For the transition period from _______________________ to __________________________
Commission File Number: 1-8422
COUNTRYWIDE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
|
DELAWARE (State or other jurisdiction of incorporation or organization |
13-2641992 (IRS Employer Identification No.) |
|
4500 Park Granada, Calabasas California (Address of principal executive offices) |
91302 (Zip Code) |
(818) 225-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
| Yes X | No |
Indicate by check mark whether the registrant is an accelerated filer (as denifed in Rule 12b-2 of the Exchange Act).
| Yes X | No |
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
|
Class Common Stock $.05 par value |
Outstanding at August 12, 2003 135,990,419 |
(Unaudited)
June 30, December 31,
2003 2002
----------------------- ------------------------
A S S E T S
Cash $ 707,228 $ 697,457
Mortgage loans and mortgage-backed securities held for sale 35,719,076 15,025,617
Trading securities owned, at market value 5,509,904 5,983,841
Trading securities pledged as collateral, at market value 4,794,250 2,708,879
Securities purchased under agreements to resell 7,477,648 5,997,368
Loans held for investment, net 12,162,402 6,070,426
Investments in other financial instruments 14,141,818 10,901,915
Mortgage servicing rights, net 4,654,664 5,384,933
Property, equipment and leasehold improvements, net 656,282 576,688
Other assets 5,962,294 4,683,659
----------------------- ------------------------
Total assets $ 91,785,566 $ 58,030,783
======================= ========================
Borrower and investor custodial accounts
(segregated in special accounts - excluded from corporate assets) $ 22,277,857 $ 16,859,667
======================= ========================
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable $ 35,002,545 $ 19,293,788
Securities sold under agreements to repurchase 28,778,720 22,634,839
Bank deposit liabilities 8,050,772 3,114,271
Accounts payable and accrued liabilities 10,256,519 5,342,442
Income taxes payable 2,301,714 1,984,310
----------------------- ------------------------
Total liabilities 84,390,270 52,369,650
Commitments and contingencies - -
Company-obligated mandatorily redeemable capital trust pass-through
securities of subsidiary trusts holding solely Company guaranteed
related subordinated debt 1,000,000 500,000
Shareholders' equity
Preferred stock - authorized, 1,500,000 shares of $0.05 par value; none
issued and outstanding - -
Common stock - authorized, 240,000,000 shares of $0.05 par value; issued
and outstanding, 135,082,762 shares and 126,563,333 shares at
June 30, 2003 and December 31, 2002, respectively 6,754 6,330
Additional paid-in capital 2,124,062 1,657,144
Accumulated other comprehensive income 277,787 186,799
Retained earnings 3,986,693 3,310,860
----------------------- ------------------------
Total shareholders' equity 6,395,296 5,161,133
----------------------- ------------------------
Total liabilities and shareholders' equity $ 91,785,566 $ 58,030,783
======================= ========================
Borrower and investor custodial accounts $ 22,277,857 $ 16,859,667
======================= ========================
The accompanying notes are an integral part of these statements.
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------- ----------------------------------
2003 2002 2003 2002
---------------- ---------------- ---------------- ----------------
Revenues
Gain on sale of loans and securities $ 1,825,638 $ 619,533 $ 3,269,642 $ 1,276,159
Interest income 805,167 527,434 1,447,289 1,042,356
Interest expense (509,127) (341,994) (923,256) (659,606)
---------------- ---------------- ---------------- ----------------
Net interest income 296,040 185,440 524,033 382,750
Loan servicing fees and other income from
retained interests 692,910 461,406 1,296,169 930,318
Amortization of mortgage servicing rights (557,274) (244,259) (919,774) (501,990)
Impairment of retained interests (1,551,847) (697,227) (2,214,260) (710,899)
Servicing hedge gains 748,081 462,409 754,442 131,974
---------------- ---------------- ---------------- ----------------
Net loan servicing fees and other income from
retained interests (668,130) (17,671) (1,083,423) (150,597)
Net insurance premiums earned 168,183 133,728 339,319 250,048
Commissions and other income 128,496 77,292 242,454 153,714
---------------- ---------------- ---------------- ----------------
Total revenues 1,750,227 998,322 3,292,025 1,912,074
Expenses
Compensation expenses 747,868 410,720 1,402,990 802,149
Occupancy and other office expenses 142,793 96,071 270,335 190,518
Insurance claim expenses 85,851 59,922 173,949 111,179
Marketing expenses 25,461 23,885 46,791 42,018
Other operating expenses 126,932 102,450 252,070 194,842
---------------- ---------------- ---------------- ----------------
Total expenses 1,128,905 693,048 2,146,135 1,340,706
---------------- ---------------- ---------------- ----------------
Earnings before income taxes 621,322 305,274 1,145,890 571,368
Provision for income taxes 238,461 114,418 436,738 212,953
---------------- ---------------- ---------------- ----------------
NET EARNINGS $ 382,861 $ 190,856 $ 709,152 $ 358,415
================ ================ ================ ================
Earnings per share
Basic $2.89 $1.54 $5.45 $2.90
Diluted $2.74 $1.48 $5.19 $2.80
The accompanying notes are an integral part of these statements.
Accumulated
Additional Other
Number Common Paid-in- Comprehensive Retained
of Shares Stock Capital Income Earnings Total
-------------- ---------- ---------------- ------------------ --------------- ---------------
Balance at December 31, 2002 126,563,333 $ 6,330 $ 1,657,144 $ 186,799 $ 3,310,860 $ 5,161,133
Cash dividends paid - $0.25 per
common share - - - - (33,319) (33,319)
Stock options exercised 3,343,829 167 104,906 - - 105,073
Tax benefit of stock options
exercised - - 41,435 - - 41,435
Issuance of common stock 4,973,843 247 309,548 - - 309,795
Contribution of common stock to
defined contribution employee
savings plan 201,757 10 11,029 - - 11,039
Other comprehensive income, net
of tax - - - 90,988 - 90,988
Net earnings for the period - - - - 709,152 709,152
-------------- ---------- ---------------- ------------------ --------------- ---------------
Balance at June 30, 2003 135,082,762 $ 6,754 $ 2,124,062 $ 277,787 $ 3,986,693 $ 6,395,296
============== ========== ================ ================== =============== ===============
The accompanying notes are an integral part of these statements.
Six Months Ended June 30,
------------------------------------
2003 2002
----------------- ------------------
Cash flows from operating activities:
Net earnings $ 709,152 $ 358,415
Adjustments to reconcile net earnings to net cash (used) provided by operating
activities:
Gain on sale of available-for-sale securities (111,166) (99,322)
Amortization and impairment of mortgage servicing rights 3,014,203 1,162,717
Impairment of other retained interests 119,831 50,172
Contribution of common stock to 401(k) Plan 11,039 7,533
Depreciation and other amortization 52,244 39,629
Deferred income taxes payable 304,232 (36,638)
Origination and purchase of loans held for sale (226,965,308) (86,005,981)
Principal repayments and sale of loans 206,271,849 87,905,660
----------------- ------------------
(Increase) decrease in mortgage loans and mortgage-backed securities held for (20,693,459) 1,899,679
sale
Increase in trading securities (1,611,434) (3,981)
Increase in securities purchased under agreements to resell (1,480,280) (369,365)
Decrease in other financial instruments 3,755,095 422,361
(Increase) decrease in other assets (1,292,775) 227,155
Increase in accounts payable and accrued liabilities 4,914,077 184,679
----------------- ------------------
Net cash (used) provided by operating activities (12,309,241) 3,843,034
----------------- ------------------
Cash flows from investing activities:
Additions to mortgage servicing rights (3,118,050) (1,503,986)
Additions to available-for-sale securities (7,256,190) (10,468,353)
Proceeds from sale of available-for-sale securities 920,470 4,836,606
Proceeds from the sale of securitized mortgage servicing rights 311,768 326,684
Additions to loans held for investment, net (6,091,976) (356,285)
Purchase of property, equipment and leasehold improvements, net (117,698) (84,735)
----------------- ------------------
Net cash used by investing activities (15,351,676) (7,250,069)
----------------- ------------------
Cash flows from financing activities:
Net increase in short-term borrowings 18,819,190 1,308,107
Issuance of long-term debt 6,323,483 3,291,187
Repayment of long-term debt (3,290,035) (2,488,300)
Net increase in bank deposit liabilities 4,936,501 1,786,995
Issuance of Company obligated manditorily redeemable capital trust pass-through 500,000 -
securities
Issuance of common stock 414,868 67,518
Payment of dividends (33,319) (28,021)
----------------- ------------------
Net cash provided by financing activities 27,670,688 3,937,486
----------------- ------------------
Net increase in cash 9,771 530,451
Cash at beginning of period 697,457 495,414
----------------- ------------------
Cash at end of period $ 707,228 $ 1,025,865
================= ==================
Supplemental cash flow information:
Cash used to pay interest $ 852,113 $ 634,667
Cash used to pay income taxes $ 131,744 $ 258,759
Non-cash investing and financing activities:
Unrealized gain on available-for-sale securities, net of tax $ 90,988 $ 134,210
Contribution of common stock to 401(k) Plan $ 11,039 $ 7,533
Securitization of mortgage servicing rights $ 834,116 $ 333,837
The accompanying notes are an integral part of these statements.
Three Months Ended Six Months Ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
--------------------------------- ----------------------------------
NET EARNINGS $ 382,861 $ 190,856 $ 709,152 $ 358,415
Other comprehensive income, net of tax:
Unrealized gains on available for sale
securities:
Unrealized holding gains arising
during the period, before tax 74,315 397,947 149,669 276,145
Income tax expense (28,134) (149,718) (56,544) (104,302)
---------------- --------------- ---------------- ----------------
Unrealized holding gains arising
during the period, net of tax 46,181 248,229 93,125 171,843
Less: reclassification adjustment for gains
included in net earnings, before tax (36,764) (95,877) (3,434) (60,475)
Income tax expense 13,863 36,042 1,297 22,842
---------------- --------------- ---------------- ----------------
Reclassification adjustment for gains
included in net earnings, net of tax (22,901) (59,835) (2,137) (37,633)
---------------- --------------- ---------------- ----------------
Other comprehensive income 23,280 188,394 90,988 134,210
---------------- --------------- ---------------- ----------------
COMPREHENSIVE INCOME $ 406,141 $ 379,250 $ 800,140 $ 492,625
================ =============== ================ ================
The accompanying notes are an integral part of these statements.
NOTE 1 –
BASIS OF PRESENTATION
The accompanying
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and notes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the six months ended June 30, 2003 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2003. For further information, refer to the consolidated financial statements
and notes thereto included in the Annual Report on Form 10-K for the year ended
December 31, 2002 for Countrywide Financial Corporation (the
“Company”).
Certain amounts reflected in the consolidated financial statements for the three and six month periods ended June 30, 2002 have been reclassified to conform to the presentation for the three and six months ended June 30, 2003.
NOTE 2 –
EARNINGS PER SHARE
Basic earnings per share is
determined using net earnings divided by the weighted-average shares outstanding
during the period. Diluted earnings per share is computed by dividing net
earnings by the weighted-average shares outstanding, assuming all potential
dilutive common shares were issued.
