Please see disclaimer at bottom of this document
Countrywide Financial Corp. (CFC)
Countrywide Financial Corporation (CFC) is a diversified financial service holding company engaged primarily in residential mortgage banking and related businesses. It operates in five segments: Mortgage Banking, which originates, purchases, securitizes and services mortgage loans; Capital Markets, which operates as an institutional broker-dealer that primarily specializes in trading and underwriting mortgage-backed securities; Insurance, which offers property, casualty, life and credit insurance as an underwriter and as an independent agent; Banking, which operates a federally chartered bank that primarily invests in mortgage loans and home equity lines of credit primarily sourced through its mortgage banking operation, and Global Operations, which provides mortgage loan application processing and mortgage loan servicing. During the year ended December 31, 2005, the Mortgage banking generated 59% of the Company's pre-tax earnings.
September 8, 2007 "Ramblings"
Here is some stuff I have been thinking, etc. most of below is
about Berkshire and CFC rumors.
I saw a press release yesterday about CFC situation. it appears to be removed from their site. I didn't even notice they "postponed" investors day on 9/5 and 9/6.
Here are some things I came up with in regards to CFC. I have thought about the CFC case quite a bit with Berkshire. Here are a few ramblings:
1. Mozilo, in my opinion, opted for the short term, and sacrificed business model, models that have existed for 100's of years, and has potentially sacrificed CFC as a going concern in the future. Stanley Kurland left the company a little over a year ago. I questioned if the move had to do with potential ratings discussions, or any type of concern for CFC by Kurland.
2. Mozilo via his compensation, has been raping the shareholders. He has made over $100M in compensation over the last few years. He showers himself with golden rewards of cash.
3. He sells shares in his company religiously and with materiality.
4. He might not be such a straight shooter. Comments such as "I am surprised." or "No one came up to me and told me things would get real bad." How do I know that is not so, because I talked to him, at length, in a public forum in September 2006.
5. What does CFC have that Berkshire would want? Plenty
When rumors were going around about CFC and Buffett, I would often think about it. I knew that Mozilo and Buffett didn't seem right. But, I thought that Berkshire could lay claim to the assets and ownership of CFC , via Wells Fargo, BAC or USB. Ultimately, I think that Berkshire in some fashion will own a bit of CFC (probably indirectly via BAC, or perhaps a future consortium, which could include WFC and USB. I am sure that WEB would be fine with BAC (whom I just am not familiar with, but just think of them like WFC, and I do that with really no knowledge of BAC philosophy etc.)
I think that current balance sheet wise, we could see that CFC is actually insolvent. Yet, couldn't BAC make a deal, say, buy the remaining (80% or > ) of CFC for say $4B. They could do this by negotiating with the creditors, banks, investment houses and investors of the paper that CFC owes. In turn, if BAC or like, were to take over, they do it with an arrangement with current creditors, that gives them some remuneration ( a lot less than planned, and ultimately an awful investment for those investors). Meaning if CFC sold a securitized high rated pool of Alt A Option Arms, for say 1.03, well maybe BAC says, we will pay you as though you paid 0.75. At the same time BAC says, "no problemo securitizer asset loaded to the rim dude, we will just split this scene, and you could get substantially less than what we are offering. Take it of leave it, to be blunt, we don't care."
Hence, I am thinking a BAC type could take over the servicing section of CFC and own the very large and I am sure, when structured conservatively, look to the long term, severe profit streams. They could also absorb the current $200b of assets, but only absorb them at their "mark to market" that buyer ( conduit of Berkshire) is comfortable with. This is where Berkshire comes in. They could probably price these vehicles to own as good as anyone. Yet, they can be generous on their stress factors, which would minimize the price they would buy these "marked down assets." Once they own it, a few years go buy, and the "mark" of distress is lifted, and BAC (Berkshire) would secure a profitable future revenue stream, with the typical Berkshire lower risk profile. What I mean is that on all mortgages and assets bought by BAC (synonymous for Berkshire conduit), there is a certain price, that includes reasonable stress levels. Reasonable stress levels, like hurricane insurance after Katrina and such, would have greater than normal uncertainties, and on the pricing of these assets, conduit buyer take advantage of low prices, and at the same time show reasonable attempt to give a fair price to current owners and creditors of CFC and related debts. Maybe there is a way to deal with the buyers of these "bankruptcy remote qSPE's"
Summing it up Mozilo and Buffett, do not seem like a fit. CFC is better off without the leaders (even the founder) that pay such great personal compensation packages, used incompetent judgment in their business model, etc, etc. But, BAC and WFC have that expertise, and we could see a means where indirectly WEB takes over an entity, by use of a conduit subsidiary or material investment where they have an influence on (WFC), BAC or USB , for now). Buffett wouldn't come in and run the place ala Solomon, but he could have a company that already is a leader in the industry do it.
They can save the world ;-)
August 21, 2007 "Note of mine to NY Times"
I would like to talk with you about Countrywide's ALT A and Option Arm situation. I brought the advertisement in from NY Times today and Countrywide had a full page. I found the following odd:
1. CFC mentioned investment grade credit rating...... my response...they have for a long time bragged about their high credit rating. they didn't mention "oh, just last week, most rating agencies downgraded us, two (2) full notches." If you go to the www.nasdbondinfo.com you will see that Moody's does not rate them investment grade. I think they rate them Ba2 , which I think is, 'spec" could be wrong. I think all ratings agencies also have them on credit watch negative.
2. The ad mentioned that they have over $100 billion in assets. They didn't mention the quality of the assets. option arm mortgages, lots of non FNMA stuff. They didn't mention that they have assets / equity in excess of 15X.
3. If gain on sale disappears, earnings turns into material loss.
4. If assets marked to market, decrease 5%, then CFC would lose about $6 bil in stockholders equity.
Question for you. Do you think fed lowered the window, to stop a
run on CFC on Friday. Feel free to call me, day or
August 16, 2007 - quick thoughts and
note to NY Times in regards to their call to me on Countrywide
4. Negative amortization was over 40% of earnings reported last quarter. That will expand when Gain on Sale contracts (or disappears). I wouldn't be surprised to see negative amortization become greater than eps.
5. Option arms (negative amortization) will start seasoning in 2008 - 2010. I imagine this will cause balance sheet impairment, as defaults and foreclosures will probably rise.
I am not comparing to Enron, but if I remember correctly, Enron hit the credit lines real quick when in distress. Fitch and Moody's did cut their ratings today on CFC. Moody's cut 3 notches and Fitch 2.
July 28, 2007 - quick thoughts
1. I do suspect that securitizers are
requiring a materially higher OC, retained interest now.
2. with such a slow down, and with wider spreads, etc, how are Gain on Sale so large in 2Q07, for many of the banks, at least the ones I was (am) short, being DSL and CFC. I materially reduced those shorts, and did fully cover FED. I suspect Gain on Sale margins will soon materially reduce.
3. CFC in my view is not suffering from a 6
sigma event. One issue for them is sub prime, for sure. The other is that they
are holding these marked to market (or marked to model) assets, and these assets
are at around (going from memory here) about 10X shareholder equity. hence, a
little disruption on the mark, goes a long way. Also, the seasoning of Pay
option loans next year, might cause some increased defaults, and I am not so
certain the reserve is proper.
4. I am thinking is that based on not only the environment for loans, but also the potential concern of CFC's leverage, quality of assets and so forth, that securitizers are requiring a step down on how much they will pay for bonds, and some type of mechanism that puts CFC more at risk in a similar fashion as over-collateralization (OC).
5. CFC, with their leverage, and what I consider to be a potential quality of assets and reserve issue, would feel stress, exacerbated by their leverage if they have been "marking to high" and/or "reserving to little."
6. 5 years ago, CFC assets (and liabilities )
looked so much different. I mentioned previously that a major ratings agency and
I spoke, and I was surprised they weren't modeling potential future distress in
Alt A Option Arm loans for CFC. This type of loan is huge for CFC and a huge
Marked to Market asset. (yet, they now might move to investment and then "lower
of Cost or Market" takes over, but that is a whole different story). Anyway, the
ratings agency said, "we monitor by timely payments in our daily tapes." what I
think they were missing, was the fact that option arms, can for 4 years (+/- a
year or so), will continue with very low payments, and default would be
difficult. So, it is a live and learn, even for the best in the business.
July 26, 2007 - further research on CFC
Further research was warranted by comment received about our concern of MSR's affecting the gain on sale. Upon further review, our thesis was correct that CFC was retaining more of the securitized loans. However, we were looking for capitalized MSR's. This terminology is incorrect and we should have been calling it retained interests. Reviewed the 1Q07 10q (2nd qtr not yet released) for retained interest and found that the retained interests did increase $548M over 1Q06 (224%).
Any creation of a retained interest appears to resulted in a gain on sale. These retained interests are to be valued at FMV and should regularly re-valued for Marked to Market. Bear Stearns recently received no bids when they attempted to sell mortgage obligations. Interesting to see impairment, if any, recognized by CFC in the 2nd qtr.
July 25, 2007 - Business Week claims Ronald Redfield has "Gumption."
I was concerned as I first fell upon this article. Then I looked up the word, "Gumption", and found out it means, "Boldness of enterprise; initiative or aggressiveness. Guts; spunk. Common sense." Here is a cut and paste from an article at www.businessweek.com from July 25, 2007
For all the buzz over Countrywide’s poor earnings report on Tuesday and CEO Angelo Mozilo’s bearish comments about the housing market, I think we’d be remiss if we didn’t discuss the elephant in the room: The fact that Mozilo was an aggressive seller of Countrywide’s stock during the past year: By the count of New York Post writer Paul Tharp, Mozilo has sold $118 million in options since last December.
