Hedge Weakness Slows Countrywide's Growth.

Calabasas, CA -- Countrywide Financial Corp. had a pretty good year in 2004, but its fourth-quarter results were marred by poor hedging correlation, demonstrating why Countrywide is among the big lenders that would like to shrink the size of the servicing asset on their balance sheets by carrying a lower servicing fee.

Hedging the MSR portfolio is supposed to reduce earnings volatility. But even the experts run into trouble once in a while. Countrywide posted a $278 million pretax loss attributable to the company's loan servicing unit as the value of its financial hedges fell, but MSR values failed to rise as expected to offset the hedging losses. Blame it on an unexpected flattening of the yield curve between Treas-uries and 30-year mortgage rates.

That hedging snafu limited mortgage earnings to $220 million on a pretax basis, down from $680 million in the fourth quarter of 2003.

Overall, Countrywide's loan servicing income fell by $255 million in the fourth quarter as a flattening of the yield curve, a tightening of mortgage-swap spreads and a reduction in interest rate volatility combined to reduce the value of hedge instruments without producing a corresponding increase in the value of its MSR portfolio.

Stanford Kurland, president and chief operating officer of CFC, said in a conference call with investors and analysts the company does not plan to change its hedging strategy, and he urged investors to look at the long-term performance of Countrywide's hedging strategy. One problem with quarterly financial statements is that they give investors a snapshot of hedges and MSR values at the end of the quarter, rather than averaging out performance over the quarter or giving investors a longer-term view into hedging reliability.

What was unique in this quarter for Countrywide was that despite increases in rates affecting Treasuries, mortgage rates were relatively unchanged. The tightening of mortgage rates to Treasury rates "plays a little bit of havoc with the valuation of the MSR asset," Mr. Kurland said.

The economic conditions that unfolded in the fourth quarter led to less recovery in MSR values than the company's models would have predicted, he acknowledged.