Take me to the lab and wipe my brain

I listened to the Countrywide Financial call today, and man I literally cannot sleep tonight. These guys are a mortgage lender That has Assets/Equity of around 10x like most banks. Almost all of their assets, lets say 180 Billion (I am working from memory so numbers may be wrong), consist of mortgage loans, and a significant portion of those loans are held for sale. They also have other great assets such as MSRs. These are servicing revenue residuals that are capitalized with some ongoing assumptions. Half of CFC liabilities come from the bond market. That is right. Not deposits. Not repos. As far as I can tell they have $70 bills in unsecured notes, mostly fixed rate. They are BBB so their interest expense on new debt (that they just issued to buy stock of course) is 7%.

The MSRs come from a near Trillion dollars worth of loans that they service. They make up about 10% of assets so if they got wiped out they would wipe out the equity book. On the loan side, they are not overly concerned with credit quality because they simply buy credit enhancement to insure that their loan portfolio is fine. No problem there they bought insurance.

Also the brillian analysts on the call kept wondering how they could reduce costs servicing their trillion dollars in old loans, so they could make a bundle. After good QTR comments, they really wanted them to reduce costs there.

So here are my fears:

• Servicing is worth zero, because these guys have no underwriting standards. They are writing subprime loans which are defaulting in mass. Especially the current vintages. I have a feeling that it costs a lot more to service a loan in default than it does to "to service" someone like my grandma, whose loan check probably arrived one week before it was due. In fact, I would say that there is high probably that servicing is worth negative.
• Credit Enhancement is a joke. Right now this is a win/win for everyone. Borrowers get to lower lending costs. MBIA rakes in their insurance fees. Everyone is happy. The day that someone needs to collect on their credit enhancement, is the day that market melts down. It is kind of crazy that this shit really exists.
• The A/BBB credit that is Countrywide is like "picking up pennies in front of a steamroller" similar to Enron/LTCM/DRL/FMT and others. They are not taking a hit and subprime is in meltdown right now. I dont get it. Why is everyone not in this business if you can coumpound Equity at 30% a year. What are they doing that WaMu or Citi or really any bank cannot do.
• According to my boy Grant, you cannot sell loans for more than you wrote them. That is bad for these guys if that is true.
• Lenders like FMT are having to buy back loans that they have sold because borrowers could not even make the first payment. Don't worry, they then sell these to "Dent and Scratch" loan collectors for 0.80 on the dollar. No problem. Off the balance sheet.

OK, so here is my final take. Every subprime guy that I know is either going out of business, or tightening credit standards and raising FICO scores. As far as I know the real estate inventory is no joke, like 7 months of supply. They are eliminating the marginal buyer from a frothy market that people overpaid in. The 2005 to 2006 subprime loans are F'd if that case is accurate. Let me repeat: No one wants to lend to the people that made the market go up. The market is soft and no one can sell their home for what they paid for it to pay off their loans.

This is when times are good and unemployment is low???? What happens if that turns on a dime which it has known to do? I think that is the major question. Maybe times do not get bad any more.

My take on this:

• Buy short term bonds. Rates are going to go back to one before they go to 10.
• Buy commodity baskets for the long term.
• We are in the wrong business. Get ready to purchase distressed real estate if rates do not come down. The hard lending is at the gate.