Original Source: FD (FAIR DISCLOSURE) WIRE
. Angelo Mozilo, Countrywide Financial Corporation., Chairman & CEO
. Keith McLaughlin, Countrywide Financial Corporation., CFO . Stan Kurland, Countrywide Financial Corporation., President & COO
CFC's 3Q total fundings were $92b, bringing the nine-month total to $268b, which included record purchase volumes of $52b for the quarter and $130b through nine-months. Banking remains the most profitable of the diversification segments. CFC's revised guidance for 2004 is a range of $3.75-4.00 per diluted share. Q&A Focus: Salary, production margins, capital markets, sub-prime space, and competition.
A. Key Data From Call 1. 3Q04 total fundings = $92b. 2. 3Q04 net earnings = $582m.
S1. Opening Comments (A.M.) 1. Operational and Earnings Highlights:
1. For 3Q, total fundings were $92b, bringing the nine-month
total to $268b, which included record purchase volumes of $52b
for the quarter and $130b through nine-months. 2. The volume of adjustable rate fundings was $56b for the quarter and $139b for the nine months. 3. Adjustable rate loans comprised 61% of the total volume in the quarter, and 52% YTD. 4. As of September 30, CFC's pipeline applications were at $51b. 5. CFC's total servicing portfolio reached $786b and bank assets were $34b. 6. Securities trading volume in the capital market segment were $795b for the quarter and $2.4t through the nine-month period. 7. Net earnings in the quarter were $582m down 47% from last year's record-breaking 3Q. 8. In 3Q of this year CFC's recorded MSR impairment expense net of hedge gains was $205m. 9. Last year's extraordinary 3Q results included $231m in MSR impairment recovery net of hedge losses. 1. This variance roughly half, accounts for the $518m decline in earnings vs. the same period last year. 10. For the nine months YTD net earnings approached $2b, up 9% for the first nine months of last year. 11. Earnings per diluted share were $0.94 down from last year's 3Q. 1. The first nine months diluted EPS of $3.19 were down 2% from the same period last year. 12. YTD, return on average equity was 29%, vs. 38% for the
comparable period last year. 2. Breakout of Earnings: 1. Mortgage banking pretax earnings declined 58% from 3Q of last
year while nine-month mortgage banking's earnings were up 2%.
2. 3Q diversification earnings rose 13% from last year's 3Q.
1. YTD, an increase of 36% over the same period last year. 3. Diversification accounted for 31% of consolidated earnings in
3Q and 28% YTD. 1. Both numbers up from the comparable period last year when mortgage-banking earnings hit record highs. 3. Mortgage Banking Sector: 1. Production pretax profits for the quarter were $633m down 55% from 3Q of last year. 1. This decline was primarily attributable to changing market conditions as the overall mortgage origination market now includes considerably less refinance volumes than it did a year ago. 2. Nine-month reduction earnings were down 31% from the same period last year. 3. Profitability on the servicing side also declined, posting a loss of $23m during the quarter vs. a gain in last year's 3Q. 4. A primary cause of a decline in longer-term interest rates during the quarter resulted in net MSR impairment expense. 5. For the nine month period, pretax servicing earnings improved by nearly $1.2b from the comparable period last year when prepayment fees were considerably higher. 4. Key Business Lines: 1. The interest rate environment during the quarter featured a sharp rally in the ten-year treasury bonds. 2. Over the course of the quarter, the ten-year yield fell 48 bp to close at 4.14%. 3. The decrease in rates created MSR impairment net of hedge gains of $205m resulted in a servicing segment loss in the quarter. 1. Normally, a rate movement such as this might be expected to trigger a corresponding surge in production profitability. 4. In 3Q, CFC did indeed see strong funding levels and an increase in quarter-end pipeline, margins declined however, largely as a result of a product mix-shift towards adjustable rate loans and a generally more competitive environment.
5. 3Q Highlights: 1. The pipeline of applications in process rose 8% to $51b. 2. Based on public disclosures, it appears that CFC has widened its market share lead as the Number 1originator in 3Q. 3. The servicing portfolio increased by nearly $60b. 4. The MSR capitalization rate was reduced 12 bp to 114 bp. 5. The MSR impairment reserve increased from $778m to $1.2b. 6. As the market conditions continues to transition from refinance boom conditions to a more normal environment, CFC's servicing portfolio is likely to become increasingly prominent in its earnings mix. 7. CFC has increased the size of its portfolio while reducing its MSR capitalization rate and its weighted average coupon. 1. These three metrics provide an indication of the long-term
earnings potential of this asset. 6. Performance of the Diversification Segments: 1. Banking remains the most profitable of these segments.
