The dizzying rate at which Countrywide Financial Corp.'s prospects are changing from bad to worse can make one forget that two weeks ago Washington Mutual's own struggles were sharing headlines. What a difference several days, hours and minutes make in the dramatic downturn of America's biggest mortgage lender.

Countrywide's prospects have become so muddled that its own survival has been questioned, a once seemingly unthinkable subject to broach. On Aug. 16, the company was forced to draw on an $11.5 billion line of credit to bolster its liquidity.

The decision came on the heels of a stunning report by Merrill Lynch's research analyst Kenneth Bruce in which he downgraded Countrywide from a "buy" to a "sell" and argued that too much liquidation in a weak market could bankrupt the company. Bruce further suggested that the fallout from the current subprime market meltdown could surpass the liquidity crisis of 1998. "Frankly, the secondary mortgage market has evaporated even more quickly, which we think could leave a longer-trail of collateral damage," he wrote.

But as of press time, the majority of analysts were not predicting Countrywide would go under, as it still has resources at its disposal besides the $11.5 billion in emergency loans it tapped. Analysts from Moody Investors Service said in a Thursday conference call that the company had enough liquidity to carry them through the end of 2008.

In a conference call with Fitch Ratings last week, Christopher Wolfe, a managing director for the firm's financial institutions group, noted that the company has $60.5 billion in deposits and $29 billion in FHLB advances. "So there are options on the table for them, but it's probably not going to stay in the area when they had full access to the capital markets," he said.

Still, by the end of last week, Countrywide was a battered firm. Its stock was down 57% for the year as of press time and Moody's slashed its credit rating to Baa3', the lowest investment-grade level. Moody's indicated that it could further lower Countrywide's debt to junk status or below investment grade. Meanwhile, Fitch downgraded its credit ratings two notches to BBB+'.

Wolfe, whose comments came before Fitch's ratings action, said Countrywide's significant exposure to capital markets makes it especially vulnerable. "What's happening with the dislocation in the capital markets is having a real impact on Countrywide in terms of its ability to affect its earnings," he said. "The liquidity concerns have been magnified broadly in the market."

But what to make of Washington Mutual, which more than two weeks ago was drawing headlines when its shares plunged after it warned on Aug. 3 of a significant fall off in the subprime market? While the firm's shares have dropped 18.2% in the past six months, its stronger foothold in the shaky market appears to be a result of a strategic plan to diversify its funding resources.

"I think it has done a really good job over the last several years of diversifying its funding and diversifying its franchise so that it's not just a mortgage play," said Sharon Haas, another managing director in Fitch's financial institutions group. "That said, when you say mortgage you still think of [WaMu] because it's a big part of its business." Haas noted that as of June, subprime mortgages made up about 6% of its balance sheet.

Both Countrywide and WaMu have made extensive changes in their subprime offerings, eliminating traditional 2-28 and 3-27 production. Both firms are utilizing alternative financing and cutting back the number of transactions they are looking to do.

Fitch's analysts were quick to point out that the market's troubles extend far beyond these two companies. Rui Pereira, managing director of Fitch's RMBS group, said that "better-looking collateral attributes, increasing credit and just general spread widening will bring investors back in the market," though it's hard to say when that will happen. "While I think the combination of those factors will bring the market back, I also expect the size of the RMBS market is going to decline quite a bit, particularly in the Alt-A and subprime markets," he said.

"I see it as a pendulum," Haas said. "For quite a few years, there was perhaps more complacency than was ever justifiable and I think the marketplace, particularly investors in mortgage paper, have shown their ability to swing completely to the other side." She added, "I say this somewhat guardedly, but I think there's been a bit of overreaction perhaps that is occurring of late."

Opinions on when the subprime market will recover have mostly been widely varied, but Wolfe noted that when the last serious downturn occurred in 1999 it wasn't until 2002 that investors started putting their feet back in the water. "There's still some cleansing that needs to go through the system," he said. "I think we are going to see some contraction in the near term, but in the long run the RMBS market is a very important market for the U.S. economy demands." - PM

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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