That’s notable because during the same period, Countrywide was
buying back its own stock (which critics argue could have had the effect of
providing a cushion under the stock during the period that Mozilo was selling.
If you want to see a list of all of Mozilo’s stock sales,
click here at BusinessWeek’s new Company Insight Center, which
(shameless plug alert) provides a wealth of information about public companies
and the executives who run them.
I don’t often put much stock in the so-called “earnings calls” that companies hold with Wall Street analysts immediately after each quarterly earnings report, given that the majority of analysts are terrified of asking tough questions lest they offend the CEO and lose their access. But one investor, Ronald Redfield of Redfield, Blonsky & Co., a small New Jersey CPA and investment firm that appears to be short Countrywide’s stock (see commentary here that Redfield posted on his web site a week before Countrywide reported earnings), had the gumption to question Mozilo about the sales. It was an interesting exchange. Mozilo briefly defended the sales, but you could tell the question was eating at him because at the end of the earnings call, he brought it up again. Here’s the exchange:
Ronald Redfield - Redfield, Blonsky & Co.:
Were there any buybacks during the quarter? Do you find, Angelo,
with all respect, you selling a material amount of shares into buybacks? You
previously mentioned you own 10 million shares. How many shares do you currently
own, not including options?
Angelo Mozilo: I don't know the answer to that question. I own -- including options, I think around -- I think it is around 11, 12 million, something like that. The sales of the stock had nothing to do with buybacks because that 10b5-1 agreement was made well over a year ago.
Ronald Redfield - Redfield, Blonsky & Co.: No, the legality is fine, but one can think that perhaps the price is being held up the buybacks creating a demand.
Angelo Mozilo: Yes, well, if you think like that it's -- I don't think like that. The buybacks were done because we thought it was in the best interest of shareholders. I have -- as somebody pointed out, I'm 68 years old, I own a lot of shares, and I have 10b5-1 that is in process right now. That is selling into this market when the buybacks are not holding it up.
So it is an independent issue that is not relevant to buybacks or not buybacks. It is a personal situation that I'm selling into a market no matter where the price of the stock is.
The call continues as other analysts ask questions, and at the conclusion, Mozilo says this:
Angelo Mozilo: Okay, some final comments. One to the individual who asked about my sale of stock. The decision to buy back stock is a collective decision, really emanates from the financial operations of the Company as to what is the best return for the investment of the shareholders, invested capital for the shareholders. So it is totally unrelated to any of my issues relative to the sale of stock.
Secondly, as I said, I don't know the exact amount of shares that I have. But the shares that I have, actual stock I have, I have retained for 39 and a half years. Not sold a share of the initial stock that I got when Dave and I started this Company that I got, that I purchased.
The only thing that is being sold under the 10b5-1 are options with expiration dates.
END OF CALL"
July 25, 2007 - notes reviewing 2Q07 8k and
Neg am income about the same vs. 1Q07-6.33% of total interest income and 7% in 1Q.
Delinquencies and loan losses continue to increase. Loan losses increased to $103,475 from $38,649 in 1Q07.
Gain on sale remained strong and represented 300% of net income. From the call, CFC was only able to sell the prime loans. Contradicted each other several times at various times during call as to credit spreads tightening or widening. Sense that they are not quite sure where the credit market stands and how long the difficulty in selling loans will last. The gain on sale may have been influenced by the increase MSRs during the quarter. we are speculating that in order to get the sale done, more loans had to be retained.
Mozilo noted in call that increased delinquencies were due to economic reasons (unemployment, price decline, etc.), and not resetting of variable rates. Later in the call, David Sambol mentioned that delinquencies could have been worse if not for the economy. Later, the delinquencies and foreclosures were due to different situations in various regions.
Mozilo noted that the tough environment would last thru the end of 07 and stabilize in 08. That was his estimate. Take away is that the end of the tough period is not in sight but CFC did provide a big dose of reality for the industry outlook and I was surprised that so many analysts seemed to be taken aback by the difficulties.
July 18, 2007 (34.94) Notes from http://www.fpafunds.com/news_070703_absense_of_fear.asp
“There have been several studies as to how inflated housing prices had become prior to the present correction. According to the work done by Gary Shilling’s firm, home prices would have to correct between 22% and 28% to return to the equivalent of the median asking rent or to the trend line of the CPI. Prior to 1996, both of these measures approximated the rate of increase in home prices. According to Robert Shiller of Yale University, his real quality-adjusted existing house price index would have to correct nearly 45% to bring it back into alignment. My initial reaction to this estimate was one of disbelief and that it appears excessive; however, home prices would appear to have a considerable way to fall, given the high level of total homes available for sale. With nearly 4.5 million homes for sale in 2007, this compares to an average of approximately 2.5 million homes since 1990 or an excess of approximately 2 million homes. Since 1965, the median dollar volume of single-family homes sales as a percentage of nominal GDP has averaged 8.4% versus 16.3% at the 2005 peak, according to Northern Trust Global Economic Research.”
“Two years ago, we noticed a problem developing in our bond portfolios involving Alt-A securities. Despite having average FICO scores of 718 on the underlying loans, these securities experienced rapidly escalating delinquencies and defaults after just nine months. We sold them since we did not want to wait around to find out the reason why this was happening. Our worst fears were recently confirmed in a study by First American Financial entitled, “First American Real Estate Solutions Report, Alt-A Credit—The Other Shoe Drops?” This report shows the following changes in underwriting standards between 1998 and 2006, with the major changes occurring in the last two or three years:
· ARM % of originations rose from 0.7% to 69.5%
· Negative Amortization rose from 0% to 42.2%
· Interest Only rose from 0.1% to 35.6%
· Silent Seconds rose from 0.1% to 38.7%
· Low Documentation rose from 57% to 79.8%
· FICO scores were essentially unchanged at an average of 706.
What is interesting is that the origination volumes for the last two years, when the most egregious deterioration in underwriting standards occurred, total more than the previous seven years of originations combined. Of further interest, Dale Westoff, senior managing director of Bear Stearns, Inc., estimates that 25.8% of sub-prime and 41.2% of Alt-A originations were in California; the combination of these total 33.7% of the total sub-prime/Alt-A universe. For 2006, sub-prime/Alt-A represented approximately 40% of total mortgage originations. I reference this Alt-A underwriting data because I believe it reflects the wider trend of underwriting deterioration throughout the entire mortgage universe. Because of a laxness in credit underwriting standards, along with an accommodative Fed, the housing price bubble was magnified and, thus, it has spread into the asset-backed securitizations market. “
“A recent example of the flawed nature of this market came to my attention when my associate, Julian Mann, showed me a very garden variety LIBOR sub-prime floating rate security. A major pricing service valued this bond at par, while on March 19, 2007, one of the major rating agencies rated this bond A3. To affirm the accuracy of this bond’s pricing, we went to two brokerage firms that traffic in this type of security and requested what their bid might be, if we owned this security. One responded with a $7 bid. In other words, a 7% of par bid, a difference of 93% to the pricing service. The other firm declined to bid, but they did indicate that, if they were to, their bid would have probably been around this level. Julian has found several other similar examples, so this one does not represent the proverbial “needle in the haystack.””
Just Some Ramblings
Certain banks make loans, using non traditional financing, and
giving loans to individuals which typically would not have gotten loans in past.
This is not merely sub prime, but also Alt A. (Alt A is formerly sub-prime, but
changed name for a new tier). Reserves are at an all time low, where as risks
seem higher. Entities (builders and developers) also, I suspect are
getting loans, based on "what will be after project is completed, rented or
sold. Reserves are at an all time low, where as risks seem higher.
We are short FED, DSL and CFC, all for the same reasons. They all have a material part of their net income tied into income recognized in mortgages, and cash not being collected. CFC also makes a lot of money on securitizing their loans. Our thesis is this securitization will materially slowdown, and that stress of option arm mortgages (payment optional kind of) will be greater than modeled. Balance sheet write downs of loans held for sale and for investment. I think CFC has 12:1 Assets to Equity.
Historically, banks have made money by getting your money, paying
less interest, and loaning it out for longer periods of time, and collecting
greater interest. CFC it appears, in recent years, has deviated from
that history. CFC now reports earnings, yet not necessarily are they
collecting money and at the same time, their reserves are lower than historical.
They also make a ton on selling their loans, this is called "Gain on Sale" via
securitizations. Now that credit spreads have widened, this "Gain on Sale,
should be less. Once sold, they have forfeited future interest income. If loan
defaults or prepays, they may have to reverse gain on sale previously picked up.
They also carry a huge amount, compared to equity, of Mortgages as investment,
which are reported quarterly at "lower of cost or market" and Mortgages held for
sale, which is "marked to market." I theorize that many are not liquid, hence
mark to market is suspect. Playing devils advocate, even if liquid, markets have
dropped, and I think that will be evident on many banks reportings for
June 30 , 2007 (due 8/15/07).
Watch the total assets on the banks and brokerages. If they start dropping, does American liquidity start to get tighter? Now liquidity is great, when he goes home, it could be great as well.