The following table summarizes the basic and diluted earnings per share calculations for the quarter and six month periods ended June 30, 2003 and 2002:
Quarter Ended June 30,
-----------------------------------------------------------------------------------------
2003 2002
-------------------------------------------- --------------------------------------------
(Amounts in thousands, except Per-Share Per-Share
per share data) Net Earnings Shares Amount Net Earnings Shares Amount
------------- -------------- ------------- -------------
- ---------------------------------- ------------- --------------
Net earnings $382,861 $190,856
============= ==============
Basic EPS
Net earnings available to common
shareholders $382,861 132,516 $2.89 $190,856 124,029 $1.54
Effect of dilutive stock options - 7,371 - 5,279
------------- ------------- -------------- -------------
Diluted EPS
Net earnings available to common
shareholders $382,861 139,887 $2.74 $190,856 129,308 $1.48
============= ============= ============== =============
Six Months Ended June 30,
-----------------------------------------------------------------------------------------
2003 2002
-------------------------------------------- --------------------------------------------
(Amounts in thousands, except Per-Share Per-Share
per share data) Net Earnings Shares Amount Net Earnings Shares Amount
------------- -------------- ------------- -------------
- ---------------------------------- ------------- --------------
Net earnings $709,152 $358,415
============= ==============
Basic EPS
Net earnings available to common
shareholders $709,152 130,145 $5.45 $358,415 123,461 $2.90
Effect of dilutive stock options - 6,569 - 4,638
------------- ------------- -------------- -------------
Diluted EPS
Net earnings available to common
shareholders $709,152 136,714 $5.19 $358,415 128,099 $2.80
============= ============= ============== =============
Stock-Based Compensation
The Company generally grants stock options to employees for a fixed number of shares with an exercise price equal to the fair value of the shares at the date of grant. The Company recognizes compensation expense related to its stock option plans only to the extent that the fair value of the shares at the grant date exceeds the exercise price.
Had the estimated fair value of the options granted been included in compensation expense, the Company’s net earnings and earnings per share would have been as follows:
Quarter Ended June 30, Six Months Ended June 30,
--------------------------------- ---------------------------------
(Dollar amounts in thousands except per share 2003 2002 2003 2002
data)
- -------------------------------------------------- --------------- ----------------- ----------------- ---------------
Net Earnings
As reported $382,861 $190,856 $709,152 $358,415
Deduct:
Total stock-based employee compensation $7,246 $6,650 $12,240 $12,524
Pro forma $375,615 $184,206 $696,912 $345,891
Basic Earnings Per Share
As reported $2.89 $1.54 $5.45 $2.90
Pro forma $2.83 $1.49 $5.35 $2.80
Diluted Earnings Per Share
As reported $2.74 $1.48 $5.19 $2.80
Pro forma $2.69 $1.42 $5.10 $2.70
The fair value of each option grant is estimated as of the date of grant using the Black-Scholes option-pricing model that has been modified to consider cash dividends to be paid. To determine periodic compensation expense for purposes of this pro forma disclosure, the fair value of each option grant is amortized over the option’s vesting period. The weighted-average assumptions used to value the option grants and the resulting average estimated values were as follows:
Quarter Ended June 30, Six Months Ended June 30,
---------------- ------------------ ------------- -----------------
2003 2002 2003 2002
- ---------------------------------------- ---------------- ------------------ ------------- -----------------
Weighted Average Assumptions:
Dividend yield 0.79% 0.97% 0.80% 1.00%
Expected volatility 33% 33% 33% 33%
Risk-free interest rate 2.27% 4.06% 2.27% 4.05%
Annual expected life (in years) 4.37 4.16 4.35 4.16
Fair value of options $18.15 $14.46 $17.79 $12.11
NOTE 3 –
MORTGAGE SERVICING RIGHTS
The activity in mortgage
servicing rights (“MSRs”) for the six months ended June 30, 2003 and
2002 is as follows:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------------------- ------------------------ -----------------------
Mortgage Servicing Rights
Balance at beginning of period $ 7,420,946 $ 7,051,562
Additions 3,118,050 1,503,986
Securitization of MSRs (834,116) (359,647)
Amortization (919,774) (501,990)
Application of valuation allowance to write down permanently
impaired MSRs (1,801,277) (335,924)
------------------------ -----------------------
Balance before valuation allowance at end of period 6,983,829 7,357,987
------------------------ -----------------------
Valuation Allowance for Impairment of Mortgage Servicing Rights
Balance at beginning of period (2,036,013) (935,480)
Additions (2,094,429) (660,727)
Application of valuation allowance to write down permanently
impaired MSRs 1,801,277 335,924
Application of valuation allowance to securitization of MSRs - 25,810
------------------------ -----------------------
Balance at end of period (2,329,165) (1,234,473)
------------------------ -----------------------
Mortgage Servicing Rights, net $ 4,654,664 $ 6,123,514
The following table summarizes the Company’s estimate of amortization of the existing MSR asset for the five-year period ending June 30, 2008. This projection was developed using the assumptions made by management in its June 30, 2003 valuation of MSRs. The assumptions underlying the following estimate will change as market conditions and portfolio composition and behavior change, causing both actual and projected amortization levels to change over time. Therefore, the following estimates will change in a manner and amount not presently determinable by management.
(Dollar amounts in thousands)
Estimated MSR Amortization
Year ended June 30,
- ------------------------------------------------------ -----------------------------
2004 $ 2,214,644
2005 1,484,288
2006 1,048,808
2007 741,653
2008 529,179
-----------------------------
Five year total $ 6,018,572
=============================
NOTE 4 –
TRADING SECURITIES
Trading securities, which consist
of trading securities owned and trading securities pledged as collateral, at
June 30, 2003 and December 31, 2002 include the following:
(Dollar amounts in thousands) June 30, 2003 December 31, 2002
- ------------------------------------------------------ ----------------------- ------------------------
Mortgage pass-through securities:
Fixed-rate $ 7,591,054 $ 6,948,203
Adjustable-rate 503,720 446,770
8,094,774 7,394,973
Collateralized mortgage obligations 1,558,849 959,881
Agency debentures 438,950 266,699
Other 211,581 71,167
----------------------- ------------------------
$ 10,304,154 $ 8,692,720
======================= ========================
As of June 30, 2003, $9.3 billion of the Company’s trading securities had been pledged as collateral for financing purposes, of which the counterparty has the contractual right to sell or re-pledge $4.8 billion.
NOTE 5 –
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL
As of June 30, 2003, the
Company had accepted collateral with a fair value of $7.6 billion for which it
had the contractual ability to sell or re-pledge. As of June 30, 2003, the
Company had re-pledged $6.9 billion of such collateral for financing purposes.
As of December 31, 2002, the Company had accepted collateral with a fair value of $5.9 billion for which it had the contractual ability to sell or re-pledge. As of December 31, 2002, the Company had re-pledged $5.7 billion of such collateral for financing purposes.
NOTE 6 –
LOANS HELD FOR INVESTMENT
Loans held for investment as
of June 30, 2003 and December 31, 2002 include the following:
(Dollar amounts in thousands) June 30, December 31, 2002
2003
- ------------------------------------------------------------- -- ------------------ ------------------
Mortgage loans $ 8,162,415 $ 2,245,419
Warehouse lending advances secured by mortgage loans 3,098,269 2,159,289
Defaulted FHA-insured and VA-guaranteed loans repurchased
from securities 949,898 1,707,767
------------------ ------------------
12,210,582 6,112,475
Allowance for loan losses (48,180) (42,049)
------------------ ------------------
$ 12,162,402 $ 6,070,426
================== ==================
At June 30, 2003, mortgage loans held for investment totaling $3.4 billion and $2.6 billion were pledged to secure securities sold under agreements to repurchase and Federal Home Loan advances, respectively.
At June 30, 2003, the Company had accepted mortgage loan collateral with a fair value of $3.7 billion securing warehouse lending advances for which it had the contractual ability to sell or re-pledge. As of June 30, 2003, no such mortgage loan collateral had been re-pledged.
NOTE 7 –
INVESTMENTS IN OTHER FINANCIAL INSTRUMENTS
Investments in other
financial instruments at June 30, 2003 and December 31, 2002 include the
following:
(Dollar amounts in thousands) June 30, 2003 December 31, 2002
- ------------------------------------------------------------------ ------------------------ ------------------------
Home equity AAA asset-backed securities $ 6,069,212 $ 3,470,858
Servicing hedge instruments:
Derivative instruments 783,701 1,592,550
Principal-only securities 244,777 779,125
------------------------ ------------------------
Total servicing hedge instruments 1,028,478 2,371,675
Securitized excess servicing fees 449,847 -
Other interests retained in securitization:
Prime home equity residual securities 454,115 437,060
Subprime AAA interest-only securities 451,207 522,985
Subprime residual securities 324,728 71,251
Prime home equity line of credit transferor's interest 266,781 233,658
Nonconforming interest-only and principal-only securities 136,609 150,967
Prime home equity interest-only securities 60,277 109,438
Other 76,985 78,241
------------------------ ------------------------
Total other interests retained in securitization 1,770,702 1,603,600
Insurance and banking investment portfolios:
Mortgage-backed securities 4,605,751 3,204,737
U.S. Treasury securities and obligations of U.S. Government
corporations and agencies 214,668 247,470
Corporate securities 2,915 3,171
Other 245 404
------------------------ ------------------------
Investments in other financial instruments $ 14,141,818 $ 10,901,915
======================== ========================
All of the securities listed above are classified as available-for-sale, with the exception of securitized excess servicing fees, which are classified as trading securities, and the derivative instruments.
At June 30, 2003, the Company had pledged $6.1 billion of home equity AAA asset-backed securities to secure securities sold under agreements to repurchase, and $1.8 billion of mortgage-backed securities pledged to secure Federal Home Loan Bank advances.
Amortized cost and fair value of available-for-sale securities at June 30, 2003 and December 31, 2002 are as follows:
June 30, 2003
------------------------------------------------------------------------
(Dollar amounts in thousands) Amortized Gross Gross Fair
Unrealized Unrealized
Cost Gains Losses Value
- -------------------------------------------------- ---------------- ----------------- ---------------- -----------------
Home equity AAA asset-backed securities $ 5,861,496 $ 207,716 $ - $ 6,069,212
Other interests retained in securitization 1,597,245 173,457 - 1,770,702
Principal-only securities 213,183 31,594 - 244,777
Mortgage-backed securities 4,575,490 35,418 (5,157) 4,605,751
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies 205,250 9,418 - 214,668
Corporate securities 1,523 1,392 - 2,915
Other 240 5 - 245
---------------- ----------------- ---------------- -----------------
$12,454,427 $ 459,000 $ (5,157) $ 12,908,270
================ ================= ================ =================
December 31, 2002
------------------------------------------------------------------------
(Dollar amounts in thousands) Amortized Gross Gross Fair
Unrealized Unrealized
Cost Gains Losses Value
- -------------------------------------------------- ---------------- ----------------- ---------------- -----------------
Home equity AAA asset-backed securities $ 3,366,477 $ 104,381 $ - $ 3,470,858
Other interests retained in securitization 1,452,467 151,133 - 1,603,600
Principal-only securities 746,479 34,212 (1,566) 779,125
Mortgage-backed securities 3,179,332 25,414 (9) 3,204,737
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies 237,076 10,394 - 247,470
Corporate securities 1,873 1,439 (141) 3,171
Other 394 10 - 404
---------------- ----------------- ---------------- -----------------
$ 8,984,098 $ 326,983 $ (1,716) $ 9,309,365
================ ================= ================ =================
Gross gains and losses realized on the sales of available-for-sale securities are as follows:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ------------------------ -----------------------
Other interests retained in securitization:
Gross realized gains $ 21,081 $ 40,522
Gross realized losses (8,521) (63)
------------------------ -----------------------
Net 12,560 40,459
------------------------ -----------------------
U.S. Treasury securities and obligations of U.S
Government corporations and agencies:
Gross realized gains 1,123 2,238
Gross realized losses - (1,608)
------------------------ -----------------------
Net 1,123 630
------------------------ -----------------------
Principal-only securities:
Gross realized gains 91,981 103,214
Gross realized losses - (41,895)
------------------------ -----------------------
Net 91,981 61,319
------------------------ -----------------------
Mortgage-backed securities:
Gross realized gains 5,502 2,757
Gross realized losses - (262)
------------------------ -----------------------
Net 5,502 2,495
------------------------ -----------------------
Corporate securities:
Gross realized gains - 5,369
Gross realized losses - (10,950)
------------------------ -----------------------
Net - (5,581)
------------------------ -----------------------
Total gains and losses on available-for-sale
securities:
Gross realized gains 119,687 154,100
Gross realized losses (8,521) (54,778)
------------------------ -----------------------
Net $ 111,166 $ 99,322
======================== =======================
NOTE 8 –
OTHER ASSETS
Other assets as of June 30,
2003 and December 31, 2002 include the following:
(Dollar amounts in thousands) June 30, 2003 December 31, 2002
- ------------------------------------------------------ ----------------------- ------------------------
Securities broker-dealer receivables $ 2,999,392 $ 544,296
Reimbursable servicing advances 658,026 647,284
Derivative margin accounts 267,899 919,749
Receivables from sale of securities 228,318 1,452,513
Investment in Federal Reserve Bank and Federal Home
Loan Bank stock 213,860 67,820
Capitalized software, net 203,666 188,435
Interest receivable 201,155 141,148
Prepaid expenses 188,911 168,678
Federal funds sold 135,000 -
Other assets 866,067 553,736
----------------------- ------------------------
$ 5,962,294 $ 4,683,659
======================= ========================
At June 30, 2003, the Company had pledged $142.4 million of other assets to secure securities sold under agreements to repurchase.
