The Company

The News

Americans, even the folks who favor the comics over the business page, learned a valuable lesson in 2007: If lots of people borrow money to buy houses and don't pay it back, there are far-reaching repercussions. Investors in

Countrywide Financial

"We were in a bubble and the bubble has popped," says Paul Miller, an analyst at Freidman Billings Ramsey & Co. "I think a lot of these companies were overconfident of their own capabilities, and I think [Countrywide Chief Executive] Angelo Mozilo, who'd said he'd never seen a soft landing in housing, was even surprised that so much of this crisis landed on his front door."

At the eye of the storm that hit Main Street and Wall Street with equal severity were the subprime loans made to borrowers with less-than-stellar credit histories. As defaults on these riskier mortgages that readjusted to higher interest rates accelerated from a pitter-pat to a steady drumbeat to a flailing John Bonham-Led Zeppelin drum solo, Countrywide paid a steep price. Adding to its woes, so-called Alt-A loans, which required little or no income verification but were considered a step up from subprime, began to unravel too.

Amid the meltdown, CEO Mozilo retained a cheerful public demeanor. After all, Countrywide's subprime exposure was far less than competitors such as New Century Financial, which was forced to declare bankruptcy in April. When the extent of problem with Alt-A loans, which represented big business for Countrywide, started to grow over the summer, the company in August sold a $2 billion stake to Bank of America to ward off worries.

But by October, Countrywide unveiled its first-ever quarterly loss and announced write-downs of $1.2 billion, with admissions of more to come. That made it official: The company was being swept along in the current of a market collapse.

Despite shedding more than $20 billion in market cap Countrywide survived, and that's something of a triumph, says Miller. Chalk it up to luck or foresight, but Mozilo's ambition to dominate the business prompted his company to expand into banking services, and its certification gave Countrywide access to federal bank insurance, which made all the difference. Look at New Century, or any of the 209 other companies that wound up on the inauspicious Mortgage Lender Implode-O-Meter, which has diligently chronicled the fallen in the ongoing subprime crash.

"If you weren't able to tap the federal home loan banking system, you went under," says Miller. "If [Countrywide] hadn't gone out and gotten a bank charter a couple of years ago, they would not have survived this."

Countrywide Financial (CFC) vs. S&P 500

The Analysis

There's plenty of finger pointing to go around, and Countrywide deserves its fair share. But calling Mozilo the poster boy misses the point that Countrywide was operating within a system where lax regulation and an insatiable appetite for bundled, securitized pools of mortgages kept inflating the bubble.

Robert Brusca, chief economist at Fact and Opinion Economics in New York, says former Federal Reserve Chairman Alan Greenspan, who famously warned of irrational exuberance in the technology stock boom of the 1990s, failed to heed signs of overly lax lending standards. Combined with low interest rates, the stage was set for an unsustainable mortgage boom.

When Edward "Ned" Gramlich, then a Fed governor, raised red flags about too-easy credit in 2001, "Greenspan basically told him to mind his own biz and let the market sort it out," according to Brusca. "If the Fed had gotten on top of this three years ago, we wouldn't be in this situation today." Gramlich died Sept. 5.

Looking at the bigger picture, Brusca points out that Countrywide was doing whatever the market allowed it to do. As demonstrated by a spate of recent lawsuits, investigations by state attorneys general and a Securities and Exchange Commission inquiry into Mozilo's $132 million profit on sales of company shares, Countrywide's not blameless. But neither did it unilaterally create the bubble.

What it did, like many other lenders, was to hand out loans to people who probably wouldn't have qualified for mortgages in less heady time, or found ways to get borrowers bigger mortgages that their budgets could handle.

"Countrywide has always been the supermarket of mortgages," says Morningstar analyst Erin Swanson. "If something is being offered in the industry, they're going to offer it."

In October, Countrywide backtracked a bit on its aggressive tactics, letting about 52,000 subprime borrowers refinance their homes with prime mortgages or ones set up under a federal plan to prevent foreclosures. It also gave better terms to another 30,000 homeowners who were falling behind in payments but had not yet defaulted.

It was a decent enough public-relations move, but it doesn't begin to address the company's biggest troubles: There aren't any buyers for the packages of loans it hoped to sell to big investment banks and other financial institutions. That's where Countrywide and other mortgage lenders were burned by following market dictates, says FBR's Miller.

"It's a mortgage industry thing. Wall Street forced these guys to go to lower and lower FICO [credit] scores for borrowers" to feed appetites for these securitized pools of mortgages, he says. "They were taking excessive risk on their underwriting, and when it went bad, Wall Street said, 'We don't want these loans and we don't want these loans, and oh, the ones we got last week we want to give 'em back to you.'"

"Mortgage lenders all woke up one day and their pipelines, which were massive, had no market," Miller says.

Countrywide's still undetermined write-downs could reach as high as $2 billion, he says. The company didn't return phone calls seeking comment for this story.

The Bottom Line

The coming year won't be easy for Countrywide, but that doesn't mean it'll close up shop.

"People aren't going to quit needing mortgages anytime soon," Morningstar's Swanson points out. "Even though the market has tightened up considerably, Countrywide and others continue to originate loans, and over the long term there's value inherent in the business. That's not only the origination side, but the servicing side, which is the more attractive part of the business."

While the mortgage industry will march on, it'll surely march with a limp. A Dec. 14 report by Frederick Cannon, an analyst at Keefe Bruyette & Woods, suggests that origination volume will drop 35% in 2008, which largely reflects the end of the subprime and Alt-A markets. "The market has already priced in a real-estate recession," adds the report.

But federal moves to halt subprime lending may help Countrywide more than other mortgage lenders, suggested a Fox-Pitt Cochran Caronia Waller report published Nov. 30.

"It is a necessary step to stabilize reeling mortgage markets and avoid a further downturn, as servicers struggle to cope with a cascade of current and potential foreclosures. We believe this is good news for our sector as a whole, but believe that CFC will be prime beneficiary as the nation's largest servicer and top originator," analyst Howard Shapiro wrote.

Shapiro upgraded the stock to Outperform from In Line and suggested aggressive buying, predicting "significant upside through 2009, as the mortgage market begins to normalize."

FBR's Miller is more cautious: "The bodies are still flying and Countrywide's not out of the woods yet."

"This is a binary situation it's either going to make it or it's not," he says. "If it makes it it'll be a $25 stock if not, it's taken over by Bank of America as a $2 stock."

Swanson, who takes a longer-term view, says investors shouldn't expect much stability in the shares, particularly since nobody knows the final tally on Countrywide's loan losses.

"The way I phrase it is that there is headline risk that's still there, that it's still going to be a long and bumpy road," she says. "We don't have complete visibility on all the issues at this point, but, given the risk, there is return potential."