Agreement on Auto Deal - Sighs of Relief alround
Posted on September 26, 2007
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General Motors Corp. and the United Auto Workers early Wednesday morning announced a tentative agreement on a new national contract for about 74,000 U.S. auto workers that includes a historic restructuring of GM’s obligations for UAW retiree health care and sets up a mechanism for GM to buyout many of its current workers and replace them with new employees at lower wages.
GM shares rose 5.1%, or $1.75, to $36.17 on the New York Stock Exchange Wednesday morning. Ford Motor Co. shares also rose, up 26 cents, or 3.1%, to $8.60.
The tentative pact means UAW workers, who went on strike at all of GM’s U.S. plants Monday, should start coming back to work Wednesday afternoon.
The tentative pact, which still must be ratified by UAW-GM members, marks a turning point in a nearly 30-year struggle by the UAW and the three Detroit auto giants to outrun forces of global competition that have rendered their traditional business model obsolete.
NY Times to Drop Fees for Online Version
Posted on September 20, 2007
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New York Times Co. said it would drop its paid TimesSelect service, which charged a fee for online access to certain New York Times columnists, and make the vast majority of its Web site — and archives — available free.
The move comes two years after the Times introduced the subscription service, an effort to generate an additional revenue stream. But the revenue was relatively modest, and the publisher believes the revenue it is giving up will be more than offset by the additional ad revenue it can generate by broadening the site’s audience.
The decision highlights a conundrum for newspaper publishers, which are struggling to increase the revenue from their online businesses amid steep declines in print revenue industrywide. It also shows how difficult it is for Web sites to start charging for content previously available free. Times shares were down 15 cents to $19.65, a 10-year low, in New York Stock Exchange composite trading.
Since September 2005, the Times had charged $7.95 a month or $49.95 a year for access to its columnists and its archives. Print subscribers to the paper had continued to get free online access to the material.
As of August, TimesSelect had 227,000 paying subscribers, generating $10 million in annual subscription revenue, according to the Times. Since the Times introduced the service, though, the “online landscape” — including how people consume news online — has changed, said Vivian Schiller, senior vice president and general manager of NYTimes.com.
The company anticipates subscription revenue “would only grow in the single digits, where advertising revenue will far exceed that,” Ms. Schiller added. The company said it will offer subscribers pro rata refunds.
TimesSelect had caused dissatisfaction among some columnists, who complained they were losing readership and influence. TimesSelect had blocked access to 23 columnists. “We are happy that they will be happy now, but that’s not why we did this,” said Ms. Schiller. “This was a business decision.”
The move will take effect tomorrow. The Times will make available free the past 20 years of the paper’s archives as well as its archives from 1851 to 1922. The paper will still charge for archives between 1923 and 1986.
American Express Co. will be the first sponsor of the newly opened areas of NYTimes.com, the Times said.
401 Plans Retirement plans not quite what they were thought
Posted on September 15, 2007
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Peter Ching, 28, landed a job as a programmer at a New York software company this summer. But he had second thoughts when he saw the menu of mutual funds in the company’s 401(k) retirement-savings plan.
“The options are awful,” he vented recently on the personal-investing chat room Diehards.org, describing them as mutual funds with “atrocious” fees.
The replies came fast and furious. “Awful does not properly describe this plan,” one person wrote. Another added: “I would seriously start looking for another job.” The most comforting comment: “Your plan is not as craptacular as my spouse’s plan.”
These spirited conversations highlight another wrinkle in the debate over the disappearing traditional pension plan. As workers are being forced to fund their own retirement, many are up in arms about workplace savings plans that, for all their tax advantages, saddle them with high fees, a limited range of investment choices and inadequate disclosure about costs and performance.
By limiting employees’ choices to a few mutual funds with high fees, companies can reduce the amount they have to pay fund firms for administering retirement plans. But such savings can be shortsighted because they can hurt employee morale and may even hinder recruitment efforts.
Merriman Capital Management, a fee-only financial-planning firm in Seattle that last year merged to become Merriman Berkman Next Inc., concluded in a 2005 survey that many big companies “shortchange” employees by offering expensive mutual funds or by failing to provide ready access to a wide variety of asset classes. The company says that its survey of 20 large employers in the Northwest found 401(k) plans “loaded” with domestic large-company growth funds, which have mostly been relative laggards over the past seven years.
“I was stunned,” says Merriman financial planner Tom Cock. “We’ve told workers we’re not going to provide pensions, but the choices we give them in 401(k) plans are poor.”
