Despite a sharp drop in first-quarter earnings due to subprime-related charges and a reduction of its full-year guidance, Countrywide Financial Corp. said mortgage market conditions had improved.
Specifically, executives said price competition had cooled off and that demand had picked up for bread-and-butter products like prime loans and refinancings.
The company also detailed changes in its underwriting guidelines that will shift its production mix away from controversial "affordability" products. Observers called the decisions prudent, though they noted that volume and perhaps the credit performance of existing loans could suffer as a result.
On a conference call Thursday, Angelo Mozilo, Countrywide's chairman and chief executive, said mortgage-industry consolidation had resulted in "more rational competition" in prime lending, which is fueling some optimism that profit margins could improve.
"There were many players that entered the business in the last five years that exhibited irresponsible behavior, and acquisitions are taking place at a more rapid pace than I've ever seen," he said. "You see the pipeline for our prime business is increasing dramatically, and that's a trend toward higher-quality loans and better margins."
Countrywide had a significant increase in refinancing volumes and stable pricing in the first quarter, which offset lower purchase volume.
"The outlook is very good for our prime business and prime margins," said David Sambol, Countrywide's president and chief operating officer. "We are cautiously optimistic, but there are a lot of moving pieces that could" affect the company.
Countrywide expects subprime lending volumes to fall 25% to 50% and subprime lending to account for 4% to 6% of overall originations, down from 8% in the fourth quarter, he said.
It has cut back significantly on 100% loan-to-value mortgages, which made up roughly 25% of its subprime loans in the fourth quarter but will account for less than 5% in the future, Mr. Sambol said.
The company also has eliminated 100% financing of adjustable-rate mortgages and is cutting back on second liens and reduced-documentation loans.
Frederick Cannon, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc., said he is concerned about what effect Countrywide's actions would have on the market now that it has scaled back by nearly 50% in the subprime business.
"They're doing the right thing by adjusting to a very difficult environment," he said, "and while I hope it gets better in the near term, there's still a lot of pain to go. Countrywide is a big enough player in the mortgage industry that there will be a reaction to this."
He said a significant number of first-time homebuyers may be unable to get loans. In addition, borrowers facing problems with ARM resets also may be unable to get refinancing.
"There are larger credit implications to this," Mr. Cannon said.
Mr. Sambol said Countrywide expects a "nominal" increase in foreclosures due to ARM resets, which he said were related more to changes in a borrower's income than in payment amounts. He also suggested that losses from vintage 2006 loans may not turn out to be as bad as expected.
Still, deteriorating housing market conditions and rising delinquencies hit earnings by another 14 cents a share, causing Countrywide to trim its 2007 guidance to $3.50 to $4.30 a share, down from $3.80 to $4.80.
Its earnings fell 37%, to $434 million, or 72 cents a share, in the quarter, and revenue dropped 15%, to $2.4 billion. Analysts surveyed by First Call had expected Countrywide to report earnings of 77 cents a share.
Revenue from subprime operations plummeted $400 million in the first quarter and cut overall earnings by 41 cents a share.
Countrywide took a $212 million impairment charge for retained interest in subprime loans and a $218 million market value adjustment on its subprime inventory. It also had a $119 million impact from market conditions in first-quarter subprime loan sales. These charges were offset by a $149 million gain from hedge trading in the secondary ABX market, resulting in the overall $400 million subprime revenue decline.
Kenneth Bruce, an analyst at Merrill Lynch & Co. Inc., said: "The first quarter was very messy because of the subprime spread widening, but when you peel back those numbers, the quarter looked strong." The subprime losses were offset by a $68 million loss reserve reversal in its insurance segment, analysts said.
