The sinking subprime market: Creating woes for Countrywide and Balboa?

Many in the financial industry are speculating what could happen to insurance companies as a result of the subprime mortgage mess, but the truth is it may be too soon to tell.

One of the hardest-hit lenders, Countrywide Financial Corp. — “the largest mortgage lender by volume, accounting for more than 13 percent of the loan servicing market as of June 30,” according to the mortgage industry publication Inside Mortgage Finance — is also the parent of Balboa Insurance Group (BIG).

BIG provides property/casualty/life insurance and also owns Balboa Reinsurance Co., a provider of reinsurance coverage to primary mortgage insurers; Countrywide Insurance Services Inc., an independent insurance agency that provides homeowners and other insurance products; and DirectNet Inc., a full service third-party insurance agency.

Earlier this year, BIG noted aggressive growth plans, expecting to expand nationwide with new products. Yet because of the negative implications associated with parent Country-wide Financial Corp., analysts are not sure those plans can be carried out.

Subprime mortgages were generally provided to high risk borrowers with poor credit histories often with adjustable rate mortgages. As interest rates have escalated, many borrowers are defaulting on their payments, forcing foreclosures and lenders to go out of business.

Countrywide has illustrated how difficult it has been to continue operating as usual. In early August, the company gave the first indication that disruptions in credit and secondary mortgage markets were hurting its financial condition in a report to the Securities and Exchange Com-mission. The company said, “it had enough capital to hold onto mortgage loans and mortgage-backed securities until the housing market picks up, but if the debt markets tightened, it could result in the lender’s loan production volumes falling, which would hurt earnings,” the AP reported.

The following week, shares of the company’s stock dipped, plunging the stock to a level half its value of one year ago. Merrill Lynch & Co. downgraded its rating on the stock from “sell” to “buy,” citing “accelerating liquidity challenges.” Similarly, Moody’s Investors Service downgraded the company’s senior debt rating to “Baa3” from “A3,” citing funding problems.

“We fear that the acceleration of margin calls and forced asset sales in the capital markets could lead to more problems for (Country-wide) to finance its mortgage operations,” Merrill Lynch analyst Kenneth Bruce told the AP.

Country-wide Chief Executive Angelo Mozilo maintained the company had enough cash to survive the credit market turmoil.

But on August 16, it tapped a $11.5 billion credit line from a group of 40 banks to help it fund loans. “Countrywide has taken decisive steps, which we believe will address the challenges arising in this environment and enable the company to meet its funding needs and continue growing its franchise,” President and Chief Operating Officer David Sambol said in a statement.

Meanwhile, the company began laying off employees and issued the following statement:

“In recent months, the volume of subprime mortgage lending has contracted significantly across the industry. Last week, Countrywide announced reductions in branch and operations support levels of its Full Spectrum Lending Division and the subprime lending unit of the Wholesale Lending Division. Approximately 500 positions have been eliminated across the country. The company will continue to monitor market changes and production levels on an ongoing basis and respond as appropriate.

“Countrywide continues to recruit and hire sales professionals in its pursuit of profitable market share growth. It also is carrying on with its strategic growth initiatives in its banking, insurance, capital markets and global endeavors. ”

However, A.M. Best Co. placed the financial strength of BIG’s credit ratings under review “with negative implications,” a status that “reflects the financial pressures that currently exist at the group’s ultimate parent, Countrywide Financial Corp.,” Best explained. “The ratings will remain under review pending discussions with the managements of Balboa and CFC in order to explain the current situation and the proposed strategic initiatives put in place to lessen any potential negative impact on the insurance operations due to the recent significant deterioration at CFC. Prior to the conclusion of these discussions, any further deterioration in the financial condition at CFC, as perceived by A.M. Best, would result in a downgrade of all the financial strength ratings and insurer credit ratings of Balboa’s insurance companies.”

CFC maintains: “Operational efficiency and rapid response to market changes have been hallmarks of Countrywide’s continued success and increased strength through multiple housing cycles. When appropriate, Countrywide takes steps to adjust staffing levels, particularly in areas where the cost structure must align with production volumes.”

Countrywide placed ads in the Los Angeles Times and Detroit Free Press, attempting to reassure investors and customers that their money is safe. “The future is bright,” the ads say.

Yet judging by the potential ratings downgrades and the company’s refusal to comment on the subprime situation to Insurance Journal after repeated phone calls, the financial picture at Country-wide and Balboa Insurance is not glowing as it once seemed.

Reports from the Associated Press contributed to this article.