Similarly, Christopher Davis, an analyst with Chicago research firm Morningstar Inc., wrote last fall that retirement plans were “overly focused on large-cap domestic-stock mutual funds,” giving higher-performing small-cap and international funds “short shrift.”
Merriman also criticized the fees plan participants were paying. For example, Amazon.com Inc. offered funds in 2005 with an average expense ratio — the percentage of assets taken out of an investor’s account annually — of 1.14%, Merriman said. The average annual expense ratio for all U.S. stock funds is 0.96%, according to Russell Kinnell, director of mutual-fund research at Morningstar.
Amazon.com spokeswoman Patricia Smith says that, since 2005, the company has switched administrators for its 401(k) plan to “provide a greater diversity of investment options for our employees at lower costs.”
A recent study by plan administrator Transamerica Corp. suggested that employers often underestimate the importance of retirement benefits to prospective employees. Transamerica, a unit of Dutch insurer Aegon NV, asked workers and companies whether employees would choose a “higher salary over excellent retirement benefits.” Some 56% of employers answered that workers would opt for the higher salary. But only 34% of employees said the same.
“It kind of brings to light” that individual employees may be analyzing retirement plans “more than is expected,” says D.J. Lucey, an analyst for Cerulli Associates, a Boston financial-services consultant.
Some companies are capitalizing on such research. International Business Machines Corp. considers its 401(k) plan, which gives employees access to more than 200 mutual funds, a recruiting tool, says Clint Roswell, a company spokesman. IBM needs to offer employees an appealing 401(k) since the company is phasing out its pension plan starting in January 2008. “We need to help them make this transition,” Mr. Roswell says.
But plenty of other companies still have unappealing plans. So what can employees do if they are dissatisfied?
Financial planners are loath to suggest that employees walk away from participating in workplace retirement plans. The pretax savings are hard to replicate in other investment vehicles. Workplace plans let investors defer taxes on the money put into the plan and its investment earnings. Plus, if the employer provides a matching contribution, not participating in a workplace plan is like leaving “free money on the table,” writes Mr. Davis, of Morningstar.
Some analysts suggest that employees who meet the income qualifications for a Roth IRA can use that investment vehicle to plug gaps in their 401(k) plans, assuming they have spare after-tax money to invest.
A more direct approach is to vent to the boss. “If the plan really stinks, put some pressure on the employer,” says Jill Schlesinger, a fee-only financial planner and radio-show host in Providence, R.I. She says that “a lot of larger employers and midlevel employers will respond.” Smaller companies are less likely to alter their plans. That’s because the more employees a company has participating in a plan, the more leverage it has with the fund provider. So a bigger employer may be able to offer lower-cost funds or a greater range of funds without incurring a substantial increase in what the company pays the firm that administers the plan.
Last year, the Tennessee Consolidated Retirement System greatly expanded the number of funds available to state employees after it received repeated calls requesting that certain funds be added, says Beth Chapman, the system’s director.
A free Web site, 401khelp.com, owned by Merriman Berkman Next, provides sample complaint letters to send to trustees of company retirement plans, requesting that low-cost index funds be added to the menu.
Mr. Ching, the New York software programmer, says his employer doesn’t provide a matching contribution. He knew that when he took the job. But he didn’t know what the fund fees would be. He says he has 10 mutual-fund options in his retirement plan; the funds he named all have expense ratios of at least 1.3%, and several are above 2%.
Mr. Ching went to the company’s human-resources department to request a plan with better choices, to no avail. He says he was told that his employer, which he declined to identify, plans to evaluate other providers “down the road,” but wasn’t sure “if and when” the switch would occur.
3 Core Principals for the maintenance of mature and successful growth
Posted on September 12, 2007
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Even the most successful business models erode over time. Microsoft Corp. is under threat from Web-based software such as Google Inc.’s Writely and open-source offerings such as Linux. Coca-Cola Co. is facing challenges from bottlers flexing their muscle and increasingly health-conscious consumers.
Manufacturers across the board are struggling with the new dominance of China, and professional firms are similarly threatened by the growing presence of India.
Do you agree with the article “Path to Growth” that there are three paths corporations can choose (industrial, knowledge, network)? Do these paths resonate with your corporation’s experience? And if so, what has your success been using one or more of these paths? Join Professors Norman T. Sheehan and Ganesh Vaidyanathan in a discussion at the Business Insight forum.