You could look at our notes on that and see the following:
1. Gain on Sale income has been on average, from F2003 - F2006, around 200%. In theory, that ratio looks like it could drop in F2007, even though is is 284% at 1Q07. Nevertheless, something to watch, especially as we know credit spreads have widened.
2. If you look at negative amortization you will see " % Non Cash Interest Income / Total Net Interest Income", in 2003 was not material (0.00%) and is now 27.5% of NI before taxes. In 1Q07 that amount rose to 41%.
3. Insider selling has been brisk. For most of the insider selling period, you have had company buybacks in the ratio "buybacks/insider selling) of about 3:1. Just mentioning and not insinuating a thing.
4. As of May 31, 2007, nearly 1% of all cfc serviced loans are in foreclosure.
5. Insurance division seems to be much more profitable than traditional insurance companies. When I mention this, I am not at all focusing on mortgage insurance, but focusing on Balboa. The potential exists that they are being too aggressive with their assumptions.
I think we are all starting to realize that the analysis of CFC
is real difficult. If it weren't that difficult, the ratings agencies
would have gotten it correct. I don't blame them one bit for their lack of
correctly modeling the increased stress on the system. . This was new to them.
Look at the velocity since 2004. I was at a securitization conference in
February. A major securitization and banking analyst for one of the major
agencies, told me they were not at all stress testing negative amortization
loans. If the loan was current, they were modeling all was okay.
The data they were using in my opinion, was skewing the loans to look more
favorable than actual, more favorable than history. Why is that? My guess is
that the loans were performing, because one will not default till seasoned. Why
would you stop paying on the negative amortization loan . In a negative
amortization home, you can live super comfortable for 53 months, and hope things
work out before them. So, I think the major agencies are now modeling
negative amortization. The ratings agencies are evolving. It's just natural.
Yet, we see some recent Countrywide securitizations (as recent as Friday) be
rewarded Aaa. One thing is for certain, every ratings agency and most
banking analysts, know a lot more about this stuff than me.
I do think CFC will feel some balance sheet stress. I think CFC will at a minimum feel pressure from their ratings agencies.
None of above is recommendation for any investment, just sharing
some thoughts. sorry if errors.
June 21, 2007 (37.66)
Review of 2006 10K and March 2007 10Q
CFC sells 85%-90% of originated loans and has benefited from gain on sale of those loans. This % is very high compared to DSL and FED. 1Q07 gain on sale represented 284% of net income for CFC while DSL was 19% and FED was 9%. See #6 below.
Efficiency ratio reported in q much lower than calculated—why? CFC reported efficiency ratio includes banking operations only. The 22% reported is very good by industry standards-someone at Ryan class told me Hudson City Savings Bank was around 19% and that was thought to be excellent and as low as he had seen. Maybe overhead costs not being allocated to banking divisions fairly so the efficiency ratio might not be reliable.
Pre-tax earnings decline 37% March 07 vs. March 06. Divisional allocation of pre-tax earnings also reflected significant changes:
% of pre-tax earnings
% of pre-tax earnings
CFC gain on sale of loans accounted for 285% of net income in March 07 versus 199% of net income in March 06 and 212% for year end Dec 2006.
Negative amortization included in loan totals was $815.8M as of March 07 and $654.0M in Dec 06, an increase of 20%. DSL and FED analysis showed a greater negative amortization % as % of interest income. 1Q07 CFC negative amortization income represented 40% of net interest income (17% in 1Q06) while DSL negative amortization was 62% of net interest income and FED was 46% of net interest income.
American Banker chart (6/25/07) showed CFC foreclosure rate was up to .9% as of May 2007. The 6/25/07 issue also had an article detailing recent bond market problems and noted that the likely outcome would be tighter margins and higher securitization costs. Investors will demand higher yields leading to “pressured gain-on-sale margins and more residual write-downs for originators”. Need to watch how this affected (or will affect) CFC in the 2nd and possibly the 3rd quarters of 07.
46% of CFC loans held for investment are for California properties. This could be an area of concern if CA economy falters. Recent unemployment report showed an increase in CA unemployment from 4.8% to 5.2%.
Being so large will possibly give CFC an opportunity to pick up market share as other lenders falter.
Reporting: hard to get a handle on the $ amount of delinquencies. CFC reports on option arms and negative amortization but not sure about total portfolio.
Annual CFC Metrics
|Conventional Loans % $ Volume||77.10%||79.20%||76.90%||84.10%|
|Nonprime Loans % $ Volume||8.70%||8.90%||10.90%||4.60%|
|FHA/VA Loans % $ Volume||2.80%||2.10%||3.60%||5.60%|
|Non Purchase Transactions % $ Volume||55.00%||53.00%||51.00%||72.00%|
|Adjustable Rate Loans % $ Volume||45%||52.00%||52.00%||21.00%|
|% Loans Pending Foreclosure||0.65%||0.44%||0.42%||0.43%|
|Average FICO Scores||718||720||730||not avail|
|Negative Amort / Net Interest Income||27.31%||5.25%||0.07%||0.00%|
|Negative Amort / Gross Interest Income||6.09%||1.55%||0.03%||0.00%|
|Average Loan To Value At Inception||75.00%||75.00%||73.00%||not avail|
|Average Loan To Value Current|
|Average Assets (presented in K)||80,763,154||61,324,821|
|Average Earning Assets (avg. total loans from K)||79,748,333||60,686,976|
|Average Equity (presented in K)||5,505,439||3,989,372|
|Stockholders Equity to Total Assets||7.16%||7.32%||8.02%||8.25%|
|Average Equity to Average Assets||6.82%||6.51%||#DIV/0!||#DIV/0!|
|Average Assets to Average Equity||14.67||15.37||#DIV/0!||#DIV/0!|
|Negative Amortization on All Loans||$653,974||$74,748||$29|
|Negative Amortization loans as % of all single family homes||????||????||????||????|
|Total Interest Income||$12,056,043||$7,970,045||$4,645,654||$3,342,200|
|Total Net Interest Income||$2,688,514||$2,353,620||$2,037,316||$1,401,993|
|Non Cash Interest Income (from statement of cash flows)||$734,244||$123,457||$1,503||$0|
|% Non Cash Interest Income / Total Interest Income||6.09%||1.55%||0.03%||0.00%|
|% Non Cash Interest Income / Total Net Interest Income||27.31%||5.25%||0.07%||0.00%|
|Net Income Before Taxes||$4,334,135||$4,147,766||$3,595,873||$3,845,772|
|Net Income After Taxes||$2,674,846||$2,528,090||$2,197,574||$2,372,950|
|% Non Cash Interest Income / Net Income Before Taxes||16.94%||2.98%||0.04%||0.00%|
|% Non Cash Interest Income / Net Income after Taxes||27.45%||4.88%||0.07%||0.00%|
|Negative Amortization / Stockholders Equity||5.13%||0.96%||0.01%||0.00%|
|Tax Rate Calculated||38.28%||39.05%||38.89%||38.30%|
|Loans Held for Investment||$78,346,811||$70,054,648||$39,660,086||$26,368,055|
|Total Delinquent Loans (from SEC filing)|
|Delinquencies as % of Loans Held for Investment||0.00%||0.00%||0.00%||0.00%|
|Delinquencies as % of Total Loans (from sec filing)||5.02%||4.61%||3.83%||3.91%|
|Ratio of allowances for loan losses to Loans Held for Investment||0.33%||0.27%||0.32%||0.30%|
|Non-Performing assets to total assets (from SEC filing)|
|Net Interest Rate Spread||1.87%||1.85%||2.26%||2.04%|
|Net Interest Margin||3.37%||3.88%||#DIV/0!||#DIV/0!|
|Loan Originations (from SEC filings)||$468,172,000||$499,301,000||$363,364,000||$434,864,000|
|Loans and Mortgages Sold||$403,035,000||$411,848,000||$326,313,000||$374,245,000|
|% of loans Sold from Originations||86.09%||82.48%||89.80%||86.06%|
|Fully Diluted Shares Outstanding||622,057||615,107||605,392||567,691|
|% Change in Fully Diluted Shares Outstanding||1.13%||1.60%||6.64%||#DIV/0!|
|Diluted Earnings Per Share||$4.30||$4.11||$3.63||$4.18|
|Gain on sale of loans||$5,681,847||$4,861,780||$4,842,082||$5,890,325|
|% gain on sale/net income||212.42%||192.31%||220.34%||248.23%|
|Gain on sale of loans / Loans and Mortgages Sold||1.41%||1.18%||1.48%||1.57%|
|Total non-performing (non-accrual) assets||$929,048||$273,384|
|Allowance for loan losses||$261,054||$189,201||$125,046||$78,449|
|Allowance as % of non-performing assets||28.10%||69.21%||#DIV/0!||#DIV/0!|
|Provision (reduction) for credit losses||$233,847||$115,685||$71,775||$48,204|
|Net loan charge-offs as % of allowance||60.08%||13.30%||20.13%||15.05%|
|Net loan charge-offs as % of provision||67.07%||21.76%||35.08%||24.49%|
|% MSRs/Loans sold||1.38%||1.29%||1.15%||1.18%|
Selected Quarterly CFC Metrics
|Conventional Loans % $ Volume|
|Nonprime Loans % $ Volume||6.74%||8.64%|
|FHA/VA Loans % $ Volume||not avail||not avail|
|Non Purchase Transactions % $ Volume||62.07%||55.28%|
|Adjustable Rate Loans % $ Volume||35.29%||50.62%|
|% Loans Pending Foreclosure||0.69%||0.47%|
|Average FICO Scores||717||718|
|Negative Amort / Net Interest Income||40.52%||17.33%|
|Negative Amort / Gross Interest Income||7.00%||4.22%|
|Average Loan To Value At Inception||79.00%||78.00%|
|Average Loan To Value Current|
|Average Assets (presented in K)||82,873,799||74,865,633|
|Average Earning Assets (avg. total loans from K)||79,911,716||74,041,938|
|Average Equity (presented in K)||4,972,428||5,248,172|
|Stockholders Equity to Total Assets||7.13%||7.22%|
