Housing Bubble
Fitch places Countrywide on Rating Watch Negative
February 20, 2003
Fitch Ratings today placed the 'A' medium-term notes rating, 'A-' preferred stock rating, and 'F1' commercial paper rating of Countrywide Home Loans, Inc. (Countrywide) on Rating Watch Negative. Fitch also placed the 'A' convertible debentures rating of parent company Countrywide Financial Corp. (CFC) on Rating Watch Negative. Over $18 billion of rated debt is affected by this action.
Today's action is due to concerns within Fitch regarding the increasing risk of impairment that is present within mortgage banking companies' balance sheets. This risk is particularly prevalent for those companies that have significant business concentrations in mortgage banking, such as CFC, with high levels of capitalized mortgage servicing rights (MSRs) as a percentage of equity. At initiation, MSRs are derived from the present value of expected future income to be received over the expected life of the mortgages. The value is based on assumptions regarding prepayment rates, discount rates, ancillary fees, and costs to service.
In the past, Fitch has noted its concerns over CFC's significant, albeit declining, concentration of MSRs in relation to capital. In addition, CFC's MSRs contain an increasing level of subprime, home equity lines of credit, jumbo mortgages, and adjustable-rate mortgages, which we believe are far more difficult to model and hedge relative to conventional mortgage products. Also, CFC's MSRs are generated using aggressive valuation assumptions regarding the capitalizing of other fees and cross-sell income, such as interest earned on escrow balances and late fee income. Fitch notes that CFC has made numerous modifications to its MSR assumptions, however there remains much subjectivity in valuing MSRs, a lot of which Fitch does not believe would be transferable in the open market. These concerns are specifically relevant for these companies specializing in mortgage banking.
Given the changing dynamics of the mortgage banking industry, Fitch believes that the difficulty in hedging the volatility of MSRs will likely increase in the future. Fitch recognizes CFC's solid historical performance, buoyed recently by the existing refinance boom that has prevailed in the U.S. for well over a year, reflecting the company's market leadership in the mortgage banking industry. While CFC has moved to diversify its operations away from traditional mortgage banking activities, through capital markets, insurance, and banking services, the core of this diversification is still heavily tied to the mortgage business. Some of the other diversification activities, notably subprime mortgage lending, have added an increased level of credit risk to the overall operations that was not present prior to the late-1990s.
Fitch expects reconciliation of the Rating Watch Negative to occur over the near-term. The focus of their analysis will center on reviewing the full financials for 2002 as well as reviewing CFC's financials for the first quarter of 2003, with particular attention focusing on the performance of the MSR and analyzing actual cash flows versus expected assumptions.
Countrywide Financial Corp. is the largest independent mortgage banking company in the U.S. Its vast mortgage banking operations engage in the business of loan production and servicing primarily through Countrywide, which originates, purchases, securitizes, sells, and services mortgage loans. CFC also maintains subsidiaries that encompass insurance, capital markets, banking, loan closing services, and a global mortgage servicing operation that is a 70%-owned joint venture with a subsidiary of Barclays Bank of the U.K.
Source: Fitch Ratings