NOTE 9 - NOTES PAYABLE
Notes payable as
of June 30, 2003 and December 31, 2002 consist of the following:
(Dollar amounts in thousands) June 30, 2003 December 31, 2002
- ------------------------------------------------------ ----------------------- ------------------------
Medium-term notes, various series:
Fixed-rate $ 13,146,215 $ 13,065,268
Floating-rate 4,148,125 3,695,624
----------------------- ------------------------
17,294,340 16,760,892
Asset-backed commercial paper 12,303,872 -
Federal Home Loan Bank advances 3,500,000 1,000,000
Unsecured commercial paper 1,368,000 123,207
Convertible debentures 512,635 510,084
Secured notes payable 23,698 21,553
Secured revolving credit facility - 878,052
----------------------- ------------------------
$ 35,002,545 $ 19,293,788
======================= ========================
Medium-Term
Notes
During the six months June
30, 2003, Countrywide Home Loans, Inc. (“CHL”), the Company’s
principal mortgage banking subsidiary, issued medium-term notes under shelf
registration statements or pursuant to its Euro medium-term note program as
follows:
Outstanding Balance Interest Rate Maturity Date
-------------------------------------------- ----------------------- -------------------------------
(Dollar amounts Floating Fixed
in thousands) Rate Rate Total From To From To
- ------------------ -------------- ------------- ------------- ---------- ----------- ---------------- --------------
Series K $ 880,000 $ 30,000 $ 910,000 1.53% 6.00% January 2004 January 2018
Series L $ 1,152,000 $1,025,000 $2,177,000 1.44% 6.00% April 2004 May 2023
Euro Notes $ 85,543 $ 592,650 $ 678,193 1.31% 2.37% March 2004 June 2006
As of June 30, 2003, $1,426.5 million foreign currency-denominated medium-term notes were outstanding. Such notes are denominated in Yen, Deutsche Marks, French Francs, Portuguese Escudos, and Eurodollars. The Company has executed currency swap transactions that have the effect of translating the foreign currency-denominated medium-term notes into borrowings denominated in United States Dollars.
During the six months ended June 30, 2003, CHL redeemed $3.3 billion of maturing medium-term notes.
Of the $2.1 billion of floating-rate medium term notes issued by the Company during the six months ended June 30, 2003, $1.1 billion were effectively converted to fixed-rate borrowing using interest rate swap contracts.
Of the $1.6 billion of fixed-rate medium term notes issued by the Company during the six months ended June 30, 2003, $140.5 million were effectively converted to floating-rate borrowings using interest rate swap contracts.
Asset-Backed
Commercial Paper
In April 2003, the Company
formed a wholly-owned special purpose entity for the purpose of issuing
short-term secured liquidity notes (“SLNs”) to finance certain of its
Mortgage Loan Inventory. The entity issues short-term notes with maturities of
up to 180 days, extendable to 300 days. The SLNs bear interest at rates indexed
to LIBOR. The SLN program’s capacity, based on aggregate commitments from
underlying credit enhancers, was $15.3 billion. The Company has pledged $12.6
billion in mortgage loans to secure the asset-backed commercial paper at June
30, 2003. At June 30, 2003, the weighted average interest rate was 1.22%.
Federal Home
Loan Bank Advances
During the six months ended
June 30, 2003, the Company increased its borrowings from the Federal Home Loan
Bank by $2.5 billion. The advances all bear interest at fixed rates ranging from
1.69% to 3.90% and have maturity dates ranging from January 2006 through 2010.
At June 30, 2003, the Company had pledged $1.7 billion in available-for-sale
securities and $2.6 billion in loans held for investment to secure the advances.
NOTE 10 –
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Company routinely
enters into short-term financing arrangements to sell securities under
agreements to repurchase. All securities underlying repurchase agreements are
held in safekeeping by broker-dealers or banks. All agreements are to repurchase
the same, or substantially identical, securities. At June 30, 2003, repurchase
agreements were secured by $5.1 billion of loans and MBS held for sale, $9.1
billion of trading securities, $5.1 billion of securities purchased under
agreements to resell, $6.6 billion in investments in other financial
instruments, $3.4 billion of loans held for investment, and $142.4 million of
other assets.
NOTE 11 –
COMPANY-OBLIGATED CAPITAL SECURITIES OF SUBSIDIARY TRUSTS
In April 2003, Countrywide
Capital IV, a subsidiary trust of the Company, issued $500 million of 6.75%
preferred securities, which are fully and unconditionally guaranteed by the
Company and CHL (the “6.75% Securities”). In connection with the
issuance by Countrywide Capital IV of the 6.75% Securities, the Company issued
to Countrywide Capital IV $500 million of its 6.75% Junior Subordinated
Debentures, which are fully and unconditionally guaranteed by CHL (the
“Subordinated Debentures”). Countrywide Capital IV exists for the sole
purpose of issuing the 6.75% Securities and investing the proceeds in the
Subordinated Debentures. The Subordinated Debentures are due on April 1, 2033,
with interest payable quarterly on January 1, April 1, July 1 and October 1 of
each year. The Company has the right to redeem, at 100% of their principal
amount plus accrued and unpaid interest to the date of redemption, the 6.75%
Securities at any time on or after April 11, 2008.
In relation to Countrywide Capital IV, the Company has the right to defer payment of interest on the Subordinated Debentures for up to 20 consecutive quarterly periods by extending the payment period. If interest payments on the Subordinated Debentures are so deferred, the Company may not, among other things, declare or pay dividends on, or make a distribution with respect to, or redeem, purchase or acquire, or make a liquidation payment with respect to, any of its capital stock.
NOTE 12 –
DERIVATIVE INSTRUMENTS AND RISK MANAGEMENT ACTIVITIES
The primary market risk
facing the Company is interest rate risk. From an enterprise perspective, the
Company manages this risk through the natural counterbalance of its loan
production and servicing businesses. In addition, the Company utilizes various
financial instruments, including derivatives, to manage the interest rate risk
related specifically to its committed pipeline, mortgage loan inventory and MBS
held for sale, MSRs, trading securities and other retained interests, as well as
a portion of its debt. The overall objective of the Company’s interest rate
risk management activities is to reduce the variability of reported earnings
caused by changes in interest rates.
The Company uses a variety of derivative financial instruments to manage interest rate risk. These instruments include MBS mandatory forward sale and purchase commitments, options to sell or buy MBS, Treasury and Eurodollar rate futures and options thereon, interest rate floors, interest rate caps, capped swaps, swaptions, and interest rate swaps. These instruments involve, to varying degrees, elements of interest rate and credit risk. The Company manages foreign currency exchange rate risk, which arises from the issuance of foreign currency-denominated debt, with foreign currency swaps.
The Company has interest rate risk relative to its Mortgage Loan Inventory and its interest rate lock commitments (“IRLCs”).
The Company’s loan production consists primarily of fixed-rate mortgages. Fixed-rate mortgages, like other fixed-rate debt instruments, are subject to a loss in value when market interest rates rise. The Company is exposed to such losses from the time an IRLC is made to an applicant (or financial intermediary) to the time the related mortgage loan is sold. To manage this risk of loss, the Company utilizes derivatives, primarily forward sales of MBS and options to buy and sell MBS, as well as options on Treasury futures contracts.
In general, the risk management activities connected with 80% or more of the fixed-rate Mortgage Inventory is accounted for as a “fair value” hedge. The Company recognized pre-tax gains of $1.8 million and $14.8 million, representing the ineffective portion of such fair value hedges of Mortgage Inventory, for the six months ended June 30, 2003 and 2002, respectively. These amounts, along with the change in the fair value of the derivative instruments that were not designated as hedge instruments under SFAS 133, are included in gain on sale of loans in the statement of earnings.
IRLCs are derivative instruments as defined by SFAS 133. As such, IRLCs are recorded at fair value with changes in fair value recognized in current period earnings (as a component of gain on sale of loans and securities). Because IRLCs are derivatives under SFAS 133, the risk management activities related to the IRLCs do not qualify for hedge accounting under SFAS 133. The “freestanding” derivative instruments that are used to manage the interest rate risk associated with the IRLCs are marked to fair value and recorded as a component of gain on sale of loans in the statement of earnings.
MSRs and other retained interests, specifically interest-only securities and residual securities, are generally subject to a loss in value, or impairment, when mortgage interest rates decline. To moderate the effect on earnings of impairment, the Company maintains a portfolio of financial instruments, including derivatives, which increase in aggregate value when interest rates decline. This portfolio of financial instruments is collectively referred to as the “Servicing Hedge.” During the six months ended June 30, 2003 and 2002, none of the derivative instruments included in the Servicing Hedge was designated as a hedge under SFAS 133. The change in fair value of these derivative instruments was recorded in current period earnings as a component of Servicing Hedge gains and losses.
The financial instruments that comprise the Servicing Hedge include options on interest rate futures and MBS, interest rate swaptions, interest rate floors, interest rate caps, interest rate swaps, and principal-only securities. With respect to the interest rate floors, options on interest rate futures and MBS, interest rate caps and swaptions, the Company is not exposed to loss beyond its initial outlay to acquire the hedge instruments plus any unrealized gains recognized to date. With respect to the interest rate swap contracts outstanding as of June 30, 2003, the Company estimates that its maximum exposure to loss over the various contractual terms is $234.0 million. The Company derives its estimates of loss exposure based upon observed volatilities in the interest rate options market. Using the currently observed volatilities, management estimates, to a 95% confidence level, the maximum potential rate changes over a one-year time horizon. Management then estimates its exposure to loss based on the estimated maximum adverse rate change as of the measurement date.
