CreditSights: Too Early to Declare Victory for 'Exotic' Products

Analysts at CreditSights say that while "exotic" mortgage products haven't been a problem for Countrywide Financial Corp. to date, it is "too early to declare victory in credit performance."

In a recent investor presentation, Countrywide executives reiterated their plan to continue gaining market share, even as the industry faces challenges from overcapacity and weaker fundamentals. Countrywide is already the nation's largest mortgage originator and servicer.

CreditSights noted that Countrywide continues to defend alternative mortgage products such as payment-option products, interest-only mortgages and 40-year amortization home loans. And so far, the credit performance has been good.

"That said, we continue to question whether these products have yet been effectively tested across interest rate cycles, especially considering the more sizable volumes of origination for what were once very selective niche products," CreditSights analysts David Hendler, Baylor Lancaster and Richard Hofmann said in a report.

Countrywide noted that conforming loan products no longer dominate origination market share. In 2001, loans that conformed to Fannie Mae and Freddie Mac standards accounted for about three-quarters of origination volume. But in 2005, the conforming loan share had fallen to 37%. Countrywide believes that alternative mortgage products are beneficial, allowing borrowers to better manage their financial situation and boosting home affordability.

Because many of the new products are adjustable-rate payment schedules, they may ease the burden of hedging mortgage servicing rights, CreditSights said.

Countrywide believes that the shorter duration and higher-option-adjusted spread of ARMs create more robust refinancing opportunities and higher yields and return on equity for the company than traditional fixed-rate products.

Moreover, Countrywide also expects the implementation of FAS 156, which allows for "fair value" accounting of mortgage servicing rights, will simplify hedging of the MSR asset as well.

Another growth opportunity for Countrywide is reverse mortgage lending. Countrywide expects to increase its reverse mortgage volume by about 40% this year.

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