|Average Equity to Average Assets||6.00%||7.01%|
|Average Assets to Average Equity||16.67||14.27|
|Negative Amortization on All Loans||$815,826||$168,712|
|Negative Amortization as % of all single family homes||?????||?????|
|Total Interest Income||$3,351,982||$2,593,758|
|Total Net Interest Income||$578,975||$631,297|
|Non Cash Interest Income (from statement of cash flows)||$234,589||$109,433|
|% Non Cash Interest Income / Total Interest Income||7.00%||4.22%|
|% Non Cash Interest Income / Total Net Interest Income||40.52%||17.33%|
|Net Income Before Taxes||$700,795||$1,119,363|
|Net Income After Taxes||$433,981||$683,511|
|% Non Cash Interest Income / Net Income Before Taxes||33.47%||9.78%|
|% Non Cash Interest Income / Net Income after Taxes||54.06%||16.01%|
|Negative Amortization / Stockholders Equity||1.58%||0.85%|
|Tax Rate Calculated||38.07%||38.94%|
|Loans Held for Investment||$75,551,461||$74,279,882|
|Total Delinquent Loans (from SEC filing)|
|Delinquencies as % of Loans Held for Investment||0.00%||0.13%|
|Delinquencies as % of Total Loans (from sec filing)||4.29%||3.68%|
|Ratio of allowances for loan losses to Loans Held for Investment||0.50%||0.23%|
|Non-Performing assets to total assets (from SEC filing)||0.95%|
|Net Interest Rate Spread||2.04%||1.88%|
|Net Interest Margin||2.45%||2.23%|
|Loan Originations (from SEC filings)||$116,975,000||$106,498,000|
|Loans and Mortgages Sold||$108,599,136||$90,684,325|
|% of loans Sold from Originations||92.84%||85.15%|
|Fully Diluted Shares Outstanding||603,000||620,322|
|% Change in Fully Diluted Shares Outstanding||-2.79%|
|Diluted Earnings Per Share||$0.72||$1.10|
|Gain on sale of loans||$1,234,104||$1,361,178|
|% gain on sale/net income||284.37%||199.15%|
|Gain on sale of loans / Loans and Mortgages Sold||1.14%||1.50%|
|Total non-performing (non-accrual) assets||$1,219,457||$1,276,499|
|Allowance for loan losses||$374,367||$172,271|
|Allowance as % of non-performing assets||30.70%||13.50%|
|Provision for credit losses||$151,962||$63,138|
|Net loan charge-offs as % of allowance||10.32%||46.48%|
|Net loan charge-offs as % of provision||25.43%||126.81%|
|% MSRs/Loans sold||1.75%||1.33%|
March 16, 2007
1. Pay option stuff etc from 10K
Net Income 2,674,846
Included in Net Income is non cash interest income. This is the capitalized portion of pay option loans. Basically the amount that is recorded as interest income, but not collected. Capitalized portion is 734,244. Hence, non cash income from pay option loans is 27.5% of Net income.
Last year the ratio was 5%.
Later, perhaps I will discuss the reserve for loans held for investment. They are reserving .0033 on loans held for investment.
The other day, American Banker wrote an article on some banks having reserves as low as 0.60%.
If CFC brought their reserve up to 1%, they would have a stockholders equity hit of $523M. If that were to occur (and I did not include Loans held for sale), book value would decrease by 4%.
2. here is another company First Federal Financial (FED)
Net Income 129,090
Included in Net Income is non cash interest income. This is the capitalized portion of pay option loans. Basically the amount that is recorded as interest income, but not collected. Capitalized portion is 153,177. Hence, non cash income from pay option loans is 119% of Net income.
Last year the ratio was 62%. In 2004 the ratio was 2%.
They are reserving 1.31% on loans held for investment.
The other day, American Banker wrote an article on some banks having reserves as low as 0.60%. FED increased their reserve a bit. Substantially higher than DSL and CFC.
3. here is another company Downey Financial (DSL)
Net Income 205,174
Included in Net Income is non cash interest income. This is the capitalized portion of pay option loans. Basically the amount that is recorded as interest income, but not collected. Capitalized portion is 292,949. Hence, non cash income from pay option loans is 143% of Net income.
Last year the ratio was 62%. In 2004 the ratio was 21%.
Later, perhaps I will discuss the reserve for loans held for investment. They are reserving .0044 on loans held for investment.
The other day, American Banker wrote an article on some banks having reserves as low as 0.60%.
If DSL brought their reserve up to 1%, they would have a stockholders equity hit of $78M. If that were to occur (and I did not include Loans held for sale), book value would decrease by 5.5%.
4. Nationalmortgagenews.com on insider selling on 3/7/07
"Countrywide Insiders Sold $288M in Stock
Amid the meltdown in the subprime sector, insiders at Countrywide Financial Corp. -- including chairman and chief executive Angelo Mozilo -- have sold 7.8 million shares over the past six months, according to figures compiled by Thomson Financial. Based on an average share price of $37, that means insiders -- officers and directors alike -- have unloaded $288 million worth of stock. Since March 1, Mr. Mozilo has exercised options, selling 186,000 shares at a market price of $6.77 million. According to the Quarterly Data Report, Countrywide is the nation's largest subprime servicer, and third-largest funder. Countrywide recently disclosed that $22 billion, or 19%, of its subprime receivables are in some form of delinquency. Its shares now trade at $4 above its 52-week low. Its high is $45. "
5. Nationalmortgagenews.com on insider selling Insider selling response by Angelo 8-Mar-07 02:13 pm from nationalmortgagenews.com
"Countrywide Financial Corp. chairman and chief executive Angelo Mozilo has defended his decision to sell $140 million worth of company stock over the past 14 months, noting that "I have almost all my personal net worth tied up in the company." In an interview with National Mortgage News, Mr. Mozilo -- who founded Countrywide in the late 1960s -- said he started the firm with his own money and has made tremendous profits for shareholders. "I have created $25 billion in value for the shareholders," he said. "It's been one of the best-performing stocks on the New York Stock Exchange. I gave them 98% of the value and took 2%. And they [the shareholders] didn't have to do the work. I did it for them." The 68-year-old executive has been criticized by financial columnists and shareholder activists for unloading such large blocks of stock at a time when the mortgage industry -- subprime in particular -- is cratering. Mr. Mozilo, though, has been exercising options, which have an expiration date, and then selling those shares. He said if he kept all the shares, he'd have to pay taxes on them. "These critics expect me to hold my shares forever?"
Many officers are selling with great velocity.
He tells us what he has done for the company, and that is why he makes such a disgusting amount of money. What he did for shareholders in the past, should have no bearing on his current compensation. His compensation seems terribly excessive. Warren Buffett does not sell shares, really did have his entire net worth tied into the company, until he donated most of it, and he whistles every day to work, apologizing to his shareholders (bosses) about his salary of $100,000. I have yet to read a complaint of him not receiving options.
Mozilo is a tuff, smart bull dog, living in Coyote country. I respect what he has done, but I find his compensation practices to be obscene.
the pay option loans won't even season for 4 years, and he will be retired.
just my views.
6. a comment of mine on insider selling
Insider selling has been excessive. Hundreds, upon hundreds of $$$$millions (probably close to billion) has been sold by the leaders of CFC. The captains of the boat have been dumping their shares.
But, they must have believed in the story. for they claimed the company to be undervalued while they were buying back the stock, with your money, at the same time the Captain and your "team" were selling.
I watched the Enron story "Smartest Guys in the Room" last night. The similarities are astounding to me in many regards.
Watch the bonds. I watch the 2016's. They haven't broken par......yet.
7. WSJ on CFC and late payments 2-Mar-07 09:11 am
"Countrywide said in a regulatory filing that late payments made up 2.9% of all its prime home-equity loans at the end of last year, up from 1.6% a year earlier. Payments were late on 19% of subprime mortgages. "The new data come amid growing anxiety about a surge in late payments on subprime loans, which accounted for about a fifth of all new home mortgages granted last year."
that is an 81% increase.
8.Lehman analyst on DSL see 3 above, in regards to pay options, etc
actually a nice written report. Yet, here is a quick one.
Analyst notes that loans are performing better than expected.
I don't think the Alt-A pay options will start to implode until seasoning of around 48 months after loan issue. Figuring materiality started 6/05, you really have till late 2009 up till 2010 till the crap hits the fan.
It seems now that to default would be difficult. Here is my reasoning.
Use this example....
You live in Union County NJ. You buy a McMansion in Mountainside for near no money down and use pay option. Your monthly payment is say $1200 before taxes. all interest and government subsidizes via a deduction say $300, hence your outlay is around 900. figure real estate taxes , net of itemized deduction is 500. Hence, you have monthly nut of 1500 to live in big McMansion.
or you use this option.....
don't pay the mortgage, default and rent a 2 bedroom apartment in a town for 1800 per month.