The key to thriving under such tough conditions is adaptability. Many companies get stuck in a rut, coming up with just one way to make themselves valuable to customers and sticking with it no matter how much the market changes. Instead, companies must continually update their business model in response to threats and opportunities.
When faced with these challenges, most managers consider a host of conventional approaches, such as copying competitors or finding unexplored niches to exploit. But there’s another way to approach the problem, a method that can uncover new and unexpected ways to boost business: Look at value-creation strategies.
The idea is simple. All of the possible methods of bringing customers value — anything from more-efficient production lines to new products and services — boil down to just three fundamental strategies. All business models can be seen as one of these three things, or a combination of two or more. In that light, the best way to tweak a business model is to find a new combination of building blocks that better fits market conditions.
Here are those three fundamental strategies, as developed by Charles Stabell and Øystein Fjeldstad, professors at the Norwegian School of Management:
• Industrial efficiency, which creates value by producing standardized offerings at low cost. Manufacturers and fast-food restaurants rely on this approach.
• Network services, which creates value by connecting clients to other people or other parts of the network. Telephone companies, delivery services and Internet middlemen such as eBay use this method.
• Knowledge intensive, which creates value by applying customized expertise to clients’ problems. Law firms and medical practices are prime examples.
Housing, Credit Worries Hurt Stocks
Posted on September 7, 2007
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Renewed worry about the health of the housing and credit markets dragged stocks lower Wednesday, even as a report from the Federal Reserve said that recent financial-market distress has yet to filter more widely into the economy.
Halting two days of gains, the Dow Jones Industrial Average declined 143.39 points, or 1.1%, to 13305.47. The blue-chip index is now up 6.8% for the year. The Standard & Poor’s 500 dropped 17.13, or 1.2%, to 1472.29, and the Nasdaq Composite Index was off 24.29 to 2605.95. Those market gauges are up 3.8% and 7.9% on the year, respectively.
Yesterday, optimism about the Fed cutting its target for the federal-funds rate and a strong tech rally had lifted stocks. But today, stocks tumbled as markets digested reports of weak home sales and tepid job growth alongside the Fed’s assessment that the economic fallout from the turmoil in the markets had been limited so far.
“It’s a tug of war between those who think we have a Wall Street problem, confined to finance and housing, and those who think it’s going to spread and affect the whole economy,” said Jim Awad of W.P. Stewart Asset Management.
The Fed’s Beige Book report on regional economic conditions indicated that fallout from credit problems and financial upset were mostly confined to the real-estate sector. “Outside of real estate, reports that the turmoil in financial markets had affected economic activity during the survey period were limited,” it said.
Some analysts said the report argued against the need for quick action on rates by the central bank. “It argues against the Fed having to cut rates,” said Robert Pavlik, of Oaktree Asset Management. Nevertheless, futures-market activity suggested investors still expect the central bank to cut the funds rate to 5% at its next meeting on Sept. 18, and to follow that with additional cuts by the end of the year.
Some interpreted that report as a sign of worse to come. Economist Robert Iley, of BNP Paribas, wrote that the NAR report reflected the period before August’s financial turbulence, and that data for that month could be “quite frightening.” Investors reacted by beating down builder stocks. Toll Brothers slipped 3.3%, Lennar shed 3.1%, Beazer Homes lost 3.3%, and KB Home dropped 5%.
Renewed credit-market concerns also weighed on financial stocks. Citigroup fell 2.4%, and Wall Street brokerages including Lehman Brothers Holdings, Bear Stearns and Morgan Stanley continued to experience declines as markets await more news of credit problems. “Nobody knows what’s out there, and until this issue gets settled, the volatility will continue,” said Greg Church, of Church Capital Management.
Central banks were continuing efforts to cope with the changing landscape. The Bank of Canada left interest rates unchanged and hinted it might refrain from further rate increases. The Bank of England took its first major step since the outbreak of the market turmoil by saying it will raise the levels of reserves that lenders can hold with the central bank by 6%, and the European Central Bank signaled it could inject more funds into euro-zone money markets on Thursday.
Fixings of three-month London interbank lending rates, or Libor, for sterling hit 6.8%, the highest levels above official short-term lending rates over a sustained period since the collapse of Long-Term Capital Management in 1998.
Nasdaq Soars on Rate-Cut Hopes
Posted on September 5, 2007
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The Nasdaq Composite Index climbed 1.3% Tuesday, extending Friday’s rally as the release of some weak manufacturing data boosted investors’ hopes for an interest-rate cut.
