Subprime City Confidential: Aug. 16, 2007


When we last left Countrywide (CFC) , the No. 1 mortgage lender had been beset by liquidity rumors, with its stock price plunging Wednesday as a result. And a day later? Well, the company raised eyebrows and blood pressure levels on the Street when it announced that it was drawing down its entire $11.5 billion short-term credit facility to bolster its liquidity. The company also announced plans to shift more of its lending operation to its in-house bank. The shares tumbled more than 20% on the news as the move raised fresh questions about the lender's viability, though they recovered somewhat by the close of trading Thursday to finish 11% lower. Next, the rating agencies got in on the act, with Moody's, S&P, and Fitch lowering credit ratings on Countrywide Financial. S&P lowered its rating on Countrywide Financial to A- "to reflect the incremental liquidity and earnings stress" on the company. But while S&P and the other ratings shops still consider Countrywide an investment-grade credit, others on the Street aren't so sure. At one point in trading Thursday, the credit derivatives market reflected a 25% chance of default on Countrywide's debt over the next 12 months, reports Action Economics./a>


First Magnus, the 16th largest U.S. mortgage lender, said Thursday it had stopped funding home loans, citing the "collapse of the secondary mortgage market. A grim-looking notice on the company's Website advises visitors that "In light of the collapse of the secondary mortgage market, First Magnus will not fund any future mortgage loans, and is no longer accepting any mortgage loans applications or funding any mortgage loans previously originated and not yet funded." First Magnus lent money in all 50 states and funded loans in excess of $30 billion in 2006, according to a February, 2007 press release. The body count grows ...


Here in Subprime City -- where the grass is green and the resales are, um, never mind -- we haven't noticed a lot of new center-hall colonials rising from the verdant fields where Flossie and Bessie used to graze. And we're not alone. A report released Thursday showed that U.S. housing starts dropped 6.1% to 1.381 million-unit annual rate in July, from a revised 1.470 million-unit pace in June (from 1.467 million). Even worse, July permits fell another 2.8% to 1.373, from a revised 1.413 million in June (1.406 million previously). The U.S. housing starts figure of 1.381 million in July marks the new low since January, 1997, while the drop in permits to 1.373 million in July marks the lowest reading since October, 1996. "As bad as July's numbers were, they are bound to get worse in the next one to three months because of the turmoil in financial markets today," Patrick Newport, an economist at Waltham (Mass.)-based Global Insight, told BW's Maya Roney (see, Aug. 16, 2007, "Housing Starts: It's Going to Get Worse").

According to Citigroup (C) senior economist Steven Wieting, the shrinking starts, along with other negative data from the sector, "present the most concrete forward looking signs that market turmoil will impact real activity" -- that is to say, the broader economy.


Can we talk? After KKR Financial shares fell 31% Wednesday after the specialty finance outfit said a sale of $5.1 billion in residential mortgage loans will result in a $40 million loss, the company held a conference call to discuss the sale and review its liquidity position. The confab seemed to do the trick: the stock gained 26% Thursday. On the call, KKR Financial quantified its maximum loss exposure on its remaining residential mortgage-backed securities (RMBS) as $200 million, which, combined with the $40 million already recognized and a potential negative tax expense of up to $50 million, puts its total loss exposure at $290 million. After listening in, S&P equity analysts think that with over $450 million in available liquidity after the $40 million loss, "we do not believe KFN faces any near-term funding issues."

Friedman Billings Ramsey (FBR) analyst Merrill Ross upgraded the shares to outperform from market perform following the confab. Ross says that over the next two weeks, the company plans to resolve its current residential loan portfolio, and will restructure, refinance, or sell its remaining exposure in RMBS to focus on its specialty of corporate lending. The analyst thinks there is potential upside as capital extracted from the RMBS portfolio sale is invested back into its core business.

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