IMO we ain't seen nothing yet.
9. mortgage risk understated? from 2/23/07 mortgagenews.com
"Risk in the mortgage market may be severely understated, according to new research that calls into question the ability of rating agencies to assess the dangers of collateralized debt obligations backed by mortgages and communicate them to investors. A paper presented at the Hudson Institute, a nonpartisan public policy research organization based in Washington, found that such CDOs could experience significant losses if the U.S. housing market continues to stagnate. "We don't want to shut down" mortgage-backed securities, said one of the study's authors, Joseph Mason of the LeBow School of Business at Drexel University. "We're only looking for greater transparency to foster stability." As it is now, Mr. Mason said, rating agencies "can't look under the hood of these deals unless they are qualified investors." But Michael Fratantoni, senior director of single-family research and economics at the Mortgage Bankers Association, played down the research, saying that while CDOs are complicated, they should not be looked at in isolation. "Complexity is in the eye of the beholder," the MBA economist said. "There is no lack of information." However, Mr. Mason warned that the rise in private-label CDOs that are not backed by the government is a potential threat to the economy if home prices depreciate. "It won't start a recession," he said. "But if we get into an economic downturn, it could widen."
10.does CFC fit into this....
this could be one of the most important articles that any long of CFC could ever read.
"As one can see above, Lay pulled down about $17 million in 2000 and Jeff Skilling about $11 million. Additionally, these gentlemen and the other execs listed had over $200 million in potential option gains – reasonable people might call that mildly excessive."
besides Enron, cfc is the most excessive company for its employee major officers, I have seen in years. the company buys back stock, while the officers sell on a daily basis. this imo will go down in the history books.
cards will tumble down imo. crash hard.......and the pay options aren't even near seasoned.
11. kind of ot...but snips of a new yorker enron article and some other stuff.
snips below :
"In late July of 2000, Jonathan Weil, a reporter at the Dallas bureau of the Wall Street Journal, got a call from someone he knew in the investment-management business. Weil wrote the stock column, called “Heard in Texas,” for the paper's regional edition, and he had been closely following the big energy firms based in Houston—Dynegy, El Paso, and Enron. His caller had a suggestion. “He said, 'You really ought to check out Enron and Dynegy and see where their earnings come from,' ” Weil recalled. “So I did.”
Weil was interested in Enron's use of what is called mark-to-market accounting, which is a technique used by companies that engage in complicated financial trading. Suppose, for instance, that you are an energy company and you enter into a hundred-million-dollar contract with the state of California to deliver a billion kilowatt hours of electricity in 2016. How much is that contract worth? You aren't going to get paid for another ten years, and you aren't going to know until then whether you'll show a profit on the deal or a loss. Nonetheless, that hundred-million-dollar promise clearly matters to your bottom line. If electricity steadily drops in price over the next several years, the contract is going to become a hugely valuable asset. But if electricity starts to get more expensive as 2016 approaches, you could be out tens of millions of dollars. With mark-to-market accounting, you estimate how much revenue the deal is going to bring in and put that number in your books at the moment you sign the contract. If, down the line, the estimate changes, you adjust the balance sheet accordingly.
When a company using mark-to-market accounting says it has made a profit of ten million dollars on revenues of a hundred million, then, it could mean one of two things. The company may actually have a hundred million dollars in its bank accounts, of which ten million will remain after it has paid its bills. Or it may be guessing that it will make ten million dollars on a deal where money may not actually change hands for years. Weil's source wanted him to see how much of the money Enron said it was making was “real.”
Weil got copies of the firm's annual reports and quarterly filings and began comparing the income statements and the cash-flow statements. “It took me a while to figure out everything I needed to,” Weil said. “It probably took a good month or so. There was a lot of noise in the financial statements, and to zero in on this particular issue you needed to cut through a lot of that.” Weil spoke to Thomas Linsmeier, then an accounting professor at Michigan State, and they talked about how some finance companies in the nineteen-nineties had used mark-to-market accounting on subprime loans—that is, loans made to higher-credit-risk consumers—and when the economy declined and consumers defaulted or paid off their loans more quickly than expected, the lenders suddenly realized that their estimates of how much money they were going to make were far too generous. Weil spoke to someone at the Financial Accounting Standards Board, to an analyst at the Moody's investment-rating agency, and to a dozen or so others. Then he went back to Enron's financial statements. His conclusions were sobering. In the second quarter of 2000, $747 million of the money Enron said it had made was “unrealized”—that is, it was money that executives thought they were going to make at some point in the future. If you took that imaginary money away, Enron had shown a significant loss in the second quarter. This was one of the most admired companies in the United States, a firm that was then valued by the stock market as the seventh-largest corporation in the country, and there was practically no cash coming into its coffers.
Weil's story ran in the Journal on September 20, 2000. A few days later, it was read by a Wall Street financier named James Chanos. Chanos is a short-seller—an investor who tries to make money by betting that a company's stock will fall. “It pricked up my ears,” Chanos said. “I read the 10-K and the 10-Q that first weekend,” he went on, referring to the financial statements that public companies are required to file with federal regulators. “I went through it pretty quickly. I flagged right away the stuff that was questionable. I circled it. That was the first run-through. Then I flagged the pages and read the stuff I didn't understand, and reread it two or three times. I remember I spent a couple hours on it.” Enron's profit margins and its return on equity were plunging, Chanos saw. Cash flow—the life blood of any business—had slowed to a trickle, and the company's rate of return was less than its cost of capital: it was as if you had borrowed money from the bank at nine-per-cent interest and invested it in a savings bond that paid you seven-per-cent interest. “They were basically liquidating themselves,” Chanos said.
In November of that year, Chanos began shorting Enron stock. Over the next few months, he spread the word that he thought the company was in trouble. He tipped off a reporter for Fortune, Bethany McLean. She read the same reports that Chanos and Weil had, and came to the same conclusion. Her story, under the headline “IS ENRON OVERPRICED?,” ran in March of 2001. More and more journalists and analysts began taking a closer look at Enron, and the stock began to fall. In August, Skilling resigned. Enron's credit rating was downgraded. Banks became reluctant to lend Enron the money it needed to make its trades. By December, the company had filed for bankruptcy
"When Weil had finished his reporting, he called Enron for comment. “They had their chief accounting officer and six or seven people fly up to Dallas,” Weil says. They met in a conference room at the Journal's offices. The Enron officials acknowledged that the money they said they earned was virtually all money that they hoped to earn. Weil and the Enron officials then had a long conversation about how certain Enron was about its estimates of future earnings. “They were telling me how brilliant the people who put together their mathematical models were,” Weil says. “These were M.I.T. Ph.D.s. I said, 'Were your mathematical models last year telling you that the California electricity markets would be going berserk this year? No? Why not?' They said, 'Well, this is one of those crazy events.' It was late September, 2000, so I said, 'Who do you think is going to win? Bush or Gore?' They said, 'We don't know.' I said, 'Don't you think it will make a difference to the market whether you have an environmentalist Democrat in the White House or a Texas oil man?” It was all very civil. “There was no dispute about the numbers,” Weil went on. “There was only a difference in how you should interpret them.”"
Of all the moments in the Enron unravelling, this meeting is surely the strangest. The prosecutor in the Enron case told the jury to send Jeffrey Skilling to prison because Enron had hidden the truth: You're “entitled to be told what the financial condition of the company is,” the prosecutor had said. But what truth was Enron hiding here? Everything Weil learned for his Enron exposé came from Enron, and when he wanted to confirm his numbers the company's executives got on a plane and sat down with him in a conference room in Dallas.
the article then describes SPE's....good reading but no snips of mine. why , i dont know
"Victor Fleischer, who teaches at the University of Colorado Law School, points out that one of the critical clues about Enron's condition lay in the fact that it paid no income tax in four of its last five years. Enron's use of mark-to-market accounting and S.P.E.s was an accounting game that made the company look as though it were earning far more money than it was. But the I.R.S. doesn't accept mark-to-market accounting; you pay tax on income when you actually receive that income. And, from the I.R.S.'s perspective, all of Enron's fantastically complex maneuvering around its S.P.E.s was, as Fleischer puts it, “a non-event”: until the partnership actually sells the asset—and makes either a profit or a loss—an S.P.E. is just an accounting fiction. Enron wasn't paying any taxes because, in the eyes of the I.R.S., Enron wasn't making any money.
If you looked at Enron from the perspective of the tax code, that is, you would have seen a very different picture of the company than if you had looked through the more traditional lens of the accounting profession. But in order to do that you would have to be trained in the tax code and be familiar with its particular conventions and intricacies, and know what questions to ask. “The fact of the gap between [Enron's] accounting income and taxable income was easily observed,” Fleischer notes, but not the source of the gap. “The tax code requires special training.”
"“There have been scandals in corporate history where people are really making stuff up, but this wasn't a criminal enterprise of that kind,” Macey says. “Enron was vanishingly close, in my view, to having complied with the accounting rules. They were going over the edge, just a little bit. And this kind of financial fraud—where people are simply stretching the truth—falls into the area that analysts and short-sellers are supposed to ferret out. The truth wasn't hidden. But you'd have to look at their financial statements, and you would have to say to yourself, What's that about? It's almost as if they were saying, 'We're doing some really sleazy stuff in footnote 42, and if you want to know more about it ask us.' And that's the thing. Nobody did.”"
