Countrywide Financial Corporation CFC:NYSE

The sub-prime mortgage disasters continue to be exposed for being high stakes high flying gamblers on folks with poor credit. The mess is further complicated by high priced areas such as California causing a priced-out panic over the past three to four years. This priced-out panic caused a huge rush of unqualified and uneducated would be buyers to run down to their local mortgage shop hoping to qualify and get in before it was too late. I can attest first hand about this panic. I lived in Orange County, California from 2001 to 2005, and believe me when I say the only word to describe it is “Hysteria.” You had Realtors feeding the frenzy with their talk of a real estate market that had no limits to how high it could go, and more than friendly mortgage brokers ready to hand you an exotic mortgage with exotic terms that on the surface appeared to be a God-Send, but was the devil in sheep’s clothing. These exotic mortgages such as the interest-only and negative amortization loans have been a huge disservice to folks who did not understand they were literally entering into a trap that eventually would engulf them in misery.

Now that the mess of the past five years is coming undone and many companies are being led to the slaughter such as New Century and Accredited Home Lenders this may be the perfect time to scour the sector for companies with strong operating histories and balance sheets that can weather the storms of this cyclical industry.

This brings us to Countrywide Financial. The company has been operating since 1959 and has weathered every housing downturn since that time. While history is no exact predictor of the future there appears to be the real possibility that Countrywide may be oversold and undervalued in respect to the strength the company possesses and its ability to emerge from this chaotic mess stronger with fewer competitors as the high flyers started over the past five years fade away into financial oblivion.

The company is defiantly exposed to sub-prime losses, however, its exposure should be limited as its entire loan portfolio is not sub-prime and mortgage originations represent just 47% of the 2006 pre-tax earnings. The company has and is currently diversifying its business in order to avoid earnings gyrations caused by the cyclical housing market.

The company’s five operating segments are: Mortgage Banking, 47% of pretax earnings in 2006 (59% of pretax earnings in 2005), Banking, 32% (25%), Capital Markets, 13% (11%), Insurance, 7% (4%) and Global Operations, 1% (1%). In 2007, the company will likely continue to focus on diversification in an attempt to leverage its core Mortgage Banking business and provide earnings that are less cyclical.

The Standard and Poors is expecting EPS growth of 10% over the next five years. This is obviously not spectacular, but if the company is currently undervalued it could present a real opportunity to achieve an above average return. S&P has also determined the fair value of the company is $35.50. Most companies trade well above this fair value calculation.

As of the close of the trading on Friday, March 23, 2007 the company was trading around 8.6 times earnings (TTM). Current year (fiscal 2007) earnings estimates are $4.22 a share, which currently puts the stock at 8.7 times earnings. Earnings estimates for fiscal year 2008 are projected at 4.87, which puts the stock at a 7.56 times 2008 earnings. The following are PE histories for Countrywide:

Average 10-Year High PE Ratio 12.1
Average 10-Year Low PE Ratio 7.0

Average 5-year High PE Ratio 9.2
Average 5-year Low PE Ratio 5.8

The company’s major competitors are trading at higher PE Ratios such as Bank of America (BAC) at 11.25 earnings, Washington Mutual (WM) at 11.60 and Wells Fargo (WFC) at 14.06. The industry is trading at 10.41 earnings. These are all for the trailing twelve months. These competitors are more diversified financial institutions and may explain why they are trading at higher PE ratios; however, it appears that Countrywide is trading at a discount to its strength and historical PE ratio. If the company were to trade at just 10-times 2008 projected earnings the stock would be priced at $48.70, which would represent a 32% return over the next 12 to 24 months, and that would not include the dividend yield of 1.60% at current share prices.

Now all this talk about the company trading at 10 times 2008 earnings is great, but it means relatively little if the company incurs more than expected loan losses due to its exposure to non-prime mortgage loans. A review of the Company’s most recent 10-k shows that non-prime loan production represented the following as part of total loan production:

2006 8.67% of total loan production or approx. $40.5 million
2005 8.94% of total loan production or approx. $44.6 million
2004 10.85% of total loan production or approx. $39.4 million
2003 4.56% of total loan production or approx. $19.8 million
2002 3.74% of total loan production or approx. $9.4 million


For the past five years total non-prime loans originated equals $153.7 million. The company is also servicing approx. $116.2 million in non-prime mortgage loans, which are currently 19% delinquent with 3.53% of these loans pending foreclosure. As of 12-31-06 the company had common shares outstanding of 585,466,719 with basic earnings per share of $4.42 and diluted of $4.30. So if all of these non-prime loans were to be written off it would only amount to approx. $.46 per share. It is obviously unlikely that all of these non-prime loans would go bad. Sandy Samuels, an executive officer of Countrywide, recently said to the Senate Banking Committee said foreclosure rates on their non-prime loans could reach or exceed 10%. He did emphasize that 90% of the company’s non-prime borrowers will not loose their home. So if we were to establish a range of 10% to 20% it means the EPS hit could be $.05 per share to $.10 per share.

The company also has non-prime exposure in its recourse securitizations. At December 31, 2006 this exposure amounted approx. $401.5 million. Credit losses in 2006 related to these securitizations amounted to $94.8 million.

The following positives with the unpaid principles balances were noted: (1) – 70% of the unpaid principle balances at 12-31-06 had FICO scores above 700 and (2) – 44% of the unpaid principle balances had original loan-to-value ratios (LTV) of 80% or less.


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The company has a lower PE and PEG ratio than its industry.

Related Links

Loan Losses May Be Worst

CFC Not Getting Proper Credit

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