By Shenn, Jody
American Banker , Vol. 36, No. 285
On a conference call Tuesday, Countrywide Financial Corp.'s chairman and chief executive sounded frustrated and uncharacteristically glum.
Its first full-year audit by a Big Four firm had found a mistake that will make it restate 2004 earnings.
Countrywide considered its previous accounting "appropriate because it reflected the actual economics of the transaction," CEO Angelo Mozilo said. But, he said later, "the reality is we have to deal with what we have to deal with."
KPMG LLP's determination will also require Countrywide to acknowledge a "material weakness" in controls over its financial reporting in its 10-K. But it remains to be seen whether much will come of the matter beyond Tuesday's embarassing disclosure.
Analysts sounded sympathetic to the company, saying its original accounting made more sense than what KPMG, which replaced Grant Thornton as Countrywide's auditor in January 2004, is requiring.
Mr. Mozilo said auditors are trying to be conservative in the wake of accounting scandals at the mortgage industry's two biggest players. "A year ago, pre-Fannie Mae and all kinds of things like that, it would have been more of an interpretive issue than one of a bright line," he said.
Correcting the accounting is expected to move 20 cents a share in 2004 earnings into this quarter.
The Calabasas, Calif., company said it had been recognizing gains from its securitizations with embedded derivatives before selling all of the securities created, as its auditor now says is required.
In one quarter, holding on to just 0.1% of a group of securities underwritten by its Countrywide Securities Corp. and reporting the profits from selling the rest meant it was breaking the rules, it said.
In all cases, the remaining securities were sold shortly after the end of each quarter. And Countrywide did not benefit from the out-of-the-money interest rate caps embedded in them, which it technically still owned, executives said.
KPMG, Countrywide's auditor, informed it of the problem in its application of Financial Accounting Standard 140 on Feb. 18.
On the call, Mr. Mozilo said two of the Big Four accounting firms had been hired to "specifically look at this issue during last year, and neither of them had ever informed us of an issue." Countrywide tried to follow the spirit of accounting rules, he said.
"We felt that immateriality and intent were the cornerstones of FAS 140," he said at one point. The "material weakness" notation is "solely related to this issue," he added.
Asked whether the accounting treatment required by KPMG actually opened the door for a company to easily smooth earnings, Mr. Mozilo said he couldn't "imagine a responsible management team trying to pull a trick like that" but saw how it might be easy for a bad actor.
In a research note Tuesday, Robert P. Napoli, an analyst at Piper Jaffray & Co. in Minneapolis, wrote: "While the 'rule is the rule' and [Countrywide] ... must follow KPMG's directive on this, we believe the gain recognition initially used ... made more sense."
"I'm not surprised they got caught by that," said Douglas Winn, the president of the St. …