"In the spring of 1998, Macey notes, a group of six students at Cornell University's business school decided to do their term project on Enron. “It was for an advanced financial-statement-analysis class taught by a guy at Cornell called Charles Lee, who is pretty famous in financial circles,” one member of the group, Jay Krueger, recalls. In the first part of the semester, Lee had led his students through a series of intensive case studies, teaching them techniques and sophisticated tools to make sense of the vast amounts of information that companies disclose in their annual reports and S.E.C. filings. Then the students picked a company and went off on their own. “One of the second-years had a summer-internship interview with Enron, and he was very interested in the energy sector,” Krueger went on. “So he said, 'Let's do them.' It was about a six-week project, half a semester. Lots of group meetings. It was a ratio analysis, which is pretty standard business-school fare. You know, take fifty different financial ratios, then lay that on top of every piece of information you could find out about the company, the businesses, how their performance compared to other competitors.”
The people in the group reviewed Enron's accounting practices as best they could. They analyzed each of Enron's businesses, in succession. They used statistical tools, designed to find telltale patterns in the company's fi-nancial performance—the Beneish model, the Lev and Thiagarajan indicators, the Edwards-Bell-Ohlsen analysis—and made their way through pages and pages of footnotes. “We really had a lot of questions about what was going on with their business model,” Krueger said. The students' conclusions were straightforward. Enron was pursuing a far riskier strategy than its competitors. There were clear signs that “Enron may be manipulating its earnings.” The stock was then at forty-eight dollars—at its peak, two years later, it was almost double that—but the students found it over-valued. The report was posted on the Web site of the Cornell University business school, where it has been, ever since, for anyone who cared to read twenty-three pages of analysis. The students' recommendation was on the first page, in boldfaced type: “Sell.”
August 10, 2006 (34.23) Pay Options and more
The following are some quick notes, based on a discussion I had with
Investor relations. I apologize for any inadvertent errors. The
following are the mechanics of a "pay option" mortgage.
Mortgage holder takes out a note. Interest resets monthly. First interest rate is a teaser, typically 1 - 3 months. Right now, i think about 1 3/4 %.
Here are payment options:
Month 1 - can use that teaser rate for a full amortization.
starting month 2, there are 4 payment options:
1. Min payment "option arm", borrower can pay at teaser rate (currently 1.75%) . The difference between real interest and "option arm" interest will be added to principal.
2. Interest only at current rate
3. Full amortization payment based on 15N (N = year)
4. Full amortization payment based on 30N or 40N, whatever was chosen when mortgage was originated.
The above happens till month 13 (This gets good, as seasoning is a long process.)
Month 13 - new payment determined just like above. Typically interest rate is 2 + 1 month libor . Hence, around 7.5% today would be rate.
All options from above exist, except for "option 1 - option arm." THIS IS THE GOOD PART :-). There is really not a material adjustment to the borrower, yet....here is why. Borrower must pay the lower of the following:
a. New interest rate, interest only, fully amortizing.
b. Month 1 minimum payment (see 1. above) and increase that by 7.5%. Hence, if you were paying $1000 per month, you can now pay as low as $1075. Really not a stressful event as of yet.
Borrower can continue "option arm" minimum payment
until the 5 or 10 year reset, or until negative amortization reaches 115% of
original mortgage balance.
All loans are recast in 5 years, (this gets good too). About 3 to 6 months ago, this was changed to 10 years instead of 5.
At end of recast period, be it 5 or 10 years, the loan is supposed to be paid via fully amortizing principal and interest. Payment is amortized based on time left and principal balance.
5% of all loans are pay options to first time buyers.
Lets use an example.
$500K loan, 30 years, 1.75% teaser rate, real rate 7%.
1. pay option at 1.75%, payment of $729.17
2. interest payment of 2916.67, this is interest only at 7%.
3. full payment of 3326.52 for life of loan
In above example, principal would increase by 2187.50 for first month, and so on.
In month 13, borrower would need a minimum payment of 783.86, this is an increase of 7.5%. This really shouldn't be burdensome to the borrower (yet).
I'm guessing that borrower has about 25 - 40 months before they have required principal and interest. If interest rates are 7.5%, then the 30 year payment would be $4020.49 (based on 575,000 and 7.50%)
Doesn't seem affordable. Sounds like seasoning will occur around this time next year. Hence option arms increase, negative amortization increase, but defaults could seriously escalate in say 2Q07 or 3Q07.
Just doesn't seem pretty. My guess is we will see severe book value impairments.
Note on Insurance Operations
Some Quick earnings analysis from 10Q
6 MONTH STUFF
Interest recorded and not collected via Pay Option Arms (negative amortization) was 273,469 for the 6 months ended 6/30/06.
Net interest income for the 6 months ended 6/30/06 was 1,259,873.
negative amortization/net interest income for the 6 months ended 6/30/06 was 21.71%
Net income for the 6 months 6/30/06 was 1,405,701
negative amortization / net income for the 6 months ended 6/30/06 was was 19.45%
3 MONTH STUFF
Interest recorded and not collected via Pay Option Arms was 164,036 for the months ended 6/30/06.
Net interest income for the 3 months ended 6/30/06 was 628,576.
negative amortization/net interest income for the 3 months ended 6/30/06 was 26.10%
Net income for the 3 months 6/30/06 was 722,190
negative amortization / net income for the 3 months ended 6/30/06 was 22.71%
Q is out, lots to analyze.
Quick thoughts on above. 1, I did this quickly in b/w personal stuff, could be materially incorrect.
With that said, at first glance, negative amortization has far exceeded my expectations. I haven't looked at reserves yet.
I am in the midst of writing a discussion on CFC pay option practices and such. Really interesting stuff. Untested waters.
Questions I asked to CFC, along with some of their responses 8/1/06:
I think the use of negative amortization will be a very interesting item to watch during the next several reporting periods. I do not believe the massive use has ever been stress tested. I have been thinking...If I took out a $500K loan with negative amortization. How long could I go without making a payment? I'm figuring that the majority of the negative amortization portfolio is less than 15 months old. Hence, another year of seasoning and then payments will have to be made. The question is, will payments and interest adjustments be made? If they are, then I would imagine CFC will show her strength. On the other hand, perhaps defaults will increase, beyond the current loan loss reserve, and if so, I think the balance sheet could materially change.
A minimum payment must be made each month - this is a fully-amortizing payment based on an initial teaser rate for the first month. The interest rate that the loan accrues as resets resets monthly - if rates go up, then if they continue to make the minimum payment, the differential between current rates and the minimum rate accrues via neg-am. Every month, the borrower receives a statement advising them of what their payment options are - the minimum payment, an interest-only payment (at the then-current interest rate - this is available ONLY if it is more than the minimum payment); a fully-amortizing payment at the then-current interest rate based on a 15-year amortization schedule; a fully-amortizing payment at the then-current interest rate based on a 30- or 40-year amortization schedule (based on initital terms of loan as we offer both). The minimum payment is capped at an increase of 7.5% each year and the entire minimum payment is recast every 5 or 10 years (we only recently started a 10-year recast - all pay-options prior to were a 5-year re-cast). Neg-am cannot exceed 115% of the original loan balance. Fully amortizing, current interest payments are required if and when the neg-am cap of 115% is reached . So, based on the weighted average original (e.g. at time of origination) combined loan-to-value ("CLTV") of the Bank's pay-option loan portfolio of 78% - current neg-am of $301 million on $25 billion in pay-option loans with neg-am adds 1.2% to the CLTV - or 79.2%. Assuming all loans go neg-am to a max of 115%, the original CLTV would still be maxed at 90% - and this assumes no further increase in property values. One way to think about pay-option loans is that neg-am is essentially the making of a new loan and no additional expense. Then one must look to the underwriting and structuring of the product for its risk factors (weighted average FICO is 721). This loan is also priced at a premium relative to other loan products for its increased risk potential.
You mentioned that negative
amort had $132M of net growth in 2Q06. From that we see the following:
net amort growth/total assets (less than 1%) CFC says, (0.16% per my calc of $132 / $84,000)
net amort growth/ equity 1% CFC says, (2.36% per my calc of $132 / $5,601)
Total net amort / total assets < 1% CFC says, (0.36% per my calc of $301 / $84,000)
Total Net Amort / equity 2.1% CFC says, (5.37% per my calc of $301 / $5,601)
Previously your net income from negative amort / total net income was less than 1% CFC says, Since this has not been disclosed specifically, I cannot comment.
I expect this quarter that net income from negative amort / total net income will be in the area of 7% to 14%. CFC says, Unable to comment.
CFC mentioned that their " held for investment portfolio" consists of the following:
|Option Arms||40 - 45%|
The above is missing a 5% allocation, yet this is how CFC described the
allocation to me. I am not concerned, as their was an immaterial error on
their end, in an informal conversation, or on my end, in my note taking.
Again, the above is a guide, and the 5% error is not material.
July 27, 2006 (39.00) Musings and brainstorming
It blows me away that officers continue to sell and report sales today, when
indeed they have information which we do not have. We have not been presented
with the portion of the net income which is from Negative Amortization. This is
probably a very material number, and in my view will eventually bite the
mortgage lenders who use it in large volumes hard.
Think about it. If you have a negative amort loan (aka pay option), it would be incredibly difficult to default until the loan becomes seasoned. I have determined that the extensive use of these loans happened toward end of 1Q05 or beginning of 2Q05. The seasoning seems a bit away, but when it happens, watch out (IMO).
