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Mortgage Slump? Bring It On


Angelo R. Mozilo isn't lacking in confidence. The 64-year-old CEO of Countrywide Financial Corp. (CFC) didn't rise from mortgage company delivery boy at age 14 to head of the third-largest home lender in the U.S. -- behind Wells Fargo (WFC) and Washington Mutual (WM) -- by shrinking from a fight. "I'll tell you what play we're going to run, what down, and let you choose the point spread, and we'll still beat the competition," Mozilo says at Countrywide's elegant offices in suburban Los Angeles. "That's the confidence I have in our team."

So far, that confidence has been well placed. As homeowners rushed to refinance their mortgages over the past three years, Countrywide's profits, only $410 million in 2000, rocketed to an estimated $2.3 billion this year. Its stock continues to trade near a high of $108. Says James A. Johnson, former CEO of Fannie Mae: "What Angelo has managed to do is remarkably impressive."

But with interest rates rising and the refi boom at an end, Countrywide's monthly mortgage volume has plunged 44% since July. And the business of making home loans, securitizing them, and selling them off to investors doesn't look to improve anytime soon. The Mortgage Bankers Assn. expects total mortgage volume to fall more than 50% next year. The company itself projects that earnings will decline about 17% in 2004, to $1.9 billion. "The easy money has been made," says Robert L. Rodriguez, chief investment officer of FPA Funds in Los Angeles, which sold the last of its Countrywide stock in September. "Their present earning power is unsustainable due to the blowoff in refinancing."

TWO-MAN SHOP

Yet instead of simply riding out the downturn, Mozilo has begun an ambitious plan to more than double Countrywide's 13% share of the mortgage market. The idea is to offset the decline in mortgage lending. It won't be easy. Says Anthony Hsieh, chief executive of rival lender Home Loan Center Inc. in Irvine, Calif.: "They are so big, in order for them to keep their volume up they have to get 25% market share." In fact, Mozilo wants Countrywide's share of the mortgage market to hit 30% by 2008.

He figures that as mortgage bankers across the country close up shop, he can take advantage of their woes. Mozilo has done it before. Countrywide, now based in Calabasas, Calif., started life as a two-man shop in New York City in 1969, and has grown to hundreds of branches nationwide. It's now the largest independent mortgage lender in the U.S. As it grew, Mozilo and co-founder David Loeb, who died this year, noticed that during the industry's periodic refinancing booms, salaried employees spent all of their time on refi applications from existing borrowers and neglected such sources of new customers as real estate agents, attorneys, and homebuilders. So in 1998, Mozilo began to recruit commission-only sales reps for those accounts. Countrywide has 6,800 such reps now and plans to add 3,200 more over the coming year.

JUDGMENT CALLS

One thing that might attract those brokers is Countrywide's decentralized structure, which gives local offices wide latitude in granting loans rather than having approvals go through a central office. "I can close a loan in an hour if I have to," says Lorraine Best, manager of the Milltown (N.J.) branch. Hassle-free closings, she adds, keep salespeople satisfied.

The judgment of those reps will be put to the test in a down market. Because they work on commission, their natural bias is toward the quantity of loans they make, not the quality. And as mortgages become pricier, fewer people qualify for the best rates. That's why subprime mortgages -- which have higher interest rates, but also higher rates of default -- are growing. They are now 8% of Countrywide's loans, vs. 3% a year ago, although the company expects subprimes to eventually level off at 5% of its portfolio. Higher rates also mean more adjustable-rate mortgages. Even borrowers with good credit can be stung if rates spike. And because floating interest rates make ARMs hard to securitize, Countrywide holds on to many of them rather than selling. That reduces the capital the company has for other activities. Countrywide had 36% of its mortgage originations in ARMs recently, vs. 27% for the industry.

Mozilo is counting on diversifying his sources of cash. One promising area is Countrywide's mortgage servicing business, which entails collecting fees to administer the individual mortgages it has packaged and sold off. Servicing should become increasingly profitable as rates rise and borrowers stick with their current mortgages rather than refinance.

Countrywide should also be able to count on getting a boost from Virginia-based Treasury Bank, which it acquired in 2001. The bank has grown from $80 million in assets to $19 billion. Fuel for that growth has come from plentiful escrow funds for taxes and insurance tied to Countrywide mortgages. The bank alone could generate profits of $238 million in 2004, up from an estimated $136 million this year, according to Morgan Stanley's (MWD) research arm. Mozilo also has begun to sell high-yielding certificates of deposit, backed by Countrywide mortgages, through the company's branch offices.

Altogether, Countrywide intends to generate half its profits from outside of traditional mortgage making by 2008, up from 25% today. Its chief executive certainly talks like he has a strong game plan. But as Mozilo knows all too well, a slumping mortgage business will test even the best of teams. By Christopher Palmeri in Los Angeles


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