The Company enters into interest rate swap contracts which enable it to convert a portion of its fixed-rate, long-term debt to U.S. dollar LIBOR-based floating-rate debt and to enable the Company to convert a portion of its foreign currency-denominated fixed-rate, long-term debt to U.S. dollar LIBOR-based floating-rate debt. These transactions are designed as “fair value” hedges under SFAS 133. For the six months ended June 30, 2003, the Company recognized pre-tax losses of $0.1 million, representing the ineffective portion of such fair value hedges of debt. For the six months ended June 30, 2002, the Company recognized pre-tax gains of $4.6 million, representing the ineffective portion of such fair value hedges of debt. These amounts are included in interest charges in the statements of earnings.
In addition, the Company enters into interest rate swap contracts which enable it to convert a portion of its floating-rate, long-term debt to fixed-rate, long-term debt and to convert a portion of its foreign currency-denominated, fixed-rate, long-term debt to U.S. dollar fixed-rate debt. These transactions are designed as “cash flow” hedges under SFAS 133. For the six months ended June 30, 2003 and 2002, the Company recognized pre-tax losses of $0.1 million and $0.6 million, respectively, representing the ineffective portion of such cash flow hedges. As of June 30, 2003, deferred net gains or losses on derivative instruments included in other comprehensive income that are expected to be reclassified as earnings during the next 12 months are not material.
In connection with its broker-dealer activities, the Company maintains a trading portfolio of fixed income securities, primarily MBS. The Company is exposed to price changes in its trading portfolio arising from interest rate changes during the period it holds the securities. To manage this risk, the Company utilizes derivative financial instruments. These instruments include MBS mandatory forward sale and purchase commitments as well as short sales of cash market U.S. Treasury securities, futures contracts, interest rate swap contracts, and swaptions. All such derivatives are accounted for as “free-standing” and as such are carried at fair value with changes in fair value recorded in current period earnings as a component of gain on sale of loans and securities.
NOTE 13 –
SEGMENTS AND RELATED INFORMATION
The Company has five business segments. They include Mortgage Banking, Insurance, Capital Markets, Global Operations, and
Banking.
The Mortgage Banking segment is comprised of three distinct sectors: Loan Production, Loan Servicing, and Loan Closing Services.
The Loan Production sector of the Mortgage Banking segment originates prime and subprime mortgage loans through a variety of channels on a national scale. Through the Company’s retail branch network, which consists of the Consumer Markets Division and Full Spectrum Lending, Inc., the Company sources mortgage loans directly from consumers, as well as through real estate agents and home builders. The Wholesale Lending Division sources mortgage loans primarily from mortgage brokers. The Correspondent Lending Division acquires mortgage loans from other financial institutions. The Loan Servicing sector of the Mortgage Banking segment includes investments in MSRs and other retained interests, as well as the underlying servicing operations and subservicing for other domestic financial institutions. The Closing Services sector of the Mortgage Banking segment is comprised of the LandSafe companies, which provide credit reports, appraisals, title reports and flood determinations to the Company’s Loan Production sector as well as to third parties.
The Insurance segment activities include Balboa Life and Casualty Group, a national provider of property, life, and liability insurance; Balboa Reinsurance Company, a primary mortgage reinsurance company; and Countrywide Insurance Services, Inc., a national insurance agency offering a specialized menu of insurance products directly to consumers.
The Capital Markets segment primarily includes the operations of Countrywide Securities Corporation, a registered broker-dealer specializing in the mortgage securities market. In addition, it includes the operations of Countrywide Asset Management Corporation, Countrywide Servicing Exchange and CCM International Ltd.
The Global segment operations include those of Global Home Loans Limited, a provider of loan origination processing and servicing in the United Kingdom; UK Valuation Limited, a provider of property valuation services in the UK; Countrywide International Consulting Services, LLC, an international provider of mortgage services-related analytic and advisory services; and Countrywide International Technology Holdings Limited, a licensor of loan origination processing, servicing, and residential real estate value assessment technology.
The Banking segment’s operations are primarily comprised of Treasury Bank, National Association (“Treasury Bank” or the “Bank”), and of Countrywide Warehouse Lending. Treasury Bank invests primarily in mortgage loans sourced from the Loan Production sector. Countrywide Warehouse Lending provides mortgage inventory financing on a secured basis to third-party mortgage bankers.
Included in the tables below labeled “Other” are the holding company activities and certain reclassifications required to conform management reporting to the consolidated financial statements:
For the Quarter Ended June 30, 2003
- ------------------------------------------------------------------------------------------------------------------------------
Mortgage Banking Other Businesses
---------------------------------------- -------------------------------------------------------------
(Dollars are Loan Loan Closing Capital Global Grand
in thousands Production Servicing Services Total Insurance Markets Operations Banking Other Total Total
- ------------------------------------------------------------ -------------------------------------------------------------------- ----------
Revenues
External $1,970,484 $(735,021) $62,376 $1,297,839 $194,831 $ 134,348 $ 48,028 $95,301 $(20,120) $452,388 $1,750,227
Inter-segment (42,003) 17,398 - (24,605) - 34,223 - 1,723 (11,341) 24,605 -
------------------------------------------------ ------------------------------------------------------------------- ----------
TotalRevenues $1,928,481 $(717,623) $62,376 $1,273,234 $194,831 $ 168,571 $ 48,028 $97,024 $(31,461) $476,993 $ 1,750,227
=============================================== ==================================================================== ==========
Segment
Earnings
(pre-tax) $1,209,792 $(836,247) $28,872 $ 402,417 $37,015 $ 115,051 $ (225) $67,277 $ (213) $218,905 $ 621,322
=============================================== ==================================================================== ==========
Segment Assets $39,456,373 $10,124,206 $75,357 $49,655,936 $1,481,144 $24,554,379 $166,662 $15,924,568 $2,877 $42,129,630 $91,785,566
=============================================== ==================================================================== ==========
For the Quarter Ended June 30, 2002
- ------------------------------------------------------------------------------------------------------------------------------
Mortgage Banking Other Businesses
---------------------------------------- -------------------------------------------------------------
(Dollars are Loan Loan Closing Capital Global Grand
in thousands Production Servicing Services Total Insurance Markets Operations Banking Other Total Total
- ---------------------------------------------------------- ---------------------------------------------------------------------- ----------
Revenues
External $744,100 $(51,022) $33,735 $ 726,813 $157,785 $ 64,818 $23,736 $28,043 $(2,873) $ 271,509 $998,322
Inter-segment (17,570) 7,833 - (9,737) - 13,743 - (2,920) (1,086) 9,737 -
---------------------------------------------- -------------------------------------------------------------------- ----------
Total Revenues $726,530 $(43,189) $33,735 $ 717,076 $157,785 $ 78,561 $23,736 25,123 $(3,959) $ 281,246 $998,322
============================================== ==================================================================== ==========
Segment
Earnings(pre-tax)$370,531 $(157,023) $14,028 $ 227,536 $24,588 $ 37,526 $(1,274) $ 16,201 $ 697 $ 77,738 $ 305,274
============================================== ==================================================================== ==========
SegmentAssets $11,600,100 $11,741,518 $52,597 $23,394,215 $1,249,890 $12,512,415 $111,944 $4,286,622 $322,789 $18,483,660 $41,877,875
============================================== ==================================================================== ===========
For the Six Months Ended June 30, 2003
- ------------------------------------------------------------------------------------------------------------------------------
Mortgage Banking Other Businesses
---------------------------------------- ------------------------------------------------------------------------
(Dollars are Loan Loan Closing Capital Global Grand
in thousands Production Servicing Services Total Insurance Markets Operations Banking Other Total Total
- ---------------------------------------------------------------- ----------------------------------------------------------------------- ----------
Revenues
External $3,479,275 $(1,172,861) $114,026 $2,420,440 $388,629 $ 265,946 $ 94,073 $161,139 $(38,202) $ 871,585 $3,292,025
Inter-segment (80,611) 28,425 - (52,186) - 65,254 - 6,266 (19,334) 52,186 -
---------------------------------------------------- ---------------------------------------------------------------------- ----------
Total Revenues $3,398,664 $(1,144,436) $114,026 $2,368,254 $388,629 $ 331,200 $ 94,073 $167,405 $(57,536) $ 923,771 $3,292,025
=================================================== ======================================================================= ==========
Segment
Earnings(pre-tax)$2,092,211 $(1,390,421) $54,855 $ 756,645 $61,773 $ 211,163 $ 5,571 $ 110,610 $ 128 $ 389,245 $1,145,890
=================================================== ======================================================================= ==========
Segment Assets $39,456,373 $10,124,206 $75,357 $49,655,936 $1,481,144 $24,554,379 $166,662 $15,924,568 $ 2,877 $42,129,630 $91,785,566
=================================================== ======================================================================= ==========
For the Six Months Ended June 30, 2002
- ------------------------------------------------------------------------------------------------------------------------------
Mortgage Banking Other Businesses
---------------------------------------- -------------------------------------------------------------
(Dollars are Loan Loan Closing Capital Global Grand
in thousands Production Servicing Services Total Insurance Markets Operations Banking Other Total Total
- ------------------------------------------------------------ -------------------------------------------------------------------- ----------
Revenues
External $1,538,339 $(214,550) $68,826 $1,392,615 $295,155 $138,274 $43,901 $45,457 $(3,328) $ 519,459 $1,912,074
Inter-segmen (28,992) 12,005 - (16,987) - 24,916 - (4,144) (3,785) 16,987 -
----------------------------------------------- -------------------------------------------------------------------- ----------
Total Revenues $1,509,347 $(202,545) $68,826 $1,375,628 $295,155 $163,190 $43,901 $41,313 $(7,113) $ 536,446 $1,912,074
=============================================== ==================================================================== ==========
Segment
Earnings(pre-tax) $815,272 $(424,636) $28,426 $ 419,062 $48,421 $ 77,059 $(1,775) $ 26,422 $ 2,179 $ 152,306 $ 571,368
=============================================== ==================================================================== ==========
Segment Assets $11,600,100 $11,741,51 $52,597 $23,394,215 $1,249,890 $12,512,415 $111,944 $4,286,622 $322,789 $18,483,660 $41,877,875
=============================================== ==================================================================== ==========
NOTE 14 –
REGULATORY AND AGENCY CAPITAL REQUIREMENTS
In connection with the
acquisition of Treasury Bank, CFC became a financial holding company. As a
result, the Company is subject to regulatory capital requirements imposed by the
Board of Governors of the Federal Reserve System (“FRB”). The Company
is also subject to U.S. Department of Housing and Urban Development, Fannie Mae,
and Freddie Mac net worth requirements.
Regulatory capital is assessed for adequacy by three measures: Tier 1 Leverage Capital, Tier 1 Risk-Based Capital and Total Risk-Based Capital. Tier 1 Leverage Capital includes common shareholders’ equity and preferred stock and securities that meet certain guidelines detailed in the capital regulations, less goodwill, the portion of MSRs not includable in regulatory capital (generally, the carrying value of MSRs in excess of Tier 1 Capital, net of associated deferred taxes) and other adjustments. Tier 1 Leverage Capital is measured with respect to average assets during the quarter. The Company is required to have a Tier 1 Leverage Capital ratio of 4.0% to be considered adequately capitalized and 5.0% to be considered well capitalized.
The Tier 1 Risk-Based Capital ratio is calculated as a percent of risk-weighted assets at the end of the quarter. The Company is required to have a Tier 1 Risk-Based Capital ratio of 4.0% to be considered adequately capitalized and 6.0% to be considered well capitalized.