In the meantime CFC continues to have its officers sell at a great velocity. And they continue to go on excursions for non business purposes, and waste even more of shareholders money. All of above is imo and subject to error.
As James Grant says, "In this environment, it is tough to default, even if you want to." (or something to that effect.)
The timing of the sales isn't that concerning for me. they are on planned sales,
and in a supposed blind fashion. nevertheless, insider selling, imo has been
I spoke with IR last quarter and that wasn't too smooth. I do feel the investor is at a disadvantage until the Q is issued.
I don't think most analysts are in touch with the negative amortization yet. They will be. The outcome is not certain. The outcome for negative amortization could be just fine and no issues, and even rising earnings. The difficulty is that the concept has yet to be stress tested. The difference between the past history of negative amortizations is that they were always immaterial to the operations (that goes for all lenders which I am aware of.) Now the amounts are huge and meaningful. Also, CFC valuation might already have this priced in.
" Neg-am or "payment option" loans sound scary, and I agree that they are hard to evaluate until seasoned, but you need to quantify exactly what their exposure is."
Yes, I do that every quarter and year. Yet, i cant do it this quarter till the Q is released. Hence, the frustration.
Here is a little more I worked on.
P/e is low, price/book a touch high. My thesis is that there will be charges and default rises. If loan defaults (which are reported as historically low) increase by 0.25% (still low), the eps would decrease by $0.47. If > than 0.25%, could get even uglier. This is because of leverage (assets / equity), is at 13X. Historically that number used to be much smaller. I think the fuel is running low.
" The 10-K says that 19% of their origination volume in 2005 for "pay option" loans, which does sound pretty high. However, only about half of the carrying value of pay-option loans had any negative amortization, and the negative amortization was $142M on total pay-option loan portfolio balance of $26.1 billion. Again, there may be a risk here, but needs to be quantified, it might not be material."
It's material. I have it on my site as well. I have been looking at the income from negative amortizations. this can only be found in the Statement of Cash Flows. I don't have exact numbers in front of me, going from memory. I think NI w/out negative amortizations would make up about 25 to 40% of Net Interest Income. It was 5% of NI in 2005, but remember, this did not get big till 2nd quarter of 2005. Wait till you see the comps. My guess is it will be 10% of NI this year (probably even higher)
Also, if you look at my original writings, I discuss their insurance operations. Their combined ratio is 70%. I think that is unheard of. Granted they offer a lot of PMI. Yet, I looked at historical comps of PMI, and 30% profit looked quite high.
CFC's volume in nonprime was about 11% in 2005, but they seem to be making good strides here.
Loan to value is slipping a touch this Q. Q will talk about fico scores and stuff. I have fairly extensive notes and tables at my site. I think that will be helpful. I will update (I hope) after Q is released.
John Dessauer on CFC on 7/26/06
I found this on the net. I can not swear to its legitimacy.
"The news from the housing industry is that housing continues to cool
down. The number of homes for sale is at a nine-month backlog, about
double of what we saw nine months ago. Prices rose slightly last
month, but the rate of increase is clearly down from what it was.
Here in the Naples area, we can see the details. Prices are down 8%
from a year ago. However, the decline is concentrated at the low end
of the market. Luxury million-dollar home prices are holding up
quite well. The number of transactions is down 48% from a year ago.
This local data says that affordability is the main issue. And the
greatest percentage gains in the last couple of years were in the
low end of the market, so that is where the price declines are now
concentrated. There is still demand, but only when the buyer thinks
the price is right. Housing is in transition from a boom back to
more normal conditions. Speculation is being driven out and some
speculators are paying the price for their earlier exuberance. You
and I got the strategy correct. We can see that from the report on
second quarter results from Countrywide Financial (NYSE: CFC,
Countrywide reported second quarter earnings of $1.15 a share, up
25% from 2005. Based on the second quarter and a pipeline of $65
billion, management raised the low end of earnings guidance from
$3.90 to $4.00 for this year. The upper end of the range is still
$4.80. Countrywide is obviously doing extremely well, even in the
housing slump. Still, one analyst was very critical saying that the
mortgage business is soft and that the earnings cane from servicing.
I say... where has that analyst been? The servicing portfolio shows
that Countrywide is diversified, so that earnings will keep growing
even in a housing slump. The last time Countrywide had a down
earnings year was 2000. Since then, earnings have risen from $0.72 a
share to $4.21 last year. Even if this turns out to be a flat to
down year, Countrywide will have a superb long term track record.
Housing has a cyclical characteristic, but each cycle is bigger and
better than the last cycle. Housing still is a growing industry.
Countrywide is one of the top players it its field. At under 10
times 2006 guidance, Countrywide is undervalued and a Buy"
If I am not mistaken, Dessauer is a generalist, hence he probably isn't even familiar with the negative amortization situation. I don't think most analysts are in touch with the negative amortization yet. They will be. The outcome is not certain. The outcome for negative amortization could be just fine and no issues, and even rising earnings. The difficulty is that the concept has yet to be stress tested. The difference between the past history of negative amortizations is that they were always immaterial to the operations (that goes for all lenders which I am aware of.) Now the amounts are huge and meaningful. Also, CFC valuation might already have this priced in.
I am not saying Dessauer is incorrect. I merely mentioned that I believe him to be a generalist. The negative amortizations are big and new. Hence, the past might not be as telling on the lenders. Wait and see. My guess, is that I will be correct, and that negative amortizations will cause material write downs of book value.
changing the subject....slightly.
1. Option ARM's rules changing ?
2. Appraisal Inflation
"Here's why the problem doesn't get reported as extensively as it should: There is no smoking gun.
Any new stories about inflated appraisals these days seem to originate from the National Community Reinvestment Coalition, a Washington-based nonprofit that supports low-income housing who last year came up with a novel solution to the appraisal problem. I have covered the efforts of NCRC before [Soapbox].
Why does the appraisal inflation issue get so little play in the media? Likely because most real estate mortgage industry people close to the issue downplay the problem since there has not been a quantifiable cost to be held accountable to. Here are samples of the typical mortgage industry response."
3. FDIC Outlook
"The U.S. mortgage market, which for decades was dominated by fixed-rate mortgages, now includes innovations such as nontraditional mortgages, simultaneous secondlien (or piggyback) mortgages, and no-documentation or low-documentation loans.10 Nontraditional mortgages allow borrowers to defer payment of principal and, sometimes, interest and include interest-only mortgages (IOs) and adjustable-rate mortgages (ARMs) with flexible payment options (also called pay-option ARMs, or POs). Although perceived as fairly new, many of these loan types are a repackaging of existing products, marketed again in the 2000s in response to growing demand. For example, record-high fixed rates in the late 1970s and early 1980s stimulated innovation in the form of various types of ARMs. Some of today's pay-option ARMs are a reincarnation of negative amortization loans that were popular in the 1980s, but then fell out of favor in the early 1990s when rising interest rates and falling home prices in certain areas left some borrowers owing more than their homes were worth."
4. Link to housing cooling or flattening
5. Some housing links (also on my website). I think these are pretty informative.
July 26, 2006 (39.00) Review of earnings release, yet Statements are missing and analysis can not be complete.
I have read the cc. I have read the earnings release and a bunch of reports on such. Here is what I have come up with.
1. CFC mentions that competitors are
starting to crowd the mortgage market. They will not currently change their ways
for this. New competitors will get hurt because of their inexperience. They will
sacrifice market share for this. I think that is typically a great decision.
When it comes to mortgages, no argument, CFC knows their stuff.
With the above in mind. Insurance is one of CFC's growing sectors. They are new in the industry. Looking at their Insurance operations, their profitability looks greater than their competition. Competition includes All State and Berkshire. I suspect that CFC will be in for a surprise on this. I believe they are underaccruing future losses. That is the only thesis I can come up with, as their profitability in this sector not only dwarfs their competitors, but it also dwarfs the long term history of the industry.
I think that the same inexperience that CFC discusses about their competitors (Wells and Citi) is the same inexperience they have in insurance. Take out a bit of insurance earnings, and you have some concerns.
2. In all the reports I read, I saw no mention of net income generated by negative amortizations. The company reported net income of $1.4M. How much of that was non-cash (negative amortization)? For all of last year the negative amortization was 4.9% of net income. I suspect it will be near 10% of net income this time, or $0.22 per share. In F2004 the amount was negligable. It always has been until 2005. Wait till you see the year over year comparison of this one. First Q of 2006 the ratio of negative amort income/ net earnings was 16%.
3. Insiders have been selling at a great pace. Why is that? I suspect they know what they are doing in their sales. Insiders continue to sell, during the period that we have an awesome earnings report, yet at the same time a lack of disclosure on non cash income. Again, I think non cash income will be material.
4. In the statement of cash flows for this company it will show how much of net income was from "negative amortization." Negative Amortization is the income the bank picks up as interest, but that the borrower has chosen not to pay and to increase the mortgage balance instead. In 2004 the amount was immaterial. In 2005, the amount became material near the middle of the year. Now negative amortizations are a material number, yet disclosure does not accompany. Maybe they will discuss on todays' CC, but I doubt it. Last quarter was odd, because they came out with great earnings (like today), no disclosure of neg amort in Net Income, and subsequently management was selling shares quickly. To me, they were selling with information that was not available to you and me. This needs to stop.
