Countrywide plunges on bankruptcy fear

NEW YORK (Reuters) - Countrywide Financial Corp. CFC.N shares sank 13 percent, their biggest one-day decline since the 1987 stock market crash, on fears the largest U.S. mortgage lender could face bankruptcy as liquidity worsens.

"If enough financial pressure is placed on Countrywide or if the market loses confidence in its ability to function properly, then the model can break, leading to an effective insolvency," Merrill Lynch & Co. analyst Kenneth Bruce wrote. "If liquidations occur in a weak market, then it is possible for Countrywide to go bankrupt."

Countrywide debt prices fell and the perceived risk of owning its bonds rose, suggesting less confidence that the Calabasas, California-based company can pay its bills and fund operations.

This helped drag down U.S. stocks, as investors bought safe U.S. government debt to escape clouds enveloping the U.S. mortgage industry.

Bruce downgraded Countrywide to "sell" from "buy" on Wednesday. "The company can survive a period of secondary market instability; however, the steps that it would take to preserve shareholder value would be expensive, likely leading to further share price declines," he said.

Shares of Countrywide closed down $3.17 at $21.29 on the New York Stock Exchange. They have fallen 50 percent this year, and the company's market capitalization has dropped to about $12.3 billion. Countrywide did not immediately return requests for comment on Wednesday's share price decline.

Bruce's downgrade suggests deepening problems at Countrywide, which has in the last month tried to assure investors it would thrive once the credit crunch afflicting U.S. mortgage lenders passed.

The downgrade came a day after Countrywide said foreclosures and mortgage delinquencies rose in July to their highest levels since at least early 2002.

DEBT YIELDS RISE

Shares of several other companies exposed to mortgages also suffered double-digit percentage declines on Wednesday, including Deerfield Triarc Capital Corp DFR.N, KKR Financial Holdings LLC (KFN.N) and Scottish Re Group Ltd SCT.N. The KBW Mortgage Finance Index .MFX fell 2.7 percent.

The mortgage industry is struggling as defaults rise, investors refuse to buy many home loans, and bankers curtail lending to mortgage providers. Dozens of lenders have quit the industry this year, and several have gone bankrupt.

Countrywide spokesman Rick Simon declined to discuss Bruce's report, but said: "Management is completely focused on running the business in a changing environment."

Reuters obtained a copy of Bruce's report.

Countrywide's 5.8 percent notes maturing in 2012 fell 1.9 cents on the dollar to 90 cents, yielding 8.37 percent, according to Trace, the Financial Industry Regulatory Authority's bond pricing service.

The perceived risk of owning Countrywide bonds rose. Credit default swaps rose about 100 basis points (1 percentage point) to 500 basis points, or $500,000 per year for five years to insure $10 million of debt, traders said.

Countrywide's unsecured 30-day commercial paper yielded 6 percent to 6.25 percent, according to Deborah Cunningham, chief investment officer for money markets at Federated Investors.

DISRUPTIONS

Bruce said market disruptions have made it difficult for many companies to obtain even short-term financing.

He pointed to Canada's Coventree Inc. COF.TO, a structured finance firm that on Monday found itself unable to sell its own short-term debt. It said it later found buyers for C$600 million (US$556 million) of the debt.

The Countrywide downgrade is "a big deal," said Blake Howells, director of research at Becker Capital Management in Portland, Oregon. The disruptions are "an issue for Countrywide and for anyone accessing pretty reliable short-term funding."

Earlier this month, Countrywide said it had access to $186.5 billion of cash as of June 30, including $46.2 billion of "highly reliable" short-term financing.

Chief Executive Angelo Mozilo on July 24 said Countrywide expected to add market share, and eventually be among perhaps five lenders to dominate the mortgage market. Countrywide added nearly 7,000 jobs from January to July.

Bruce said "we like" Countrywide's franchise, but industrywide liquidity problems could erode its value.

(Additional reporting by Karen Brettell, Doris Frankel, Chris Sanders, Neil Shah and Dan Wilchins)