Total Risk-Based Capital includes preferred stock and securities excluded from Tier 1 Capital, mandatory convertible debt, and subordinated debt that meets certain regulatory criteria. The Total Risk-Based Capital ratio is calculated as a percent of risk-weighted assets at the end of the quarter. The Company is required to have a Total Risk-Based Capital ratio of 8.0% to be considered adequately capitalized and 10.0% to be considered well capitalized.
The following table presents the actual capital ratios and amounts and minimum required capital ratios for the Company to maintain a “well-capitalized” status by the FRB at June 30, 2003 and at December 31, 2002:
June 30, 2003 December 31, 2002
------------------------- ------------------------
(Dollar amounts in thousands) Minimum Ratio Amount Ratio Amount
Required(1)
- ---------------------------------- ------------- ---------- ------------- -------- --------------
Tier 1 Leverage Capital 5.0% 7.7% $6,429,745 7.6% $4,703,839
Risk-Based Capital
Tier 1 6.0% 11.3% $6,429,745 12.2% $4,703,839
Total 10.0% 12.2% $6,922,800 13.6% $5,230,840
(1) Minimum required to qualify as "well-capitalized."
NOTE 15 –
LEGAL PROCEEDINGS
The Company and certain
subsidiaries are defendants in, or parties to, a number of pending and
threatened legal actions and proceedings involving matters that are generally
incidental to their business. These matters include actions and proceedings
involving alleged breaches of contract, violations of consumer protection and
other laws and regulations, and other disputes arising out of the Company’s
operations. Certain of these matters involve claims for substantial monetary
damages, and others purport to be class actions.
Based on its current knowledge, management does not believe that liabilities, if any, arising from any single pending action or proceeding will have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company and its subsidiaries. The Company is not, however, able to predict with certainty the outcome or timing of the resolution of any of these actions or proceedings or the ultimate impact on the Company or its results of operations in a particular future period.
NOTE 16 –
SUBSEQUENT EVENTS
On July 22, 2003, the
Company’s Board of Directors declared a dividend of $0.14 per common share,
payable September 2, 2003, to shareholders of record on August 14, 2003.
NOTE 17 –
SUMMARIZED FINANCIAL INFORMATION
Summarized financial
information for Countrywide Financial Corporation and subsidiaries is as
follows:
June 30, 2003
-------------------------------------------------------------------------------------------------------
(Dollar amounts in thousands) Countrywide Countrywide Countrywide Other Eliminations Consolidated
Financial Home Capital
Corporation Loans, Inc. Trusts Subsidiaries
- ------------------------------------- ----------------- --------------- -------------- ---------------- ---------------- ----------------
Balance Sheets:
Mortgage loans and
mortgage-backed securities $ -
held for sale $ - $ 35,707,433 $ 11,643 $ - $ 35,719,076
Mortgage servicing rights, net - 4,654,664 - - - 4,654,664
Other assets 7,745,753 11,323,342 1,040,301 58,955,014 (27,652,584) 51,411,826
----------------- --------------- -------------- ---------------- ---------------- ----------------
Total assets $ 7,745,753 $ 51,685,439 $ 1,040,301 $ 58,966,657 $ (27,652,584) $ 91,785,566
================= =============== ============== ================ ================ ================
Company-obligated mandatorily
redeemable capital trust
pass-through securities $ - $ - $ 1,000,000 $ 0 $ - $ 1,000,000
Deposit liabilities - - - 8,050,772 - 8,050,772
Indebtedness 1,264,012 41,854,529 30,943 42,502,808 (21,871,027) 63,781,265
Other liabilities 86,445 7,660,210 9,358 4,949,207 (146,987) 12,558,233
Equity 6,395,296 2,170,700 - 3,463,870 (5,634,570) 6,395,296
----------------- --------------- -------------- ---------------- ---------------- ----------------
Total liabilities and equity $ 7,745,753 $ 51,685,439 $ 1,040,301 $ 58,966,657 $ (27,652,584) $ 91,785,566
================= =============== ============== ================ ================ ================
Six Months Ended June 30, 2003
------------------------------------------------------------------------------------------------------
(Dollar amounts in thousands) Countrywide Countrywide Countrywide Other Eliminations Consolidated
Financial Home Capital Trusts
Corporation Loans, Inc. Subsidiaries
- ------------------------------------- ---------------- ---------------- --------------- ---------------- ---------------- ----------------
Statements of Earnings:
Revenues $ 22,851 $ 1,791,863 $ - $ 1,574,457 $ (97,146) $ 3,292,025
Expenses 4,322 1,404,172 - 834,353 (96,712) 2,146,135
Provision for income taxes 7,041 147,323 - 282,539 (165) 436,738
Equity in net earnings of -
subsidiaries 697,664 - - (697,664) -
---------------- ---------------- --------------- ---------------- ---------------- ----------------
Net earnings $ 709,152 $ 240,368 $ - $ 457,565 $ (697,933) $ 709,152
================ ================ =============== ================ ================ ================
December 31, 2002
---------------------------- --------------------------------------------------------- ------------
Countrywide Countrywide Other Eliminations Consolidated
Financial Home Countrywide
(Dollar amounts in thousands) Corporation Loans, Inc. Capital IV Subsidiaries
- --------------------------------------------------------- ---------------- --------------- -------------- --------------- --------------
Balance Sheets:
Mortgage loans and
mortgage-backed securities $ $ - $
held for sale - $14,055,045 $ 970,572 - $15,025,617
Mortgage servicing rights, net - 5,384,933 - - - 5,384,933
Other assets 5,985,027 12,011,287 - 38,946,813 (19,322,894) 37,620,233
---------------- ---------------- --------------- -------------- --------------- --------------
Total assets $5,985,027 $31,451,265 $ - $39,917,385 ($19,322,894) $58,030,783
================ ================ =============== ============== =============== ==============
Company-obligated mandatorily
redeemable capital trust $ $ $
pass-through securities - - $ - $ 500,000 - $ 500,000
Deposit liabilities - - - 3,114,271 - 3,114,271
Indebtedness 745,997 23,522,271 - 32,273,803 (14,613,444) 41,928,627
Other liabilities 77,897 5,699,928 - 1,607,056 (58,129) 7,326,752
Equity 5,161,133 2,229,066 - 2,422,255 (4,651,321) 5,161,133
---------------- ---------------- --------------- -------------- --------------- --------------
Total liabilities and equity $5,985,027 $31,451,265 $ - $39,917,385 ($19,322,894) $58,030,783
================ ================ =============== ============== =============== ==============
- ---------------------------------------------------------------------------------------------------------------------------------------------
Six Months ended June 30, 2002
------------------------------------------------------------------------------------------------------
Countrywide Countrywide
Financial Home Countrywide Other
(Dollar amounts in thousands) Corporation Loans, Inc. Capital IV Subsidiaries Eliminations Consolidated
- ------------------------------------- ---------------- ---------------- --------------- --------------- ---------------- ---------------
Statements of Earnings:
Revenues $ (852) $ 1,075,690 $ - $ 865,438 $ (28,202) $ 1,912,074
Expenses 4,769 819,556 - 544,583 (28,202) 1,340,706
Provision for income taxes (2,108) 95,973 - 119,088 - 212,953
Equity in net earnings of -
subsidiaries 361,928 - - (361,928) -
---------------- ---------------- --------------- --------------- ---------------- ---------------
Net earnings $ 358,415 $ 160,161 $ - $ 201,767 $ (361,928) $ 358,415
================ ================ =============== =============== ================ ===============
Summarized information for Countrywide Capital Trusts is as follows:
June 30, 2003
--------------------------------------------------------------------
(Dollar amounts in thousands) Countrywide Countrywide Countrywide Countrywide
Capital III
Capital IV Capital Trust Consol Capital Trusts
- ------------------------------------- ---------------- ---------------- -------------- -----------------
Balance Sheets:
Mortgage loans and
mortgage-backed securities $ -
held for sale $ - $ - $ -
Mortgage servicing rights, net - - - -
Other assets 523,099 310,310 206,892 1,040,301
---------------- ---------------- -------------- -----------------
Total assets $ 523,099 $ 310,310 $ 206,892 $ 1,040,301
================ ================ ============== =================
Company-obligated mandatorily
redeemable capital trust
pass-through securities $ 500,000 $ 300,000 $ 200,000 $ 1,000,000
Deposit liabilities - - - -
Indebtedness 15,464 9,279 6,200 30,943
Other liabilities 7,635 1,031 692 9,358
Equity - - - -
---------------- ---------------- -------------- -----------------
Total liabilities and equity $ 523,099 $ 310,310 $ 206,892 $ 1,040,301
================ ================ ============== =================
Six Months ended June 30, 2003
-------------------------------------------------------------------
(Dollar amounts in thousands) Countrywide Countrywide Countrywide Countrywide
Capital III
Capital IV Capital Trust Consol Capital Trusts
- ------------------------------------- ---------------- ---------------- -------------- ----------------
Statements of Earnings:
Revenues $ - $ - $ - $ -
Expenses - - - -
Provision for income taxes - - - -
Equity in net earnings of - - - -
subsidiaries
---------------- ---------------- -------------- ----------------
Net earnings $ - $ - $ - $ -
================ ================ ============== ================
NOTE 18 – RECENTLY
ISSUED ACCOUNTING STANDARDS
In April 2003, the FASB
issued Statement No.149, “Amendment of Statement 133 on Derivative
Instruments and Hedging Activities,” which is generally effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. SFAS 149 clarifies under what
circumstances a contract with an initial net investment meets the characteristic
of a derivative as discussed in SFAS No. 133, clarifies when a derivative
contains a financing component, amends the definition of an
“underlying” to conform it to the language used in FASB Interpretation
No. 45, “Guarantor Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others”, and amends
certain other existing pronouncements. The adoption of SFAS 149 is not expected
to have a material effect on the Company’s financial condition or results
of operations.
In May 2003, the FASB issued Statement No. 150 (“SFAS 150”), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS 150 is effective for all financial instruments created or modified after May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 is not expected to have a material effect on the Company’s financial condition or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report on
Form 10-Q represents an update to the more detailed and comprehensive
disclosures included in the Company’s Annual Report on Form 10-K for the
year ended December 31, 2002. As such, a reading of the Annual Report on Form
10-K is necessary to an informed understanding of the following discussions.
GENERAL
The Company’s core
business is residential Mortgage Banking. Historically, the Mortgage Banking
business was the primary source of the Company’s earnings and the focus of
its capital investment. The Company’s results of operations historically
have been influenced primarily by the level of demand for mortgage loans, which
is affected by external factors such as prevailing mortgage rates and the
strength of the U.S. housing market.
In recent years, the Company has expanded its operations beyond Mortgage Banking. The Company now has five business segments: Mortgage Banking, Insurance, Capital Markets, Global Operations and Banking. This diversification has been pursued to capitalize on meaningful synergies with the Company’s core Mortgage Banking business and to provide sources of earnings that are not as cyclical as the mortgage banking business.
CRITICAL
ACCOUNTING POLICIES
As discussed in further
detail in the Company’s Annual Report on Form 10-K, the accounting policies
that have the greatest impact on the Company’s financial condition and
results of operations and that require the most judgment are those relating to
its mortgage securitization activities and the ongoing valuation of retained
interests, particularly Mortgage Servicing Rights (“MSRs”), that arise
from those activities, as well as the Company’s interest rate risk
management activities. The Company’s critical accounting policies involve
accounting for gains on sales of loans and securities, valuation of MSRs and
other retained interests, amortization of MSRs and accounting for derivatives
and interest rate risk management activities.
