Countrywide's Earnings Fall, But Don't Blame Servicing

Countrywide Financial Corporation's second quarter earnings fell short of Wall Street expectations, and stiff competition on the pricing of new loans appears to be the main culprit.

Countrywide said the margin in earns from loan production activity fell to 40 basis points, less than half the first quarter margin.

However, investors took the news in stride, noting that the company narrowed its earnings guidance for 2005 by raising the low end of the estimate. The company's share price rose slightly on July 26, the day earnings were released.

In a conference call with investors and analysts, Countrywide chairman Angelo Mozilo did not mince words about where the pricing pressure is coming from, naming Ameriquest and New Century as aggressive competitors in the loan market.

"That's where the pressure is coming from primarily. My own sense is that this has stabilized somewhat," he said.

Mr. Mozilo added that he believes Washington Mutual, a big buyer of loans from Ameriquest in the past, has either severed its relationship with the firm or scaled back its purchasing. A spokesperson for Ameriquest said the company would have no comment on Mr. Mozilo's remarks.

But Mr. Mozilo also said that Countrywide is seeing pricing pressure on hybrid adjustable-rate mortgage products from banks, which have an appetite for keeping three- and five-year hybrid ARMs on their books. He named Wells Fargo, Bank of America and to some extent Chase as sources of pricing pressure in this market.

Mr. Mozilo said increased pricing pressure, particularly in nonprime product categories, was not a surprise, given that margins on many of those products had been historically high.

"Anytime you see any product that has a margin larger than prime margins, that is where the industry is going to gravitate."

A shift in product mix to greater reliance on the correspondent lending channel also contributed to the decline in production margins, Countrywide said.

Countrywide earned $566 million in the second quarter, down 28% from $786 million in the second quarter of last year. Earnings-per share dipped to $0.92, compared with $1.29 a year earlier.

Most of the decline can be attributed to Countrywide's mortgage banking division, which earned $526 million on a pre-tax basis in the second quarter, down from $1 billion a year earlier. Mortgage banking contributed 56% of Countrywide's pre-tax earnings in the second quarter.

Mr. Mozilo said that Countrywide deferred potential gain-on-sale revenue from the second quarter by putting more mortgages and home equity loans on the portfolio of its bank.

During the second quarter, Countrywide's bank funded $15.7 billion of loans for its portfolio, an increase of $7.2 billion from the prior quarter. The company also retained $1.8 billion of home equity loans.

Had the combined incremental volume of $9 billion been sold into the secondary market, Mr. Mozilo said an additional pre-tax gain of about $150 million would have been recognized in the second quarter.

By retaining the loans, Countrywide is creating "a more stable stream of net interest income over the life of such loans as well as a greater base of future earnings," he said.

In contrast to some of its competitors, loan servicing was not a drag on income at Countrywide. Despite taking an impairment hit, Countrywide posted an $89 million profit from its loan servicing sector. Higher servicing fee revenue from a portfolio that is more than 30% larger than a year ago was the primary reason that servicing income rose, Mr. Mozilo said.

Despite the pricing pressure, Countrywide's total loan production volume rose to $121 billion in the second quarter, up 21% from a year earlier.

Countrywide continued to post strong growth in its "diversified" businesses, especially its bank. Earnings from the banking segment increased 111% from a year earlier to total $251 million in the second quarter. Capital markets earnings increased 17% to $105 million.

SNAPSHOT: CFC's Mortgage Unit Earnings

2nd Qtr '04 $1 Billion

2nd Qtr '05 $526 Million

Source: Countrywide Financial Corp.

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