updated 3/3/2008 9:41:35 PM ET 2008-03-04T02:41:35

Countrywide Financial Corp. has seen mortgage defaults rise as the housing market went from boom to bust, but the nation's largest home loan provider says it could have more trouble ahead with a particularly risky slate of loans — pay-option adjustable rate mortgages.

Pay-option loans give borrowers the option to make a lower payment but can result in the unpaid portion being added to the principal balance. They also have the potential to provide high yields to investors who purchased the loans from lenders during the housing boom.

As of the end of December, Countrywide had nearly $29 billion in pay-option loans, with about $26 billion of the total having grown beyond their original loan amount, the company said in a filing late Friday with the Securities and Exchange Commission.

"Our borrowers' ability to defer portions of the interest accruing on their loans may expose us to increased credit risk," the company said. It added that its risk could be greater because the amount of deferred interest on pay-option loans was on the upswing.

The company noted some 81 percent of the loans were made out to borrowers who provided little or no documentation on their income. As of the end of December, 71 percent of borrowers with pay-option loans were electing to make less than full interest payments.

Even though borrowers with such loans had the option to just make interest payments, many were increasingly missing payments, the company said.

Some 5.71 percent of the loans based on unpaid principal balance were at least 90 days late as of Dec. 31, up from 0.65 percent a year earlier.

Like other lenders, Countrywide has since tightened its lending criteria and curtailed lending of so-called no documentation loans. It has also ramped up programs aimed at modifying loans for borrowers before their loans reset to higher rates.

At the close of last year, Countrywide's total loan servicing portfolio was valued at about $1.5 trillion.

Total delinquencies as a percentage of the number of loans was 6.96 percent, up from 5.02 percent at the end of the prior year. Some 1.04 percent of loans were facing foreclosure, up from 0.65 percent a year earlier.

California accounted for the highest portion of Countrywide loans, according to unpaid principal balance, of any state, the lender said.

The state had around $389 billion in loans, followed by Florida, with loans totaling around $113 billion.

Texas, New York and New Jersey rounded out the list.

The company's banking unit, which also funds some of Countrywide's home loans, had $87.1 billion loans held for investment on its books at the end of the year.

A large portion of that stemmed from loans made in California and Florida, once-hot housing markets that have now been battered by falling prices and rising mortgage defaults and foreclosures.

About $37 billion in loans were made to borrowers in California. Another roughly $6 billion pertained to loans in Florida.

Virginia accounted for about $3 billion of the total, the company said.

In January, Bank of America Corp. agreed to purchase Countrywide for about $4 billion in stock. The transaction is projected to close in the third quarter.

Countrywide previously reported a loss of $422 million in 2007's fourth quarter and a loss of $1.2 billion in the third quarter, as higher defaults forced the lender to boost its provisions for anticipated losses.

Shares of Countrywide slipped 14 cents, or 2.2 percent, to $6.17 on Monday.

Copyright 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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