The fair values of the Company’s retained interests are affected by changes in mortgage interest rates. Mortgage interest rates decreased during the current period resulting in changes to key assumptions used in the valuation of retained interests. In addition, as part of the on-going valuation process, the proprietary statistical prepayment models used to estimate the fair value of the MSRs were refit using the Company’s most recent empirical prepayment data. This data included periods of unprecedented prepayment activity. Overall, the predictive ability of the refit models is comparable to that of the previous models; however, the refit models more accurately predict short-term prepayment rates in the current low-rate mortgage environment. The refit models were utilized to estimate the fair value of the MSRs at June 30, 2003.
The long-term estimated weighted average prepayment speed (annual rate) for the MSRs has increased from 21.7% at December 31, 2002 to 28.8% at June 30, 2003. As of June 30, 2003, the option-adjusted spread (“OAS”) used in the valuation of the MSRs ranged from 3.5% for conventional, conforming MSRs to 7.5% for subprime MSRs. As of December 31, 2002, the OAS used in the valuation of MSRs ranged from 2.9% for conventional, conforming MSRs to 6.9% for subprime MSRs.
The long-term estimated weighted average prepayment speed (annual rate) for the other retained interests has increased from 34.3% at December 31, 2002 to 36.4% at June 30, 2003. The discount rate used in the valuation of other retained interests increased from 15.0% at December 31, 2002 to 19.3% at June 30, 2003.
At June 30, 2003, the Company’s investment in MSRs was stratified as follows:
(Dollar amounts in Total Portfolio
millions)
- ---- -------------------------- -- --------------------------------------------------------------------------------
Weighted
Mortgage Principal Percent Average MSR
Rate Balance (1) of Total Maturity (Years) Balance
- ---- -------------------------- -- --------------- -- --------------- - --------------------- -- --------------- --
6% and under $ 185,036 36.7% 24.2 $ 2,181
6.01-7% 221,390 43.9% 26.6 1,741
7.01-8% 69,620 13.8% 25.8 485
8.01-9% 18,259 3.6% 25.4 154
9.01-10% 5,029 1.1% 24.5 49
over 10% 4,746 0.9% 21.6 45
--------------- --------------- ---------------
$ 504,080 100.0% 25.5 $ 4,655
=============== =============== ===============
(1) Excludes subservicing and loans held for
sale.
The Company computes MSR amortization by applying the ratio of current period MSR net cash flows to estimated total remaining undiscounted MSR net cash flows. The estimated total remaining undiscounted MSR net cash flows are determined at the beginning of each reporting period, using prepayment estimates applicable at that time. The total remaining undiscounted MSR net cash flows are estimated using a static (single rate path) cash flow model. The MSR amortization rate was 24% for the six months ended June 30, 2003 as compared to 17% for the year ended December 31, 2002.
The Company’s diluted earnings per share for the quarter ended June 30, 2003 was $2.74, an 85% increase over diluted earnings per share for the quarter ended June 30, 2002. Net earnings were $382.9 million, a 101% increase from the quarter ended June 30, 2002. This earnings performance was driven primarily by the increased level of mortgage loans produced by the Company—$130.2 billion—as compared to $42.1 billion for the year-ago period, partially offset by a reduction in value of the Company’s MSRs and other retained interests.
Industry-wide, residential mortgage originations were approximately $1,150 billion during the second quarter of 2003, up from approximately $940 billion in the first quarter of 2003 and $537 billion in the second quarter of 2002 (Source: Fannie Mae). Approximately 73% of the residential mortgages produced in the second quarter of 2003 were refinancing transactions triggered primarily by historically low mortgage rates. The balance of mortgages produced related to home purchases. Partially fueled by the level of mortgage rates, activity in the U.S. housing market also reached record levels in the second quarter of 2003.
The continuing high demand for mortgages drove not only high volumes but also high production margins. The combination of high volumes and margins increased Loan Production sector pre-tax earnings to $1,209.8 million for the quarter, an increase of $839.3 million from the year-ago period.
The high levels of mortgage refinances and home purchases resulted in significant prepayments within the Company’s mortgage loan servicing portfolio during the period. This, along with the expectation of continued higher-than-normal prepayments in the future due to historically low mortgage rates, resulted in significant amortization and impairment of the Company’s MSRs and other retained interests. The combined amount of amortization and impairment of MSRs and other retained interests, net of Servicing Hedge gains, was $1,361.0 million, resulting in a pre-tax loss of $836.3 million in the Loan Servicing sector for the current quarter, $679.2 million more than the pre-tax loss in the year-ago period.
These factors combined to produce pre-tax earnings of $402.4 million in the Mortgage Banking segment for the quarter ended June 30, 2003, an increase of 77% from the quarter ended June 30, 2002.
The Company’s non-mortgage banking businesses also were significant contributors to the earnings performance in the quarter ended June 30, 2003. In particular, the Capital Markets segment had pre-tax earnings of $115.1 million, as compared to $37.5 million in the year-ago period. Capital Markets has grown its core franchise significantly over the last five years and is now among the leading investment banking firms in its niche, the mortgage securities market. This segment continued to benefit from robust activity in the mortgage securities market, as well as from a highly-favorable interest rate environment. In addition, the Banking segment increased its pre-tax earnings by $51.1 million over the year ago quarter, driven by growth in assets in Treasury Bank. In total, non-mortgage banking businesses contributed $218.9 million in pre-tax earnings for the quarter ended June 30, 2003 (35% of consolidated pre-tax earnings), an increase of 182% from $77.7 million (25% of total pre-tax earnings) for the year-ago period.
OPERATING
SEGMENT RESULTS
The Company’s pre-tax
earnings by segment are summarized below:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- --------------------------------------------- ------------------------ ------------------------
Mortgage Banking:
Production $ 1,209,792 $ 370,531
Servicing (836,247) (157,023)
Closing Services 28,872 14,028
------------------------ ------------------------
Total Mortgage Banking 402,417 227,536
------------------------ ------------------------
Other Businesses:
Insurance 37,015 24,588
Capital Markets 115,051 37,526
Global Operations (225) (1,274)
Banking 67,277 16,201
Other (213) 697
------------------------ ------------------------
Total Other Businesses 218,905 77,738
------------------------ ------------------------
Pre-tax earnings $ 621,322 $ 305,274
======================== ========================
The Company’s mortgage loan production by segment and product is summarized below:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in millions) 2003 2002
- --------------------------------------------- ------------------------ ------------------------
Segment:
Mortgage Banking $ 120,811 $ 40,651
Capital Markets' conduit acquisitions 5,485 1,453
Treasury Bank 3,914 26
------------------------ ------------------------
$ 130,210 $ 42,130
======================== ========================
Product:
Prime $ 121,579 $ 37,392
Prime Home Equity 4,375 2,900
Subprime 4,256 1,838
------------------------ ------------------------
$ 130,210 $ 42,130
======================== ========================
MORTGAGE
BANKING SEGMENT
The Mortgage Banking segment is comprised of three distinct sectors: Loan Production, Loan Servicing and Loan Closing
Services.
Loan Production Sector
The Loan Production sector
produces mortgage loans through Countrywide Home Loan’s (“CHL”)
three production divisions Consumer Markets, Wholesale Lending and Correspondent
Lending, as well as through Full Spectrum Lending, Inc (“FSLI”).
The pre-tax earnings of the Loan Production sector are summarized below:
Quarter Ended June 30,
----------------------------------------------------------------------------
(Dollar amounts in 2003 2002
thousands)
- ---------------------------- -------------------------------------- ------------------------------------
Percent of Percent of
Loan Loan
Production Production
Dollars Volume Dollars Volume
--------------------- --------------- -------------------- --------------
Revenues $ 1,928,481 1.60% $ 726,530 1.79%
Expenses 718,689 0.60% 355,999 0.88%
--------------------- --------------- -------------------- --------------
Pre-tax earnings $ 1,209,792 1.00% $ 370,531 0.91%
===================== =============== ==================== ==============
Increased demand for residential mortgages enabled the Loan Production sector to achieve significant growth in revenues and earnings in the quarter ended June 30, 2003 compared to the year-ago period. This performance was enhanced by a significant increase in market share from the year ago period. Favorable market conditions enabled the Company to increase revenues earned on prime first mortgage loans, while high levels of productivity helped keep unit costs low. These factors combined to produce continued high profit margins (pre-tax earnings as a percentage of loan volume) for the Loan Production sector. The decline in revenues as a percentage of loan volume in the current period is attributable to unsold loan production, which amounted to 7.1% of the loans produced during the quarter, as well as to a shift in the origination and sales mix toward prime first mortgage loans, which generally generate revenues at a lower rate than home equity or subprime loans. Substantially all of the unsold loans were classified as held for sale at June 30, 2003.
Overall loan production for the quarter ended June 30, 2003 increased 197% in comparison to the year-ago period. All divisions, in particular Correspondent Lending, contributed to the increase in origination volume. The increase was due primarily to a rise in non-purchase loan production of 342%. An increase in purchase production of 48% also contributed to the higher origination volume. The increase in purchase loans is significant as this is the relatively stable growth component of the mortgage market, with average annual growth of 8% over the last 10 years. (The non-purchase, or refinance, component of the mortgage market is highly volatile as it is driven almost exclusively by prevailing mortgage rates.)
The following table shows total Mortgage Banking loan production volume by division:
Mortgage Banking
Loan Production
Quarter Ended June 30,
------------------------------------------------
(Dollar amounts in millions) 2003 2002
- ------------------------------------------------------ ----------------------- -----------------------
Correspondent Lending Division $ 60,877 $ 16,534
Wholesale Lending Division 28,719 12,183
Consumer Markets Division 29,447 11,224
Full Spectrum Lending, Inc. 1,768 710
----------------------- -----------------------
$ 120,811 $ 40,651
======================= =======================
The following table summarizes loan production by purpose and by interest rate type:
Mortgage Banking
Loan Production
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in millions) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Purpose:
Purchase $ 29,559 $ 19,988
Non-purchase 91,252 20,663
----------------------- ------------------------
$ 120,811 $ 40,651
======================= ========================
Interest Rate Type:
Fixed Rate $ 106,588 $ 34,229
Adjustable Rate 14,223 6,422
----------------------- ------------------------
$ 120,811 $ 40,651
======================= ========================
As shown in the following table, the volume of Prime Home Equity and Subprime mortgages produced (which is included in the Company’s total volume of loans produced) increased 50% during the current period from the prior period:
Mortgage Banking
Prime Home Equity and Subprime
Mortgage Production
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in millions) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Prime Home Equity $ 2,961 $ 2,769
Subprime 3,201 1,351
----------------------- ------------------------
$ 6,162 $ 4,120
======================= ========================
Percent of total loan production 5.1% 10.1%
======================= ========================
Prime Home Equity and Subprime loans carry higher profit margins historically and the demand for such loans is believed to be less rate sensitive than the demand for prime first mortgage loans; consequently, Management believes these loans will be a significant component of the sector’s future growth as interest rates increase from their historically low levels.
A major source of intrinsic value derived from the Company’s MSRs is the Company’s ability to retain its customers when they either refinance their loans or purchase new homes. The Company successfully retained a significant percentage of the customers who prepaid their mortgages during the period. The overall retention rate for the quarter was 41% as compared to 31% for the year-ago quarter. The retention rate increased for both purchase and refinance customers. The retention rate for purchase customers was 27% for the quarter ended June 30, 2003 as compared to 18% for the year-ago quarter. The retention rate for refinance customers was 44% for the quarter ended June 30, 2003 as compared to 37% for the year-ago quarter.