The Nasdaq advanced 33.88, or 1.3%, to close at 2630.24 following the release of tepid reports on U.S. construction spending and manufacturing activity. Investors were also interested in looking for technology stocks made cheaper by last month’s selling.
Morgan Stanley’s high-tech index added 11.28 to 647.32 Tuesday and the Nasdaq 100 Index of nonfinancial stocks gained 31.78 to 2020.51.
Total volume on the Nasdaq Stock Market was 1.88 billion shares. Advancers outpaced decliners, 1,948 to 1,054.
Elsewhere in tech land, Apple gained $5.68, or 4.1%, to $144.16 on the Nasdaq Stock Market, with Wall Street eagerly awaiting a media event later this week in which the company is widely expected to introduce a line of revamped iPods.
Shares of Local.com climbed 39 cents, or 6.6%, to $6.32 after the search-engine operator renewed a multiyear marketing distribution agreement with Yahoo. Shares of Yahoo added $1.24, or 5.5%, to $23.97. Both trade on Nasdaq.
Research In Motion shares lowered seven cents to $85.34 on Nasdaq following negative analyst remarks. Bear Stearns cut its rating on the maker of BlackBerry devices to “peer perform” from “outperform,” citing valuation concerns.
“While we have not seen any signs of slowing demand, RIMM could be one of the first to be affected by macro-related demand issues given its high exposure to enterprise,” analyst Andrew Neff wrote in a research report Tuesday.
Shares of Blue Nile slumped $3.92, or 4.6%, to $80.50 on Nasdaq after Citigroup cut its rating on the online jewelry vendor to “hold” from “buy,” also based on valuation.
MEMC Electronic Materials fell $3.09, or 5%, to $58.33 on Nasdaq after the company said it expects third-quarter revenue to come in about 5% below its previous forecast of $500 million and sees margins roughly flat sequentially.
“We believe we will have an opportunity to recover some of this lost production in the fourth quarter and thereby potentially reduce the impact on the full-year targets,” said Chief Executive Nabeel Gareeb in a press release.
Leap Wireless International surged $10.97, or 15%, to $83.47 after MetroPCS Communications sent a letter to Leap proposing a stock-for-stock tax-free merger in a deal with an equity value of about $5.5 billion. MetroPCS shares gained $1.36, or 5%, to $28.65. Both trade on Nasdaq.
Cree shares rose 87 cents to $27.47 on Nasdaq, extending gains from Friday, when shares climbed 9.5% on unconfirmed speculation that the light-emitting diode maker might be a takeover target for General Electric.
However, Sidoti & Co. analyst Jiwon Lee, who follows Cree, said she gave short shrift to the rumor when it first surfaced last week. “I would be shocked” if a GE-Cree deal was imminent, Ms. Lee said. “An impending deal with GE is unlikely for a number of reasons.” For one, she pointed to GE’s alliance with Cree competitor Nichia, a privately held Japanese LED manufacturer.
Chip-making equipment firm Kulicke & Soffa Industries gained 50 cents, or 5.9%, to $9.04 on Nasdaq after the company raised its fourth-quarter revenue forecast from $212 million to $226 million. The company said additional wire-bonding equipment orders were the reason for the revision.
Report in Japan could indicate Market Contraction
Posted on September 2, 2007
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Japanese firms’ capital expenditures in the April-to-June period fell for the first time in four years, and that may result in gross-domestic-product data being revised to show the economy contracted during the quarter.
Capital spending, including investment in plants, equipment and software, fell 4.9% from a year earlier to 11.628 trillion yen ($100.43 billion), the lowest level since April-to-June of 2005, according to a quarterly Ministry of Finance survey. The fall was largely because of a 22% drop in spending in the leasing industry, reflecting weaker profits stemming from a decline in new contracts amid high leasing prices.
“That’s a big negative surprise,” said Taro Saito, senior economist at NLI Research Institute. “The revised GDP for the April-June period will probably show minus growth.”
A contraction in the economy would be the first in 10 quarters. The government is set to release revised April-to-June GDP data next week. Preliminary figures showed the economy grew 0.1% from the prior quarter.
Analysts said economic conditions overall aren’t too bad. They say manufacturers’ capital spending remains strong and corporate profits remain near records.
Separately, the Ministry of Health, Labor and Welfare said Japanese workers’ average monthly income fell for the eighth straight month in July, indicating a tightening job market hasn’t translated into higher wages.
