Summary
Countywide's announcement late last Friday and Angelo Mozilo's letter to employees provide a unique window into CFC's strategy for addressing the impact of the credit crisis on its business. The letter provides details on the steps that CFC is taking to shelter itself from the fallout. Unfortunately, the strategy, while undoubtedly aggressive, may not be enough.
Analysis
Countrywide issued an announcement after the market close on Friday, that they expected to reduce headcount by up to 12,000 employees over the next three months. A letter to employese from Angelo Mozilo, Chairman & CEO of Countrywide spelled out the steps that the company is taking to address the impact on its operations, from the crisis in the credit markets. THe actions taken by the company are unquestionably aggressive and CFC is moving very rapidly to reduce its exposure to subprime mortgages. Investors should parse the text of the letter carefully to gauge the impact on earnings, even in the face of a possible Fed funds rate cut on September 18th. Also, CFC's actions do not bode well for another mortgage company, Rescap Holdings LLC, a division of GMAC.
CFC expects to move its mortgage originations to Countrywide Bank, a federally chartered thrift that it owns. They also plan on originating only conforming i.e. Fannie/Freddie/FHA loans. Note that even the non-prime loans that CFC plans to originate must be eligible for purchase by the government sponsored enterprises or GSE's (Fannie and Freddie). This has several very important implications. First, CFC will not be originating jumbo loans or those with original balances greater than the conforming limit, currently $417,000. Congressional Democrats such as Senator Schumer and Christopher Dodd are pushing to temporarily increase that limit, although there's likely to be opposition to the proposals. Secondly, gain-on-sale margins on conforming loans are less than 1% today and likely to get narrower if there is a flood of mortgage companies that suddenly start originating only conforming mortgage loans (e..g. Rescap, Impac - IMH). CFC also plans to hold the loans that it does not sell to the GSE's at the bank rather than at the mortgage company. Some of the advantages of keeping them at the bank: no need to finance the loans with fickle warehouse funding since the bank can fund the loans through more ostensibly more stable sources of funds such as customer deposits and borrowings fom the Federal Home Loan Bank. A downside to housing the loans on the bank's books are (1) CFC will almost certainly be forced to either raise a lot more equity to bolster capital at the bank to support the increase in the bank's portfolio, and/or reduce its production. Since the latter is highly unlikely - mortgage production may actually increase from current levels in the event of an aggressive Fed rate cut - CFC will probably have to inject more capital into the bank to satisfy regulatory risk based capital requirements, and (2) income from holdings loans us interest income, which has less of an incremental effect on earnings than does gain-on-sale. Gain-on-sale is likely to be lower and less of a contributor to CFC's earnings under the new roadmap.
Countrywide is not the only mortgage company that also has a bank. Rescap Holdings, the troubled mortgage banking subsidiary of GMAC - 49% owned by GM - owns GMAC Bank. Might Rescap also elect to move all mortgage originations to the bank ? We will discuss this possible development in a subsequent posting later this week.
