Countrywide's Woes Multiply
As Merrill Reduces Rating

Countrywide Financial Corp. shares dropped 13% as investors fretted about the giant mortgage lender's ability to cope with a worsening credit crunch.

The slide followed a Merrill Lynch & Co. analyst's release of a report slapping a "sell" rating on the shares of Countrywide, the largest U.S. home-mortgage lender by loan volume, and discussing a scenario under which the company could be forced into bankruptcy-court protection.

A Countrywide spokesman didn't provide a comment.

Countrywide shares fell $3.17 to $21.29 on the New York Stock Exchange. They have declined 50% so far this year.

The sell call from Merrill analyst Kenneth Bruce came just two days after he published a note rating Countrywide stock a "buy." A Merrill Lynch spokeswoman declined to make Mr. Bruce available to discuss the abrupt switch in his recommendation, which the report attributed partly to rapid deterioration in the credit markets over the past few days. Until yesterday's note, Merrill reports on Countrywide had consistently forecast share-price gains over the past two years.

Moves by central banks to pump more money into the financial system in recent days raised some hopes for an easing of pressure on mortgage lenders such as Countrywide that rely on short-term borrowings to finance their lending. "We had hoped, too optimistically in hindsight, that the market would calm down on the injection of liquidity," Mr. Bruce wrote. "It has not, in our view."

In a report titled "Liquidity Is the Achilles Heel," Mr. Bruce said demands for more collateral or repayments from lenders, along with forced asset sales, could weaken Countrywide, long viewed by Wall Street as one of the most solid mortgage companies. He said the risk of such a "liquidity event" at Countrywide is rising.

In one scenario, he wrote, if creditors were to cut off funding to Countrywide, forcing it to sell assets in a weak market, "then it is possible for (the company) to go bankrupt." Wall Street analysts rarely raise such scenarios in published research for fear of alarming the market.

The Merrill report noted that the firm has provided investment-banking and other services to Countrywide over the past year.

As of June 30, Countrywide's balance sheet showed assets including $1.15 billion of cash and $34 billion of mortgage loans held for future sale to investors. In an Aug. 2 press release aimed at reassuring investors, Countrywide said it had "almost $50 billion of highly reliable short-term funding liquidity available as a cushion today." The company's stock-market value stood at about $12.5 billion yesterday.

A collapse of Countrywide, still considered unlikely by most analysts, would sow confusion in the U.S. housing and mortgage markets. Countrywide makes or provides funding for nearly one in five U.S. home loans. It acts as the "servicer" -- collecting payments and dunning delinquent borrowers -- for about $1.4 trillion in home loans, or 14% of those outstanding.

So far this year, the U.S. mortgage market has coped with the closures of scores of small and midsize lenders. Surviving lenders' severe tightening of credit standards already is putting more downward pressure on the housing market.

Countrywide sells most of its loans to Fannie Mae, Freddie Mac and other investors but holds some of them as long-term investments. As of June 30, Countrywide held $74 billion of loans for investment. That included $27.78 billion of pay-option adjustable-rate mortgages held by the company's bank. Such loans give borrowers several payment options each month, including paying less than the interest normally due. In that case, the loan balance grows. Payments were at least 30 days overdue on 5.7% of those option ARM loans as of June 30, up from 1.6% a year earlier.

Unlike many lenders that have failed in recent months, Countrywide has a deposit-taking unit, Countrywide Bank, with assets of $90 billion, regulated by the federal Office of Thrift Supervision. That gives Countrywide more scope than some of the failed lenders to fund and retain loans without reliance on short-term borrowings.

Because of rising defaults and uncertainty over the value of mortgage-backed securities, investors over the past two weeks have shunned almost all mortgage-related paper except for loans that can be sold to Fannie and Freddie, the government-sponsored investors.

The market turmoil has forced a midsize lender, Thornburg Mortgage Inc., to delay providing funds for most of the mortgages due to be completed this week, said Larry Goldstone, president of the Santa Fe, N.M., company. "We tell borrowers we are working very hard to try to get to a place where we can start to fund mortgages again," Mr. Goldstone said in an interview. That could be as early as next week, he said.

Countrywide has recently been on the offensive, hiring hundreds of loan officers from rival lenders exiting from the business. "They are still very active and still out looking for business," said Mitch Ohlbaum, president of Legend Mortgage Corp. in Los Angeles.

There are still bulls among Wall Street analysts covering Countrywide. Reuters Knowledge said yesterday that there are six buy or "outperform" ratings, four "hold" recommendations and six sell or "underperform" calls on the company. In interviews, analysts from Keefe, Bruyette & Woods Inc.; Fox-Pitt, Kelton; and Friedman, Billings, Ramsey & Co. said they believed Countrywide can weather the current freezing up of credit for lenders.

Howard Shapiro, a Fox-Pitt analyst who has a buy rating on Countrywide, said the company can continue drawing enough funding from such sources as deposits at its banking arm and loans from the Federal Home Loan Banks.

"I believe they're going to get through the liquidity issue," said Frederick Cannon of Keefe Bruyette, but he added Countrywide faces downward pressure on earnings. Paul J. Miller Jr. of Friedman Billings noted Countrywide has a giant, cash-generating "servicing" business that gets fees for collecting loan payments and handling other administrative tasks. If the company were faced with failure, he said, "I think someone would come rescue them," though the value isn't clear now.

Mr. Miller has an underperform rating on the stock and Mr. Cannon a hold.

Countrywide bonds tumbled as much as 5% yesterday to around 90 cents on the dollar, according to data from MarketAxess.

-- Serena Ng and Aparajita Saha-Bubna contributed to this article.

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