Lender’s Value Doesn’t Always Follow Performance

Countrywide Credit Industries enjoyed a dramatic turnaround on Wall Street in 2000, with its stock price gaining 99% to become one of the year’s top performers among San Fernando Valley public companies.

The performance is all the stronger considering the Calabasas-based home mortgage lender finished 1999 as one of the worst performers among local public companies.

Countrywide’s stock finished 2000 at $50.25 for the year, after ending 1999 at $25.25 (a 50% loss for that year).

The stock gyrations are in contrast to the company’s steady financial performance. Revenues for fiscal 2000, which ended Feb. 29, 2000, increased 2% to more than $2 million, up from $1.9 million for fiscal 1999, while net earnings increased 6% to $410.2 million.

Net income for the third quarter ended Nov. 30, 2000, was $95.4 million, a 5% increase over $91 million in the previous quarter but down 5% compared to earnings of $100.6 million for the quarter ended Nov. 30, 1999.

“You have to separate the performance of the company versus the performance of the stock. Very often, they get ‘delinked,’ ” said Angelo R. Mozilo, Countrywide’s chairman, president and chief executive. “The company has not had a losing quarter since 1982, and yet the stock has been volatile because of the perception of interest rate movements.”

Analysts say Countrywide’s stock, rather than reflecting earnings changes, was buffeted in 1999 by investor fears that rising interest rates would harm the mortgage business.

The stock was then boosted in 2000 by investors’ perception that falling interest rates would improve the performances of mortgage lenders.

Countrywide engages in two primary lines of business, lending on home mortgages and servicing both its own mortgages and those of other lenders. It is the biggest U.S. non-bank mortgage lender, with more than 550 offices in 47 states and Washington, D.C.

In general, the mortgage lending side of the business tends to do better when interest rates are falling and the servicing side does better when interest rates are rising, according to Mike McMahon, an analyst with Sandler O’Neill & Partners in Alameda.

Since mortgage lending represents a larger portion of Countrywide’s business than mortgage servicing, the company traditionally has tended to do better when interest rates are declining, McMahon said.

The lending side of the business tends to do better during rate declines because falling rates prompt homeowners to refinance their mortgages, generating lots of new loans for lenders, McMahon explained.

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Both McMahon and analyst Thomas O’Donnell of Salomon Smith Barney in New York said the stock declined in 1999 because investors believed the sizzling economy might result in higher interest rates that would cool Countrywide’s business. The share price was still languishing in the middle of 2000, prompting speculation that the company was a buyout target.

But Countrywide’s stock price climbed during the second half of 2000, McMahon said, because investors believed that declining mortgage rates--along with a slowing economy that could produce even lower rates--bode well for Countrywide’s business.

The benchmark Freddie Mac 30-year fixed rate mortgage dropped from 8.52% in May to 7.13% on Dec. 29 and “we might see a sub-7% mortgage in the near future,” McMahon noted.

Countrywide “has already benefited from lower interest rates” and stands to keep doing well if the economy continues to slow and mortgage rates keep falling, O’Donnell said.

Mozilo concurred, saying Countrywide enjoys “a boomlet in refinances” when interest rates drop.

“The business tends to boom during low-interest-rate environments as people begin refinancing out of the variable rate loans they went into when rates were rising, or attempt to get cash out of their homes through refinancing,” Mozilo explained.

By contrast, rising interest rates historically have had a negative effect on the performances of Countrywide and other mortgage lenders, McMahon said.

But he said Countrywide has demonstrated that it can maintain steady earnings during periods of rising interest rates. It does this in part by being “extremely efficient” and in part by diversifying into other lines of business related to mortgage lending, like loan closing services such as appraisals, credit reports, flood hazard determinations and title insurance.

McMahon and O’Donnell both said current economic conditions favor Countrywide because, with the economy slowing, interest rates are expected to continue declining.

There is a scenario in which falling rates can harm a mortgage lender, according to McMahon.

He explained that when rates fall, the resulting boom in refinancing means that many homeowners are paying off their loan with one lender and obtaining a new loan with a different lender. Any mortgage holder who pays off a loan and refinances with a different lender is one less loan to generate servicing income for Countrywide.

But McMahon doesn’t believe Countrywide has to worry about that scenario because the company originates three new loans for each loan it loses. Furthermore, McMahon said, Countrywide is increasing the number of loans it services for other lenders, which also helps boost servicing income.

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Countrywide’s sliding stock price prompted speculation in mid-2000 that it might be a buyout candidate, but that speculation subsided after the share price recovered.

But such talk is almost certain to surface again, McMahon said, because Countrywide “is at a competitive disadvantage” against huge national banks.

“Long-term, Countrywide will almost certainly end up being owned by a larger financial services company” McMahon said, although he said it’s possible the company could remain independent if it diversifies fast enough.

“Management would like to remain in control of its own future, but it can only do so if it keeps diversifying,” McMahon said. “It’s a race against the clock to see if the company can diversify fast enough to remain competitive.”

Countrywide’s “first responsibility is to the shareholders,” Mozilo said, but he said the company has other ways of remaining competitive without being acquired.

“Our whole makeup and our culture is to dominate this business, and we will continue to look for strategies to do that,” Mozilo said. Such strategies could involve partnerships or joint ventures, Mozilo said, like the company’s Global Home Loans joint venture in Europe with Barclay’s Bank, which “is becoming a dominant force in the United Kingdom.”