Will the sinking subprime market create 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 companies, Countrywide Financial Corp., which is the “the largest mortgage lender by volume, accounting for more than 13 percent of the loan servicing market as of June 30,” according to mortgage industry publication Inside Mortgage Finance, is also the parent of Balboa Insurance Group.

Balboa Insurance Group provides property/casualty/life insurance and also owns Balboa Reinsurance Co., a provider of reinsurance coverage to primary mortgage insurance companies that insure payment of mortgage loans; Countrywide Insurance Services Inc., an independent insurance agency that provides consumers with homeowners and various 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 like its auto insurance program and two home warranty products, and hoping to develop operating efficiencies between lending and insurance divisions. Yet because of the negative implications associated with parent Countrywide Financial Corp., analysts are not sure those plans can be carried out. “Carrying on with its strategic growth initiatives in its banking, insurance, capital markets and global endeavors,” as Countrywide says it will, may be more difficult than it sounds.

Subprime mortgages were generally provided to high risk borrowers with less than stellar 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 Commission. 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.

Then, shares of the company’s stock dipped, plunging the stock to a level half of its value 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 (Countrywide) to finance its mortgage operations,” Merrill Lynch analyst Kenneth Bruce told the AP.

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

But on Aug. 16, Countrywide 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 also began laying off employees, hoping that eliminating 500 jobs from the lending division would help it ride out the credit crunch. In doing so, the company 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. … 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. The success of our strategy to expand our retail and wholesale market share relies heavily on our ability to recruit and retain talented people as they become available during the industry’s consolidation.”

Despite those testaments, A.M. Best Co. has placed the financial strength of Balboa Insurance Group’s credit ratings under review.

“The ‘under review with negative implications’ status reflects the financial pressures that currently exist at the group’s ultimate parent, Countrywide Financial Corp.” A.M. 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.” The company has taken out newspaper ads attempting to reassure investors and banking customers that their money is safe and the company will not go bankrupt as other smaller lenders have.

“The future is bright,” the ads say.

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

The Associated Press contributed to this article.