Housing Slump Hurts Freddie Mac Profit
Posted on August 31, 2007
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Freddie Mac, the second-largest U.S. home-mortgage financier, posted a 45% drop in second-quarter net income as it set aside $320 million for losses, and said it expects credit losses to continue to rise as the housing slump persists.
The McLean, Va., company predicted that credit-market turmoil would force it to mark down this quarter the value of the securities it guarantees. “Assuming nothing changes over the balance of the quarter, it will put pressure on our fair-value returns,” Chief Financial Officer Anthony “Buddy” Piszel said in an interview.
Freddie Mac and its bigger rival, Fannie Mae, were chartered by Congress to provide funding to home-mortgage lenders. They buy home loans from lenders and package them into securities that are popular because Fannie and Freddie guarantee payments on the loans that back them. Investors generally assume the U.S. government would bail out the companies in a crisis.
The companies’ market share plunged in recent years as investors took on more risk to get higher yields, but it now is rebounding as investors seek the security of the implied government backing. The companies’ combined share of mortgage-backed-securities issues jumped to 49% in the second quarter from 37% a year ago, according to the trade publication Inside Mortgage Finance.
Freddie Mac’s net interest income skidded 17% in the quarter to $973 million, largely on higher costs for long-term borrowings. In June, the company returned to quarterly reporting for the first time since a 2003 accounting scandal forced it to restate $5 billion in earnings.
Credit-related expenses jumped to $336 million from $63 million a year earlier, driven by the $320 million provision to reflect credit deterioration on mortgages originated last year and this year. The housing slowdown, the nation’s worst in more than a decade, has led to more houses being repossessed and greater losses for lenders.
“While I was an early bear of the housing market, I was not bearish enough, given the degree to which house pricing were outstripping income growth,” Chairman and Chief Executive Dick Syron said in a conference call. He added: “I do think some of the most negative foresights out there today are too severe, and many of the recent problems will be worked out in the next 18 months or so.”
Freddie Mac’s latest results come in the midst of broader struggles in the mortgage market. The trouble that began in the subprime corner has shot through to the very top of the industry. But Mr. Piszel said Freddie Mac has reduced exposure to so-called Alt-A mortgages as well as such “risk-layered” loans, which have high loan-to-value ratios and low credit scores. Alt-A loans are made to borrowers whose credit is deemed good enough to forgo verification of income or assets, but they have also become vulnerable to rising delinquencies.
Stocks Rise on Techs, Fed Letter
Posted on August 29, 2007
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The stock market’s wild gyrations continued Wednesday, as shares soared sharply higher the day after suffering their worst declines in three weeks.
Technology shares led the move upward as investors sought safe harbors amid the credit-markets storm. Also giving shares a boost was the release of a letter from Federal Reserve Chairman Ben Bernanke to Sen. Chuck Schumer, dated Aug. 27, in which Mr. Bernanke reiterated that policy makers are “prepared to act as needed” if financial-market turmoil begins to harm the broader economy.
The Dow Jones Industrial Average gained 247.44 points, or 1.9%, to 13289.29, and the Standard & Poor’s 500 added 31.40, or 2.2%, to 1463.76. But the best gains of the day belonged to tech-heavy Nasdaq Composite Index, which more than made back its losses from Tuesday, advancing 62.52, or 2.5%, to 2563.16.
Barry Hyman, equity-market strategist at EKN Financial Services, said that the rally in tech stocks “is a good sign because they represent growth prospects.”
Apple was one of the big winners, rising 5.7% after it sent out invitations for a media event next week where some analysts think it may introduce a revamped line of iPods, its popular digital-music and video player. Companies looking to take on Apple also advanced. American depositary shares of Nokia rose 7.2% after the cellphone giant introduced new music-playing handsets and a music-download service designed to compete with Apple’s iPhone.
Computer hardware makers also registered large gains. Seagate Technology, a maker of hard drives, climbed by 3.8% the day after raising its outlook for its fiscal first quarter, while the chip giant Intel, a Dow component, gained 4.7%.
Tech “is viewed as the place that is least vulnerable to the credit-market tightening,” said Christopher Zook, chairman and chief investment officer of CAZ Investments. Credit markets have tightened this summer amid problems in the subprime-mortgage sector and a general reassessment of risk levels in the markets, and investors have been seeking safe places to park their money.
The financial sector, which has suffered steep losses recently because of the credit-markets problem, also managed to reclaim some ground today. The Amex Broker/Dealer Index gained 1.4%, while Goldman Sachs added 1.6%.
