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Losses Threaten Countrywide Deal

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Capital position threatened by lower payment options.

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Mounting losses in Countrywide's (CFC) mortgage portfolio are putting the completion of its takeover by Bank of America (BAC) in question.

In Countrywide's 10K, filed last Friday, the company detailed the abysmal performance of option adjustable-rate mortgages, or Option ARMs. Option ARMs allow borrowers to choose between monthly payment options, the lowest of which result in principal being added to the balance of the loan, known as negative amortization (see number five).

Option ARMs more than 90 days delinquent increased to 5.4%, up 900% from a year ago. In Countrywide's $28 billion Option ARM portfolio, 71% of borrowers are only making the minimum payment and 80% of the loans did not require borrowers to verify their income.

$87 billion of the company's entire mortgage portfolio is backed by loans in either California or Florida

The Wall Street Journal notes higher than expected losses on home equity loans have forced loan servicers to trap repayments to protect bond investors. Countrywide is obligated to continue advancing borrowers' requested funds, further pressuring its capital position. The firm claims this situation was "deemed remote" until late 2007, and that its "maximum obligation cannot be defined."

Countrywide's already shedding assets, likely beginning with its REO portfolio of thousands of bank owned properties. The true value of REO assets is widely unknown, and forced selling may cause banks like Washington Mutual (WM) that hold vast quantities of this paper to incur additional losses. Shareholders will experience more pain, but eliminating this rot is one of the first steps to repairing the industry's balance sheets.
No positions in stocks mentioned.

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