CFC Sees Servicing Gain

Mortgage servicing played a big part in Countrywide's year-end 2005 results, helping to offset the impact of lower loan production margins.

In the fourth quarter, Countrywide reported pretax earnings of $306 million from mortgage servicing, a wide swing from the $278 million loss reported a year earlier. Servicing accounted for a big chunk of Countrywide's pretax mortgage banking earnings of $434 million in the quarter.

Countrywide grew its servicing portfolio by 33% from a year earlier, and now services north of $1.1 trillion in home loans. Additionally, lower prepayments and higher-spread income from escrow balances contributed to the turnaround in servicing results, according to Mike McMahon, an analyst who follows Countrywide for Sandler O'Neill & Partners.

"We expect continuing earnings improvement from CFC's servicing segment," Mr. McMahon said in a research report.

In its outlook, Countrywide said it expects its average servicing portfolio to reach $1.2 trillion to $1.3 trillion this year, with profit margins on the portfolio averaging one to 10 basis points depending upon interest rate conditions.

However, accounting changes are expected to affect servicing results. The Financial Accounting Standards Board is expected to implement FAS 156 this year, which will lead to fair value accounting for servicing portfolios and may lead to a retroactive write up of Countrywide's portfolio.

During the company's quarterly conference call, chairman and CEO Angelo Mozilo noted that Countrywide valued its MSR asset at a capitalization rate of 129 basis points at the end of last year. The weighted average coupon rate on Countrywide's $1.1 trillion portfolio was 6.1% at the end of 2005. The portfolio consists of 60% fixed-rate loans and 40% adjustable-rate products.

On the surface, Countrywide just closed out a pretty good year. Earnings per share were up 13% in 2005 from 2004, and fourth-quarter earnings were up 69% from the fourth quarter of 2004.

To top it off, Countrywide set an industry record for single-company mortgage lending volume, producing $491 billion of new home loans last year.

But Countrywide Financial Corp. fell short of Wall Street's consensus estimate of fourth-quarter earnings. Still, most analysts and investors remained upbeat about the company's performance and prospects.

Countrywide executives acknowledged that a flat yield curve coupled with stiff price competition in the market squeezed the company's profit margin from loan origination activities late last year, but they also said that market conditions have started to improve.

During the conference call, Mr. Mozilo said Countrywide increased its loan production market share by 25% last year.

"It should be noted that Countrywide enjoyed this market share growth without being an aggressive pricing leader," he said.

Moreover, he said the growth of Countrywide's bank subsidiary means that the company has more discretion to retain home loans on its books in addition to selling loans into the secondary market.

"Countrywide can now optimize the balance between sale and retention of mortgage assets," Mr. Mozilo said.

In fact, Mr. Mozilo said that had it not been for Hurricane Katrina, Countrywide's EPS would have beaten the annual record set by the company in the boom year of 2003.

Mr. McMahon, the Sandler O'Neill analyst, gives Countrywide Financial's stock a 12-month price target of $42 and a "buy" rating.

In a report, he said production margins "remain under intense pressure." He said that margins will remain tight until the yield curve gets steeper and industry production capacity declines from continuing consolidation.

SNAPSHOT: Countrywide's Servicing Margin

4th Q, '05 positive 11 basis points 4th Q, '04 negative 14 basis points Source: CFC

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