2. Pretax banking earnings for the quarter were $163m, up 93%
over 3Q03. 3. For the nine-months YTD banking earnings were up 99% over the same period last year. 4. Bank growth is the vehicle for pursuing the Co.'s strategic objective of redirecting a portion of its current period gain on sale income into a stable, long-term stream of spread income. 5. Capital markets experienced a 33% decline in pretax earnings from 3Q of last year, the primary causes were: 1. A reduction in mortgage securities trading volume associated with a decrease in mortgage refinance volume. 2. A reduction in margins earned on the conduit and mortgage securities trading businesses. 3. Startup costs associated with the new business lines. 6. YTD, pretax earnings for capital markets were down 4% from the prior year's first nine months. 7. The insurance segment made a pretax contribution of $30m, down 3% from 3Q03. 8. During the quarter, the Co. incurred a $23m charge related to the Florida Hurricanes. 7. Banking Segment: 1. Total banking segment assets reached $37b at quarter end of
which $34b were on the balance sheet of Countrywide Bank and
the remainder were assets of Countrywide Warehouse Lending,
Inc. 2. Bank segment assets were up 96% from 3Q last year and 22% from the previous quarter. 3. Growth in the banking segment profitability has followed a similar trend with pretax profits reaching $163m. 4. CFC's previously stated goal for the bank is to grow total assets to $120b by 2008, and the Co. is currently evaluating opportunities to accelerate this growth.
5. CFC's strategy for its banking growth targets is to continue
leveraging the strengths of its mortgage banking operations
such as its asset generating capabilities, servicing related
escrow balances, intellectual capabilities, and physical
locations. 6. The bank now has 51 financial centers located within the CFC retail branch network. 8. Bank Loan Portfolio:
1. Growth in CFC's bank loan portfolio has been steady and its
composition has remained fairly constant. 2. At September 30, 63% of the portfolio consisted of first (Indiscernible) mortgages with a majority of the remainder comprised of prime home equity lines of credit. 3. The bank continues to focus on portfolio quality as the average FICO is now 732 and the weighted average LTV stands at 80%. 9. Capital Market Segment: 1. CFC's capital market segment continues to transition from refi
boom conditions to a more normalized market. 2. Segment pretax earnings for 3Q were $90m, unchanged from the last quarter and down 33% from last year's 3Q where mortgage market volume was considerably higher. 3. A major highlight of 3Q for the capital market segment was a record underwriting revenue of $95m, up 45% from the last quarter and 119% from 3Q03. 4. Countrywide Securities Corporation underwrote and distributed $32b in mortgage-backed and asset-backed securities during the quarter, with CFC acting as a lead manager on 44 transactions and a co-lead on an additional 17 transactions. 5. Other highlights included progress in two newer business lines. 6. During the quarter CFC's commercial real estate operations funded its first loans and CFC established a Tokyo branch with license approval expected early next year.
7. Trading and conduit revenues on the other hand declined in the
face of changing market conditions. 8. Less robust conditions in the mortgage-related fixed income securities market reduced securities trading margins. 9. Securities trading revenues declined 50% from 2Q and 73% from last year's 3Q. 10. Declining volume and increased competition reduced the margins on conduit activity, with conduit revenues down 30% sequentially and 46% from last year's 3Q. 11. Looking ahead, overall mortgage market activity will remain a key driver of capital market profitability, but growth in newer business lines, the US treasuries and commercial real estate US treasury (Indiscernible) dealer and a commercial
real estate business is expected to diversify and increase
revenue opportunities going forward. 10. 2004 Guidance: 1. CFC is revising its EPS guidance for 2004. 2. The new guidance is a range of $3.75-4.00 per diluted share. 3. The revised guidance reflects CFC's actual performance through three quarters as well as its 4Q outlook. 4. Key assumptions of the guidance include the ten-year treasury yield at year-end will fall within 4.0-4.5% range and reflects the Co.'s expectations for continued production pressure, production margin pressure, and higher amortization resulting from the low interest rate environment as of September 30. 5. The Co. plans to provide 2005 earnings guidance via a press
release on 11/03/2004. 6. In addition, CFC plans to host an investor forum on November 3 at Calabasas head quarters at which time it will provide further color on its 2005 guidance.
7. Risk factors which could affect the accuracy of these forecasts are: 1. The level of interest rates, which potentially could vary substantially during the quarter. 2. Volatility of interest rates which can cause a difference in the period in which different rate sensitive elements of the Co.'s financials are recognized.
3. Price competition in the production markets can also be a
significant factor, driving market share or margins or both. 11. Historical Performance: 1. The low-end of the range $3.75 represents a 48% compounded annual growth rate since the beginning of the decade.