During the quarter ended June 30, 2003, the Loan Production Sector operated at approximately 130% of planned operational capacity. The primary capacity constraint in the Company’s loan origination activities is the number of loan operations personnel it has on staff. Therefore, the Company measures planned capacity with reference to the number of its loan operations personnel multiplied by the number of loans it expects each available loan operations staff person to process under normal conditions. The Company has continued to increase the number of sales and operations staff in its loan production divisions to capitalize upon the current market environment. When loan volumes moderate, the operations staff (which includes a significant number of temporary employees) will be reduced. Concurrent with this reduction in operations personnel will be a reduction in productivity to more sustainable levels that likely will result in higher overall unit costs. The Company plans to continue building its sales staff despite any potential drop in loan origination volume as a primary means to continue increasing the Company’s market share.
The following table summarizes the Loan Production sector workforce:
Workforce At
June 30,
--------------------------------------
2003 2002
- ------------------------------------------------------ ----------------- -------------------
Sales 7,683 4,733
Operations:
Regular employees 7,187 4,187
Temporary staff 2,755 666
----------------- -------------------
9,942 4,853
Production technology 631 378
Administration and support 1,524 989
----------------- -------------------
19,780 10,953
================= ===================
The Consumer Markets Division successfully grew its commissioned sales force during the period. At June 30, 2003, the commissioned sales force numbered 2,971, an increase of 227 during the quarter. The primary focus of the commissioned sales force is to increase overall purchase market share. The commissioned sales force contributed $6.5 billion in purchase originations in the quarter ended June 30, 2003, a 104% increase over the year-ago period. The purchase production generated by the commissioned sales force represented 70% of the Consumer Markets Division’s purchase production for the quarter ended June 30, 2003. At June 30, 2003, the Consumer Markets Division had 4 centralized processing units and 24 regional processing centers nationwide. During the quarter ended June 30, 2003, the regional processing centers handled 23% of the division’s total loan volume.
Like the Consumer Markets Division, the Wholesale Lending Division and FSLI continued to grow their sales forces as a core strategy to increase market share. At June 30, 2003, the sales force in the Wholesale Lending Division numbered 575, an increase of 5% during the quarter. FSLI expanded its sales force by 453, or 39%, during the quarter.
Loan Servicing Sector
The Loan Servicing sector
reflects the performance of the Company’s investments in MSRs and other
retained interests and associated risk management activities, as well as profits
from subservicing activities in the United States. The Loan Servicing Sector
includes a significant processing operation, consisting of 5,874 employees who
service the Company’s 4.6 million mortgage customers. How effectively this
servicing operation manages costs and generates ancillary income from the
portfolio has a significant impact on the long-term performance of this sector.
The following table summarizes the results for the Loan Servicing sector:
Quarter Ended June 30,
---------------------------------------------------------------------
2003 2002
---------------------------------- ---------------------------------
Amount Percentage of Amount Percentage of
Average Average
Servicing Servicing
(Dollar amounts in thousands) Portfolio* Portfolio*
- --------------------------------- ---------------- ---------------- --------------- ----------------
Revenues $ 667,744 0.509% $ 487,869 0.542%
Servicing Hedge gains (loss) 748,081 0.570% 462,409 0.514%
Amortization (557,274) (0.425%) (244,259) (0.272%)
Impairment (1,551,847) (1.183%) (697,227) (0.774%)
Operating expense (102,955) (0.078%) (101,148) (0.112%)
Interest expense, net (39,996) (0.030%) (64,667) (0.072%)
---------------- ---------------- --------------- ----------------
Pre-tax loss $ (836,247) (0.637%) $ (157,023) (0.174%)
================ ================ ===============
Average Servicing Portfolio $ 524,803,000 $360,093,000
================ ===============
*Annualized
The Loan Servicing Sector experienced continued losses during the recent period, driven by high amortization and impairment of the Company’s retained interests. The amortization and impairment charges reflect the loss in value of the Company’s retained interests primarily caused by the high level of actual and forecasted prepayments in the Company’s mortgage servicing portfolio. In general, the value of the retained interests is closely linked to the estimated life of the underlying loans, which in recent periods has declined primarily due to the decline in mortgage rates. The combined impairment and amortization charge was $2,109.1 million and $941.5 million during the quarters ended June 30, 2003 and 2002, respectively.
During the quarter ended June 30, 2003, the Servicing Hedge generated a gain of $748.1 million. This gain resulted from a decline in long term Treasury and swap rates, which indices underlie the derivatives and securities that constitute the essential component of the Servicing Hedge. Amortization and impairment, net of the Servicing Hedge, was $1,361.0 million for the quarter ended June 30, 2003, an increase of $881.9 million over the quarter ended June 30, 2002. In a stable interest rate environment, Management would expect no significant impairment and would expect to incur expenses related to the Servicing Hedge driven primarily by the composition of the hedge, the shape of the yield curve and the level of interest rate volatility.
During the quarter ended June 30, 2003, the Company securitized a portion of its net servicing fees (“excess servicing”). As of quarter end, the resulting interest-only security was classified as a trading security and included in “Investments in other financial instruments.” Management believes such securitizations enable the Company to improve the overall returns on its MSR investment and more efficiently manage its capital.
Despite the high level of prepayments, the Company increased its servicing portfolio to $559.1 billion at June 30, 2003, a 49% increase from June 30, 2002. At the same time, the overall weighted-average note rate of the loans serviced for others declined from 7.3% to 6.4%.
Loan Closing Services Sector
The LandSafe companies
produced $28.9 million in pre-tax earnings, representing an increase of 106%
from the year-ago period. The increase in LandSafe’s pre-tax earnings was
primarily due to the increase in loan origination activity in the Loan
Production sector.
The Company’s other business segments include Capital Markets, Banking, Insurance, and Global Operations. Pre-tax earnings from these other businesses increased $141.2 million in the quarter ended June 30, 2003 over the quarter ended June 30, 2002.
Capital Markets Segment
The Capital Markets segment
achieved pre-tax earnings of $115.1 million for the quarter, an increase of
$77.5 million, or 207%, from the year-ago period. Total revenues were $168.6
million, an increase of $90.0 million, or 115% compared to the year ago period.
Total securities trading volume increased 100% to $811.9 billion. This
performance was driven largely by a highly favorable operating environment
consisting of a robust mortgage securities market, high mortgage securities
price volatility, and low short-term financing costs.
The following table shows pre-tax earnings by company:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ----------------------------------------------------------- ----------------------- ------------------------
Countrywide Securities Corporation ("CSC")(1) $ 92,409 $ 31,605
Countrywide Asset Management Corporation ("CAMCo") 22,642 5,921
----------------------- ------------------------
$ 115,051 $ 37,526
======================= ========================
(1) Includes CSE, CCMI and CCM, Inc.
The following table shows the composition of CSC’s trading volume, which includes trades with the Mortgage Banking segment, by instrument:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in millions) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Mortgage-backed securities $ 773,801 $ 375,720
Government agency debt 23,045 14,562
Asset-backed securities 10,207 14,059
Other 4,802 1,299
----------------------- ------------------------
$ 811,855 $ 405,640
======================= ========================
The segment’s mortgage conduit activities generated $71.3 million in gross revenues during the quarter, compared to $21.8 million during the year-ago quarter. The combined amount of mortgage loans sold during the period that were acquired by the conduits totaled $8.7 billion.
Banking Segment
The Banking segment
commenced operations in calendar 2001. The segment achieved pre-tax earnings of
$67.3 million during the quarter ended June 30, 2003, as compared to $16.2
million for the year-ago period. Following is the composition of pre-tax
earnings by company:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Treasury Bank ("Bank") $ 50,190 $ 12,673
Countrywide Warehouse Lending ("CWL") 20,415 3,542
Parent and allocated corporate overhead expenses (3,328) (14)
----------------------- ------------------------
$ 67,277 $ 16,201
======================= ========================
The Bank produced pre-tax earnings of $50.2 million for the quarter, an increase of $37.5 million over the prior year quarter. The overall increase was primarily due to an increase in net interest income arising from growth in average earning assets and increased profits of $10.0 million resulting from document custodian services provided to CHL. Average earning assets increased to $10.8 billion during the quarter, an increase of $7.8 billion in comparison to the year-ago period. Asset growth was funded primarily by the transfer of custodial balances controlled by CHL from third party banks to the Bank, a capital contribution from CFC, Federal Home Loan Bank advances and growth in the Bank’s retail deposit base. As of June 30, 2003, $6.5 billion of custodial balances controlled by CHL were placed as deposits in the Bank. The Bank’s annual pre-tax return on assets for the quarter ended June 30, 2003 was 1.84%. The composition of the Bank’s assets was as follows:
(Dollar amounts in thousands) June 30, 2003 December 31, 2002
- ------------------------------------------------------ ----------------------- ------------------------
Cash $ 99,965 $ 163,547
Short-term investments 885,000 300,000
Mortgage loans, net 7,807,956 1,902,793
Investment securities classified as 3,790,977 2,590,789
available-for-sale
Other assets 507,424 153,690
----------------------- ------------------------
Total $ 13,091,322 $ 5,110,819
======================= ========================
CWL’s pre-tax earnings increased by $16.9 million during the quarter ended June 30, 2003 in comparison to the year-ago period, primarily due to growth in average outstanding mortgage warehouse advances partially offset by a decline in the average net spread from 2.33% during the quarter ended June 30, 2002 to 1.83% during the quarter ended June 30, 2003. For the current quarter, average mortgage warehouse advances outstanding were $4.4 billion, an increase of $3.7 billion in comparison to the year-ago period. The increase in warehouse advances was largely attributable to growth in the overall mortgage originations market.
Insurance Segment
The Insurance segment
pre-tax earnings increased 51% over the year-ago period, to $37.0 million. The
following table shows pre-tax earnings by business line:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ------------------------ -----------------------
Carrier Operations:
Balboa Reinsurance Company $ 24,366 $ 24,191
Balboa Life and Casualty 12,516 731
------------------------ -----------------------
36,882 24,922
Agency operations 4,335 3,399
Parent and allocated corporate overhead expenses (4,202) (3,733)
------------------------ -----------------------
$ 37,015 $ 24,588
======================== =======================
The following table shows net earned premiums for the carrier operations:
Quarter Ended June 30,
-----------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ -------------------- -------------------
Carrier Operations:
Balboa Life and Casualty $ 136,552 $ 112,863
Balboa Reinsurance Company 31,631 20,865
-------------------- -------------------
$ 168,183 $ 133,728
==================== ===================
The Company’s mortgage reinsurance business produced $24.4 million in pre-tax earnings an increase of 0.7% over the year-ago period. Net earned premiums increased 52% driven by growth in the Company’s loan servicing portfolio. The increase in net earned premiums was partially offset by a $10.7 million increase in insurance claims losses. Insurance claims expenses are a function of expected remaining losses and premiums. Expected remaining premiums have declined due to an increase in estimated prepayments within the portfolio of insured loans.
The Company’s Life and Casualty insurance business produced pre-tax earnings of $12.5 million, an increase of $11.8 million from the comparable quarter in 2002. The growth in earnings was driven by a $23.7 million, or 21%, increase in net earned premiums during the quarter ended June 30, 2003 in comparison to the year-ago quarter. The growth in net earned premiums was primarily attributable to growth in lender-placed insurance. The increase in net earned premiums was partially offset by an increase in the loss ratio from 52% to 54%. In addition, pre-tax net investment earnings increased by $4.1 million over the year-ago period.
Global Operations Segment
For the quarter ended June
30, 2003, the Global Operations segment’s pre-tax loss totaled $0.2
million, representing an improvement of $1.1 million in comparison to the
year-ago period. The decrease in Global’s pre-tax loss was due to growth in
the portfolio of mortgage loans sub-serviced and the number of new mortgage
loans processed on behalf of GHL’s minority joint venture partner, Barclays
plc, partially offset by a $6.5 million software impairment charge.
