Housing Bubble
Countrywide Financial Corporation comments on Fitch rating action
February 20, 2003
Countrywide Financial Corporation, a diversified financial services provider, commented today on the action by Fitch Ratings to place the debt of Countrywide on Rating Watch Negative.
Fitch has expressed a concern with "the increasing risk of impairment that is present within mortgage banking companies' balance sheets." In fact, "the increasing risk of impairment" has already occurred as forty-year lows in mortgage rates have been observed for an extended period. Further increase in the risk of impairment would require that mortgage rates decline to even lower levels in the future. It is noteworthy that Countrywide demonstrated its ability to produce record earnings in just such an environment.
Success in mortgage banking during low mortgage rate environments requires that lenders both sustain portfolio growth and recover their initial investments in servicing lost to prepayments. Countrywide led the industry in organic dollar growth of servicing during 2002, demonstrating the success of its macro-hedge. In 2002, fundings grew 82 percent to $252 billion and exceeded prepayments by $123 billion. Furthermore, Countrywide has been highly effective at hedging its original investment in MSRs through its servicing hedge for over ten years. The servicing hedge produced a gain of $1.8 billion, net of costs, in 2002.
In addition, Fitch noted concerns over the size of Countrywide's MSRs in relation to equity. In fact, Countrywide has historically leveraged its MSRs with associated debt at roughly three times equity. This leverage ratio is substantially more conservative than other mortgage bankers. Furthermore, the ratio of net book value of MSRs (net of deferred taxes) to equity continues to decline and reached 0.66 at December 31, 2002, down from 1.05 in the prior year. Fitch observed that Countrywide's MSRs are "generated using aggressive valuation assumptions." Countrywide's management believes that its MSRs are conservatively valued and are presently booked at historically low levels.
Fitch also commented on increased credit risk, notably in sub-prime mortgage lending. Countrywide has a proven track record at managing sub-prime credit risk. Over 80 percent of sub-prime loans are securitized in a preferred execution that virtually eliminates credit risk to Countrywide. Furthermore, sub-prime fundings accounted for less than 4 percent of consolidated total fundings in 2002. Countrywide's maximum capital at risk on sub-prime loans was less than $130 million on a tax-adjusted basis at December 31, 2002.
"Countrywide management believes that the Company is in the strongest financial position in its history and is well positioned for the future," said Angelo R. Mozilo, Chairman, Chief Executive Officer and President. "Countrywide's management remains steadfastly committed to strong corporate governance, and to maintaining a conservative capital structure and its credit ratings. With respect to the core business of mortgage banking, the market environment remains vibrant and the competitive landscape remains very favorable. The servicing portfolio stood at a record $469 billion as of January 31, 2003 and is positioned to generate significant earnings when interest rates ultimately rise. In addition, the business model has been augmented by synergistic businesses that are designed to maximize and diversify earnings. These businesses include capital markets, banking, insurance and global, which provided almost 30 percent of consolidated earnings in the most recent quarter. Countrywide grew earnings 50 percent in 2002 to $6.49 per diluted share, capping seven consecutive quarters of record earnings. It is notable that this success was achieved during a period that presented the very 'risk of impairment' focused on by Fitch in their statement."
Source: Countrywide Financial Corporation
