Countrywide Warns of Higher Credit Costs, Citing 'Piggyback' Loans

Countrywide Financial Corporation warned of "continued weakness" in the housing sector, warning investors that subprime credit problems have seeped into its prime home equity business as well.

Countrywide said the home equity deterioration largely involves piggy-back loans and lines of credit originated along with a first mortgage.

Countrywide took a $417 million impairment hit to its investments in "credit sensitive retained interests" on securitized loans. $388 million of that total represented impairment of residual securities backed by prime home equity loans, the company said, reflecting higher expected delinquency and loss rates.

On its held-for-investment portfolio, Countrywide raised its loss provision by $293 million in the second quarter. $181 million of the additional loss reserve related to prime home equity loans held by the company's bank.

Moreover, Chairman and CEO Angelo Mozilo said Countrywide expects "difficult housing and mortgage market conditions to persist" for the remainder of this year.

"During the quarter, softening home prices continued to affect many areas of the country and delinquencies and defaults continued to rise across all mortgage product categories as a result," Mr. Mozilo said during a conference call with investors and analysts.

On the bright side, Countrywide's loan production performance was the strongest since early in 2005, the company said.

Countrywide produced $123 billion of home loans in the second quarter, up from $103 billion in the second quarter of last year. Profits from loan production benefited from increases in gain-on-sale margins and higher net warehouse spread margins as well as lower expenses, Countrywide said.

Mr. Mozilo said the company is optimistic about its long-term prospects and ability to benefit from industry consolidation.

Countrywide's servicing segment posted a loss, reflecting $268 million of net impairment on the company's holdings of "credit sensitive retained interests." That was partially offset by a positive adjustment on prime quality retained interests, the company said.

While second-quarter earnings-per-share of $0.81 were up from the first quarter, the earnings were down sharply from the $1.15 EPS Countrywide reported in the second quarter of 2006. The company's mortgage banking income totaled $320 million in the second quarter, just over half of the 2006 second-quarter tally of $630 million.

Countrywide reduced its earnings forecast for this year to a range of $2.70 to $3.30, down from $3.50 to $4.40 range in April. It was the second time this year that Countrywide has trimmed its earnings forecast. The company's share price dropped 10% on July 24, the day earnings were released.

The degree of deterioration in credit quality seemed to catch analysts by surprise. Friedman, Billings Ramsey & Company lowered its rating on Countrywide's stock to "underperform."

Morgan Stanley analyst Kenneth Posner said Countrywide's credit trends "look worrisome." At Countrywide's bank, nonperforming assets rose to 1.19%, up from 0.66% at the end of 2006. And Morgan Stanley said accumulated negative amortization from the bank's portfolio of pay-option ARM home loans is still rising.

However, Morgan Stanley continues to rate Countrywide's stock as "outperform," arguing that the company's balance sheet is stronger than investors fear and that the company's risk management skills remain impressive.

"That said, we will need to reassess these views, as credit performance has surfaced as a bigger risk factor than we expected," Mr. Posner said in his report.

Countrywide's 2Q Charges

Credit Sensitive Retained Interests $417 Million

Prime HE Share of That Impairment $388 Million

Increase in Loss Provision at Bank $293 Million

HE Share of Higher Loss Provision $181 Million (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.bondbuyer.com/ http://www.sourcemedia.com/

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