Stocks got a big boost in the afternoon following the release of Mr. Bernanke’s letter to Mr. Schumer. Mr. Bernanke discussed ways lenders and policy makers might assist borrowers who have been hit by the credit crunch and downward spiral of the housing market. But he stopped short of endorsing the call made by some lawmakers to increase the limits on the loan portfolios of government-sponsored enterprises Fannie Mae and Freddie Mac.
The letter contained nothing really new, according to James Glassman, senior economist at J.P. Morgan Chase. But he said that with it, the Fed is saying it “understands there is a problem.”
Bank of America Invests $2 Billion In Countrywide
Posted on August 27, 2007
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Bank of America Corp. acquired a $2 billion equity stake in Countrywide Financial Corp., a move aimed at dispelling a crisis of confidence among creditors and investors in the nation’s largest mortgage company.
The deal, which received quick approval from regulators, provides a strong dose of security for Countrywide. In recent weeks, the company had struggled to raise the financing it needed to fund its business, stoking concerns among investors about its prospects and pummeling its stock. Worries about the health of Countrywide, which originates or funds roughly one out of every six mortgages in the U.S., have contributed to the recent tumult in financial markets.
News of the Countrywide deal came late yesterday afternoon, just hours after Wall Street investment bank Lehman Brothers Holdings Inc. announced that it was closing down a subprime-lending business and two days after another big lender, Capital One Financial Corp., closed its GreenPoint mortgage arm. Those operations joined scores of small to midsize lenders that have collapsed over the past six months amid growing anxiety over a surge in home-loan defaults and a weakening housing market.
“Countrywide is a survivor,” Angelo Mozilo, chief executive officer and co-founder of the Calabasas, Calif., company said in an interview late yesterday.
Though the deal doesn’t give Countrywide automatic access to Bank of America’s capital, it is likely to persuade investors that the company has a powerful ally ready to help in any crisis. And it removes a major source of uncertainty hanging over the nation’s credit markets at a time when investor confidence has been shaky.
Mr. Mozilo said Countrywide would have survived without help from Bank of America but will be strengthened by this “vote of confidence to the world.”
In after-hours trading yesterday, shares of Countrywide jumped $4.06, or nearly 19%, to $25.88.
Bank of America invested in Countrywide nonvoting convertible preferred stock yielding 7.25% annually. The preferred can be converted into common stock, subject to restrictions on trading for 18 months, at a conversion price of $18 a share. A full conversion would give Bank of America a 16% to 17% stake in Countrywide’s common shares, Mr. Mozilo said.
Mr. Mozilo dismissed as “frivolous” for now any speculation that the investment could lead to a full merger between Bank of America and Countrywide, but he said the two companies would explore “where we can provide services to them better than they do themselves, and vice versa…. We’ll continue discussions.”
Countrywide had long argued that it would endure the current mortgage meltdown and emerge even stronger as competitors vanished. But the company was caught up last week in a storm of speculation as it found it could no longer tap the market for commercial paper, or short-term corporate IOUs, a major source of its financing, and a Merrill Lynch analyst warned in a report that it could face bankruptcy in a worst-case scenario. To shore up its finances, Countrywide borrowed $11.5 billion from a syndicate of 40 banks.
Though the capital injection from Bank of America is a big plus, investors shouldn’t get “too euphoric,” said Frederick Cannon, an analyst at Keefe, Bruyette & Woods in San Francisco, who expects Countrywide to post a sizable loss for the third quarter. Mortgage defaults and foreclosures are expected to keep rising over the next year or two as borrowers run into trouble on loans that started out with relatively low payments, only to “reset” later to much higher ones.
During the housing boom of the first half of this decade, Countrywide was a big promoter of pay-option adjustable-rate mortgages, known as option ARMs. These give borrowers several choices each month, including paying no principal and less than the full amount of interest normally due. If they take that route, their loan balance grows, setting them up for much higher payments later on. Countrywide’s banking arm holds $27.8 billion of option ARMs on its books. Payments were 30 days or more overdue on 5.7% of these loans as of June 30, compared with 1.6% a year earlier.
Countrywide reduced its subprime lending — or lending to borrowers with shaky credit histories — to 4% of loans originated in the second quarter from 10% a year earlier. But it retains exposure to many past subprime and other risky loans sold to other parties.
When loans are packaged into securities and sold, lenders such as Countrywide often keep a portion of the securities known as “residuals.” This portion bears the first losses from defaults. As of June 30, Countrywide had $1.46 billion of those residuals, whose value will drop or even vanish if defaults continue to mount rapidly.
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