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MSR Disclosure Boosts Countrywide's Stock Price

You wouldn't expect to see a company declare that its mortgage servicing rights lost $1 billion in value to impairment and amortization - a fact quickly highlighted by journalists like myself - and then watch its stock price soar on the day it releases its quarterly earnings report.

But then again, not many companies are as agile at managing interest rate hits to its MSR portfolio as Countrywide Financial Corp. And while my outlook may be provincial - journalists love companies that disclose a lot of information - investors seem appreciative as well in Countrywide's case. The stock jumped to a 52-week high of $68.30 on the day the firm announced its earnings.

Not every mortgage company is as generous as Countrywide is with the amount of information about its MSR portfolio that it releases publicly. Then again, Countrywide can afford to be generous.

Why? Simply because the good news far outweighed its servicing hits. The company lost over $500 million from servicing, with servicing income and a bit of hedging trimming the impairment and amortization costs. But Countrywide also earned nearly $900 million from loan production activities. Its mortgage banking segment reported an impressive $354 of pretax earnings in the first quarter, a record for the firm.

But impressively, Countrywide once again relied upon its "macro hedge" to report record earnings for the eighth consecutive quarter. The natural hedge of loan production has proven to be a tricky tool for many mega-servicers. Typical replenishment ratios often aren't high enough to offset losses to the servicing portfolio when borrowers refinance in droves - unless your company is very good at the loan origination game. And Countrywide is. Just consider it produced $102 billion of home loans in the first quarter. A busy pipeline at the end of the quarter suggests that Countrywide will once again report strong origination volume when second-quarter results are released.

Another indication of Countrywide's success with its "macro hedge" is that its servicing portfolio continues to grow at a strong clip. At the end of the quarter, Countrywide serviced $502 billion (the figure was closer to $510 in late April, chairman and CEO Angelo Mozilo told investors in New York). The end-of-quarter number represents growth of 41% from the size of the company's portfolio a year earlier. And in the first three months of 2003 alone, Countrywide produced $52 billion more in loans than those that prepaid.

That's no accident. Countrywide has long stressed its commitment to growing its servicing portfolio "organically" through internal loan production rather than relying on portfolio purchases. The company once again is producing more loans than it loses to prepayments.

"As designed, Countrywide's production successes have been the primary catalyst for the record growth of our servicing portfolio," chief operating officer Stanford Kurland said in a statement about the company's March business activity.

That kind of front-end capacity is what you need to offset $660 million of impairment and $363 million of amortization to a servicing portfolio, as Countrywide clearly did.

In fact, despite cumulative servicing writedowns of more than $6 billion, Countrywide has achieved record earnings for eight consecutive quarters. Earnings per share reached $2.44 in the first quarter, up 26% from the fourth quarter of last year and beating analysts' consensus estimates by a stunning 36 cents per share.

And Countrywide says it now expects to report diluted earnings per share within a range of $10 to $11 for all of 2003, up from a prior estimate of about $8.

Moreover, Countrywide believes its MSR portfolio is poised to contribute a big portion of the company's profits in a post refi-boom environment.

Chairman and CEO Angelo Mozilo said losses from the MSR value have done nothing to diminish his enthusiasm for loan servicing. In fact, the company continues to grow its portfolio at an impressive rate, eclipsing Chase Manhattan to become the nation's third largest mortgage servicer at March 31.

Mr. Mozilo told analysts and investors in New York that Countrywide expects to reap large benefits from its MSR asset when interest rates rise and loan origination activity slows down.

The loans in the portfolio are on average just 18 months old and have a weighted-average coupon rate of 6.6%, he said during a presentation at a UBS Warburg investment conference.

Mr. Mozilo said the portfolio's intrinsic value, taking into account cross-selling potential and the ability to recapture business from the portfolio, far exceeds the $5.3 billion value that Countrywide has assigned to its MSR asset on its books.

And the value of that portfolio should rise nicely when rates rise and refinancing tapers off. Today, Countrywide's portfolio is valued at 115 basis points of the dollar amount of loans in the portfolio. That's down from 221 basis points in February of 2000, but the market value will start rising again as rates rise and the prepayment rate slows.

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