April 17, 2006 (37.00) More notes
1. Thesis would be totally incorrect if growth rates do not materially contract.
2. Interesting statistics below. Does this show increased risk? I would think that loan losses increase with pay-option loans, yet the reserve is not being increased.
All Items in % below
Conventional Loans % $ Volume
Nonprime Loans % $ Volume
FHA/VA Loans % $ Volume
Non Purchase Transactions % $ Volume
Adjustable Rate Loans % $ Volume
% Loans Pending Foreclosure
Equity to Average Assets
3. Comparisons to other lenders I worked:
Average FICO Scores
Negative Amortization / Net Interest Income Banking
Negative Amortization / Net Income
Average Loan To Value
4. Interesting snips from 10K:
a. “Forecasters currently put the market for 2006 at between $2.2 trillion and $2.4 trillion. The forecasted reduction is attributable to an expected decline in mortgage refinance activity. We believe that a market within the forecasted range would still be favorable for our loan production business, although we would expect increased competitive pressures to have some impact on its profitability. This forecast would imply declining pressure on our loan servicing business due to a reduction in mortgage loan prepayment activity. In our Capital Markets Segment business, such a drop in mortgage originations would likely result in a reduction in mortgage securities trading and underwriting volume, which would have a negative impact on profitability.”
b. “Beginning in 2004, one of the adjustable-rate loan products offered by the Company increased in prominence, from approximately 6% of loan originations during the year ended December 31, 2004 to approximately 19% during the year ended December 31, 2005. This product is commonly referred to as a “pay-option” loan. The Company has retained a significant portion of its pay-option loan production in its investment portfolio during the two-year period ended December 31, 2005. The Company’s investment in “pay-option” loans comprised 41% and 14% of the Company’s investment in mortgage loans held for investment at December 31, 2005 and 2004, respectively.”
c. “Pay-option loans have interest rates that adjust monthly and contain features that allow the borrower to defer making the full interest payment for at least the first year of the loan.”
d. “Due to pay-option loans’ amortization characteristics, the loss that the Company would realize in the event of default may be higher than that realized on a “traditional” loan that does not provide for deferral of a portion of the fully amortizing loan payment.”
5. $35.6B of Notes payable come due in 2006.
6. Mortgage banking is 59% of company revenues, as compared to 80% in F2000 and 96% in F1995.
7. Unfunded Pension liability appears to be $153M at December 31, 2005, compared to $115M at F2004. Assumptions appear to be conservative.
8. Delinquencies and employment rates appear to have a direct correlation. From the CFC presentation, it looks like the current default rate and unemployment levels are approximately 4.4%. Interesting to see, was that unemployment from 1972 – 1977 was well in excess of delinquencies. This was identified on page 120 of this link http://about.countrywide.com/presentations/docs/FINAL%20Slides.pdf
9. Wait for the Def 14 to come out. Previously officer’s compensation has been disgustingly high.
a. I’m not sure if seasonal but average daily loan applications are well below 2005 levels. This appears to be the case since December 2005.
b. Loan Fundings from consumer markets and Wholesale lending division seem to be holding up well, or growing.
c. Commercial real estate lending also putting in some big numbers.
d. 70% of YTD 2006 loans are ARM Fundings.
e. Mortgage Loans in both dollars and volume seem to be at record highs.
f. Securities Trading Volume also appears to be showing strength.
g. Workforce headcount is also doing well.
11. CFC is expanding , at the same time they have lower economic returns. CFC has mentioned this will give them a more predictable earnings flow.
12. CFC is expanding its credit exposure, even with tight credit spread. If I am not mistaken, CFC does not sell most of its Pay Option Loans. This sounds a touch risky to me. Yet, CFC has been around a long time and is a respected leader in the industry.
13. Focusing more on insurance. It will be interesting to see how they do against the likes of Berkshire.
14. Pay option loans (negative amortization) have increased substantially since 2004. The loan to value on these loans were originally 75%, but are now 78%. The increase can either happen, by a decrease in home prices or an increase in principal balance. The increase in principal balance would occur when a customer decides to defer the payment and increase the loan balance. This is called “negative amortization.” It will be interesting to monitor how a lack of change, or even a reduction in appraised home values will affect that ratio in the future. You can see in the graph below, that as of 12/31/05 the non interest income reported was $123.5M. This compares to only $1.5M in F2004. This breakdown was not offered in the 1Q06 earnings release, and the 10Q has not yet been released.
Total Consolidated Net Interest Income
Total Banking Operations Net Interest Income
Non Cash Interest Income (from statement of cash flows)
% Non Cash Interest Income / Total Banking Interest Income
Net Earnings after Taxes
% Non Cash Interest Income / Net Earnings after Taxes
April 11, 2006 (37.10)
1. Grant’s discussed in their 7/29/05 issue that in year 2000, CFC was “quoted at a discount to almost any company with a ticker symbol.” Grant’s claimed, it’s valuation was 1X book value and a 6.9X trailing p/e. CFC has risen from $6.00 in March 2000, to $37.00 today. That is an increase in excess of 6X.
2. Investment thesis is on short side.
a. Housing bubble, which in turn could increase unemployment, which in turn could cause a mortgage bubble.
b. Grants discussed balance sheet leverage doubled from year 2000 through summer of 2005. The ratio of assets to equity climbed from 5.6X to 13.6X in that period.
c. According to Grants, Mozilo ,insists that slope of yield curve is immaterial to CFC business.
d. Watch gain on sale income. According to Grants article the spread has been decreasing because of competition.
e. Watch the negative amortization loans. Watch the frequency compared to historical. Look for stress.
f. Rates on ARM’s will continue to rise. This will be a benefit to the lenders, as long as payment increases do not put stress on the borrower.
g. It is my understanding that a recession has always followed an inverted yield curve, without exception.
3. Some Links.
a. http://www.mbaa.org/ Mortgage Bankers Association of America
b. http://www.realtor.org/ National Association of Realtors
c. http://www.nahb.org/ National Association of Home Builders
d. http://www.imfpubs.com/ Inside Mortgage Finance
4. Gary Shilling on Home prices from April 2006 issue (notes)
a. Mortgage applications to purchase new and existing homes have weakened. As I look at his chart, the amounts seem level since May 2004.
b. Watch the housing inventory – sales ratios. This ratio is usually a leading indicator. What I think that means is that the ratio will change quickly at the first sign of trouble and not lag an economy. Unrelated to Shilling, I found this site, which kind of says similar things. http://www.investorsinsight.com/otb_va_print.aspx?EditionID=256 Here are some charts from that link. The charts below show very much the same data. Gary’s data was from Mortgage Bankers Association of America.
c. Gary mentions that the level to be concerned about is 7 to 8 months of inventory.
d. Gary comments that we should look at UK and Australia market as a guide.
e. “more than $2 trillion of mortgage debt, about one-fourth of the total outstanding, is scheduled for upward interest rate resets this year. Monthly payments will leap 105 to 50% for many homeowners.”
f. Gary sites, but does not name a study, which concludes that 1/8th of homeowners with ARMs originated in 2004 and 2005 will default on those loans.
g. Gary discusses how consumer spending in US is ultimately backed by housing appreciation.
5. Gain on sale accounting have apparently rebounded from 4Q05 levels. CFC says that margins are improving for gain on sale. CFC mentioned at investor day that sub-prime margins remain week.
6. Consensus estimates are $4.36 for F2006 and $4.94 for F2007.
7. Enterprise Value is $98B, yet market cap is $22B. The more I look at CFC, I do not think EV is the proper tool for them. I think that working with tangible equity is a better measure.
8. CFC is focused in other areas other than mortgages. These areas include banking and insurance. My short selling thesis would certainly be hampered by continued growth.
9. Bonds are currently rated “A” by S&P. This is an “upper medium grade” rating. Moody’s rates bonds as “A3.” A3 is the bottom rung (of 3) of “upper medium grade.”
a. Standard & Poor’s - Highest rating (Strong) for prime, subprime, alternative mortgage products, and special servicing.
b. Fitch - Highest ratings (RPS1) for prime, Alt-A and subprime, HE/HELOC, and Special Servicer (RSS1).
c. Moody’s - Highest rating of SQ1 for primary servicer of prime, subprime, government, and second lien residential mortgage loans, and for special servicer.
10. Apparently the capital markets volume just released for March was an upside surprise. CFC had record trading volume of $978M for the quarter.
11. Certainly appears that CFC is operating on all cylinders. Earnings diversification is improving, as the bank had $80B of assets at end of 1Q06. Delinquencies are improving. I have read from sources which might be terribly incorrect, that the delinquency improvement is Katrina related. Service growth improved, 10 year treasury increased about 0.31% from 4Q05, which could lead to an upside surprise on servicing section. Delinquencies are 37bp higher than year ago levels.
12. March ’06 had seasonally strong originations, larger pipeline and growth of servicing portfolio. This could be offset by tighter gain on sale margins and hedging losses (MSR).
13. ARM originations for 1Q06 declined year over year for first time since 2001. Sub-prime originations rose less than previously, this may reinforce speculation that CFC has been less aggressive on pricing sub-prime loans.
14. Look at loss reserve. Compare loss reserve to competitors. The reason I write that is I saw a report by a sell side firm, which claims that credit risk is rising, following the balance sheet growth of last few years. Report claims that delinquencies have risen “rapidly”, are at the high end of peers, yet loss reserves are low.
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