QUESTION AND ANSWER SUMMARY
Q1. On the salary side of things, it took a surprising jump in the quarter on a sequential basis even though revenues were down, and I think you mentioned briefly in the press release that there was build out going on with your -- going after the purchase business and so forth. Can you give us some more color on what's going on there? Because I'm wondering if this is a run rate or if this is something you had some one-time costs fixed in this quarter? (Michael Vinciquerra - Raymond James)
A. (Angelo Mozilo) The aspect of the investment in intellectual assets is correct. We recruited a substantial number of sales people in our quest to meet our stated goals for 2008 of 30% market shares. That requires an investment in people that takes two forms, one, people we bring aboard and they're producing loans, we pay commissions. But secondly, the acquisition of pipelines where people are coming aboard with their pipeline, and we actually acquire those, that's included in the expenses, and that amounts to the $146m of the $172m. We -- the bank, again, continue to grow the branch system at a $20m increase in bank. And in the capital markets $12m increase, a lot has to do with the establishment of the treasury desk and all of the technology related to the treasury desk.
Q2. Are these, some of these ongoing costs or it sounds like some of these would be considered, kind of one-time in nature, we might see. (Michael Vinciquerra - Raymond James)
A. (Angelo Mozilo) I would say certainly that the capital markets and the bank, although the bank is growing, so you're going to have increased expenses. I think the focus should be on the revenue side, and this should generate the revenues to maintain our ROE, which I think was about 38% this quarter, which is extraordinarily high, and so, I've to look at both sides of the equation. We continue to invest in people, continue to invest in technology, and it's not smooth as you're making these investments. They come in spurts. So, I think that every dollar spent here and the increase in expenses is one that's invested for future earnings, and future higher returns.
Q3. On production margins, what did you sell during the quarter in the sub-prime and prime space, sub-prime and home equity sectors, and what were the gains on sales margins, gain on sales dollars and margins for each of those businesses? Why don't you give a broad comment as well on the state of the competitive environment? (Bob Napoli - U.S. Bancorp Piper Jaffray, Inc.)
A. (Angelo Mozilo) These things, as I said, are not -- the flow of business is generally not smooth. The action of competition's changing market is not smooth. The margins certainly have been compressed; we'll go over that with you. But again, still very rational, based upon what we experienced back in '95 and again, I think, in '97. So, these margins have been reduced as a result of keener competition, less volume, less of a pie, less to go around, and therefore, you kind of get some margin pressures. But at this point, certainly off with their highs. I mean, comparing with the last year, when nobody had capacity except CFC, we had enormous pricing power, and was unsustainable pricing power last year, and now we're getting it to more normalized environment, that's my general comment.
A. (Keith McLaughlin) In terms of the numbers, we sold approx., $85b this quarter. $66b of that were prime mortgages, about $9.9b were home equity loans and fixed rate seconds, and about $9.1b of sub-prime mortgages.
Q4. For the home equity and sub-prime? (Bob Napoli - U.S. Bancorp Piper Jaffray, Inc.)
A. (Keith McLaughlin) $9.9b was home equity and fixed rate seconds, and another $9.1b was sub-prime.
Q5. Those are the amounts sold, what was the gain on sale? (Bob Napoli - U.S. Bancorp Piper Jaffray, Inc.)
A. (Keith McLaughlin) The net of gains was $540m for the prime mortgages, $266m for sub-prime, and $290m for the home equity and fixed rate seconds.
Q6. So looks like you still had -- pretty decent gain on sales margin in the sub-prime sector, is that right, 2.9%. (Bob Napoli - U.S. Bancorp Piper Jaffray, Inc.)
A. (Keith McLaughlin) That's right.
Q7. I guess, on the expense side, just following up on that -- you have been hiring employees, but under the mode of on a commission-only basis. So, therefore, one would generally expect that for the most part, the expenses would still track the originations, and in this quarter the expenses were significantly -- the expenses went up significantly while the originations came down, how much of that -- is that still the strategy that you're hiring variable -- you're putting on variable cost personnel? Is that still the case, and should we no longer expect -- should we expect expenses to track with originations? (Bob Napoli - U.S. Bancorp Piper Jaffray, Inc.)
A. (Angelo Mozilo) First of all, no. As I told you before, this is not smooth. Rates go down, suddenly we have tremendous amount of closings, rates go down, we have an increase in our pipeline, takes 40, 30-45 days to close, so you don't have closing exactly commensurate with the movement of interest rates. Secondly there are, even though it's a commission on the people, I think it's easy to understand, should be that these employees are not contractors, …