its inability to raise sufficient funding in the debt and cash markets for its mortgage operations. It can't roll over short-term IOUs, known as commercial paper, because investors are unwilling to take on the collateral assets that back that paper. It also is struggling to unload subprime loans it holds on its balance sheet. There are simply no buyers.
The company has a total of about $185 billion in funding available.
"Countrywide had previously established committed bank backstop facilities for the rainy day when liquidity is stressed, and the last couple weeks probably fall under the 'when it rains it pours' category," wrote David Hendler, an analyst at CreditSights.
Hendler sees acquisition as a more likely option than bankruptcy.
The Federal Reserve's open market operations added $17 billion in reserves to the system Thursday morning and said it might inject more funds later. Typically, the Fed puts money in the system a few times on Thursdays as banks prepare their weekend reserve positions.
Still, the Fed has been working to keep its targeted short-term interest rate at 5.25%, despite the huge disruptions to the credit markets in the last few weeks. In two big swoops late last week, the central bank added $62 billion to the banking system.
"In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets," the Fed said in a statement Friday. "As always, the discount window is available as a source of funding."
Today the Fed will report borrowings for the last week from that discount window, which is where commercial banks go when they need funding.
More than 70 mortgage lenders have faltered in the last year, notably the bankruptcy of New Century Financial (other-otc: NEWC - news - people ) in February, which could be said to be the starting point of this August credit crisis. Last week, American Home Mortgage (nyse: AHM - news - people )filed for bankruptcy.
As recently as Friday, Countrywide's chairman and chief executive, Angelo Mozilo, said in an interview with Bloomberg that the credit crunch has accelerated in the last 10 to 15 days, but that the Fed's actions to pump cash into the system were a good step in the right direction.
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