Gain on sale of loans and securities is summarized below for the quarters ended June 30, 2003 and 2002:
Quarter Ended June 30,
-----------------------------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ---------------------------------------------- ----------------------------------- ----------------------------------
Percentage of Percentage of
Dollars Loans Sold Dollars Loans Sold
----------------- ---------------- ---------------- ----------------
Mortgage Banking:
Prime First Mortgages $ 1,533,793 1.41% $ 457,037 1.23%
Subprime Mortgages 171,537 5.86% 72,334 6.72%
Prime Home Equity Mortgages - - 70,139 3.30%
----------------- ----------------
Production sector 1,705,330 1.53% 599,510 1.49%
Re-performing loans 61,112 7.88% 27,914 3.74%
----------------- ----------------
1,766,442 627,424
Capital Markets
Trading Securities (15,762) (22,153)
Conduit Activities 66,788 10,142
----------------- ----------------
51,026 (12,011)
Other 8,170 4,120
----------------- ----------------
$ 1,825,638 $ 619,533
================= ================
Gain on sale of loans and securities increased in the quarter ended June 30, 2003 as compared to the quarter ended June 30, 2002 primarily due to higher loan production and sales volume combined with higher margins on Prime First Mortgages. Margins on Prime First Mortgages were high in both periods on a relative historical basis, due largely to the very favorable mortgage market environment that prevailed during those periods. That mortgage market was characterized by record consumer demand for mortgages and modest price competition by historical industry standards. Management expects margins, particularly on Prime First Mortgages, to decline in the future as the level of mortgage originations subsides.
The Company did not sell any Prime Home Equity Loans during the quarter. As it has done in recent quarters, the Company plans to securitize the prime home equity lines-of-credit originated in its Mortgage Banking operation and hold those securities as long-term investments.
Capital Markets’ revenues from its trading activities consist of gains on the sale of securities and net interest income. In a very steep yield curve environment, which existed during both periods, trading revenues will derive largely or entirely from net interest income earned during the securities’ holding period. As the yield curve flattens, the mix of revenues will shift toward gain on sale of securities. The increase in Capital Markets’ gain on sale of loans related to its conduit activities was due to increased acquisitions and sales during the quarter ended June 30, 2003 in comparison to the year-ago period.
In general, gain on sale of loans and securities are affected by numerous factors, including the volume and mix of loans sold, production channel mix, the level of price competition, the slope of the yield curve, and the effectiveness of the Company’s associated interest rate risk management activities.
Net interest income is summarized below for the quarters ended June 30, 2003 and 2002:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Net interest income:
Mortgage loans and securities held for sale $ 180,395 $ 114,822
Custodial balances (66,109) 6,400
Servicing sector interest expense (64,381) (94,364)
Re-performing loans 23,751 40,564
Capital Markets securities trading portfolio 105,103 74,511
Insurance segment investments 8,261 8,966
Banking segment loans and securities 73,593 19,649
Home equity AAA asset-backed securities 26,196 11,341
Other 9,231 3,551
----------------------- ------------------------
Net interest income $ 296,040 $ 185,440
======================= ========================
The increase in net interest income from mortgage loans and securities held for sale reflects an increase in the average inventory partially offset by a lower overall net earnings rate during the quarter ended June 30, 2003 as compared to the quarter ended June 30, 2002. The Company finances the major portion of its mortgage loans and securities held for sale at prevailing short-term borrowing rates, which did not decrease in tandem with the decrease in mortgage rates when compared to the year-ago period.
Net interest income from custodial balances decreased in the current period due to the substantial increase in loan payoffs over the year-ago period. The Company is obligated to pass through monthly interest to security holders on paid-off loans at the underlying security rates, which were substantially higher than the short-term rates earned by the Company on the payoff float. The amount of such interest passed through to the security holders was $121.2 million and $31.7 million in the quarters ended June 30, 2003 and 2002, respectively. In addition, the earnings rate on the custodial balances, which is tied to short-term rates, declined from 1.74% during the quarter ended June 30, 2002 to 1.10% during the quarter ended June 30, 2003. Average custodial balances increased by $11.3 billion, or 129%, over the prior period, due largely to the increase in loan payoffs.
Interest expense allocated to the Loan Servicing sector decreased due to a decline in short-term rates (a portion of the Company’s long-term debt is variable-rate), combined with a decrease in total sector assets.
Re-performing loans are reinstated loans that had previously defaulted and were consequently re-purchased from mortgage securities issued by the Company or others. Such loans are subsequently securitized and re-sold. The decrease in interest income related to this activity is a result of a decrease in the average balance of such loans resulting from sales during the quarter ended June 30, 2003.
The increase in net interest income from the Capital Markets securities trading portfolio is attributable to an increase of 85% in the average inventory of securities held, partially offset by a decrease in the average net spread earned from 4.17% in the quarter ended June 30, 2002 to 3.19% in the quarter ended June 30, 2003. The decrease in the average net spread is the result of a flatter yield curve.
The increase in net interest income from the Banking segment was primarily attributable to asset growth both in the Bank and CWL. The increase in assets was partially offset by a small decrease in the weighted average spread from 2.10% in the quarter ended June 30, 2002 to 1.94% in the quarter ended June 30, 2003. Average assets in the Banking segment increased to $15.2 billion during the quarter, an increase of $11.5 billion over the year-ago quarter.
The increase in net interest income from home equity AAA asset-backed securities is due to an increase in the average inventory of securities held.
Loan servicing fees and other income from retained interests are summarized below for the quarters ended June 30, 2003 and 2002:
Quarter Ended June 30,
--------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Service fees, net of guarantee fees $ 469,645 $ 341,603
Income from other retained interests 104,390 45,963
Prepayment penalties 45,271 24,587
Late charges 35,476 28,565
Global segment subservicing fees 22,107 10,251
Ancillary fees 16,021 10,437
----------------------- ------------------------
$ 692,910 $ 461,406
======================= ========================
The increase in servicing fees, net of guarantee fees, was principally due to a 46% increase in the average servicing portfolio, partially offset by a reduction in the overall net service fee earned from 0.379% of the average portfolio balance during the quarter ended June 30, 2002 to 0.358% during the quarter ended June 30, 2003. The reduction in the overall net service fee was largely due to the securitization of excess service fees.
The increase in income from other retained interests was due primarily to an 22% increase in investment balances during the quarter ended June 30, 2003 combined with an increase in the effective yield of these investments from 16.2% in the quarter ended June 30, 2002 to 28.4% in the quarter ended June 30, 2003. These investments include interest-only and principal-only securities as well as residual interests that arise from the securitization of nonconforming mortgage loans, particularly Subprime and Prime Home Equity loans.
Higher prepayment penalties in the quarter ended June 30, 2003 correspond to the increase in Subprime loan payoffs during the quarter.
The increase in subservicing fees earned in the Global segment was primarily due to growth in the portfolio subserviced. The Global subservicing portfolio was $95 billion and $58 billion at June 30, 2003 and 2002, respectively.
Impairment of retained interests and Servicing Hedge gains are detailed below for the quarters ended June 30, 2003 and 2002:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- -------------------------------------------------------- ------------------------ -----------------------
Impairment of retained interests:
MSRs $ 1,491,487 $ 672,482
Other retained interests (permanent) 60,360 24,745
------------------------ -----------------------
$ 1,551,847 $ 697,227
======================== =======================
Servicing Hedge:
Hedge gains recorded through earnings $ 748,081 $ 462,409
------------------------ -----------------------
$ 748,081 $ 462,409
======================== =======================
Impairment of MSRs and other retained interests during the quarter ended June 30, 2003 resulted from a reduction in the estimated fair value of those investments primarily driven by increased forecasted prepayments on the underlying mortgage loans due to the decline in mortgage rates. In addition to the impairment charge, the Company recorded MSR amortization of $557.3 million in the quarter ended June 30, 2003.
During the quarter ended June 30, 2002, mortgage rates declined, resulting in MSR impairment of $672.5 million. The Company recorded MSR amortization of $244.3 million in the quarter ended June 30, 2002.
Rising mortgage rates in the future should result in an increase in the estimated fair value of the MSRs and recovery of all or a portion of the temporary impairment. The MSR amortization rate, which is tied to the expected net cash flows from the MSRs, likewise should reduce as mortgage rates rise.
During the quarter ended June 30, 2003, long-term Treasury and swap rates declined, resulting in a Servicing Hedge gain of $748.1 million. During the quarter ended June 30, 2002, the Servicing Hedge generated a gain of $462.4 million.
The Servicing Hedge is intended to moderate the effect on earnings caused by changes in the estimated fair value of MSRs and other retained interests that generally result from changes in mortgage rates. Rising interest rates in the future will result in Servicing Hedge losses.
Net insurance premiums earned are summarized below for the quarters ended June 30, 2003 and 2002:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Balboa Life and Casualty $ 136,552 $ 112,863
Balboa Reinsurance 31,631 20,865
----------------------- ------------------------
$ 168,183 $ 133,728
======================= ========================
The increase in net insurance premiums earned is primarily due to an increase in policies-in-force.
Commissions and other income consisted of the following for the quarters ended June 30, 2003 and 2002:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Credit report fees, net $ 21,604 $ 13,384
Appraisal fees, net 19,669 8,768
Global segment processing fees 19,188 11,398
Insurance agency commissions 13,149 15,673
Title services 12,940 7,757
Other 41,946 20,312
----------------------- ------------------------
$ 128,496 $ 77,292
======================= ========================
The increase in credit report, appraisal and title services fees is primarily due to the increased volume of mortgage loan originations in the Loan Production sector.
The increase in processing fees earned in the Global segment was due to growth in the number of loans processed.
The decrease in insurance agency commissions is due to branch consolidation and discontinuation of the agency’s home warranty and auto lines.
Compensation expenses are summarized below for the quarter ended June 30, 2003 and 2002:
Quarter Ended June 30, 2003
----------------------------------------------------------------------------
(Dollar amounts in thousands) Mortgage Other Corporate Total
Banking Businesses Administration
- ------------------------------ ----------------- ----------------- ------------------ -------------------
Base salaries $ 187,277 $ 49,422 $ 42,760 $ 279,459
Incentive bonus and
commissions 293,931 35,534 7,578 337,043
Payroll taxes and benefits 98,113 17,731 15,522 131,366
----------------- ----------------- ------------------ -------------------
Total compensation expenses $ 579,321 $ 102,687 $ 65,860 $ 747,868
================= ================= ================== ===================
Average workforce, including
temporary staff 25,660 4,925 3,051 33,636
================= ================= ================== ===================
Quarter Ended June 30, 2002
----------------------------------------------------------------------------
(Dollar amounts in thousands) Mortgage Other Corporate Total
Banking Businesses Administration
- ------------------------------ ----------------- ----------------- ------------------ -------------------
Base salaries $ 120,811 $ 37,448 $ 35,068 $ 193,327
Incentive bonus and
commissions 109,847 25,942 7,643 143,432
Payroll taxes and benefits 46,507 13,424 14,030 73,961
----------------- ----------------- ------------------ -------------------
Total compensation expenses $ 277,165 $ 76,814 $ 56,741 $ 410,720
================= ================= ================== ===================
Average workforce, including
temporary staff 16,168 3,680 2,524 22,372
================= ================= ================== ===================
Compensation expenses increased $337.1 million, or 82%, during the quarter ended June 30, 2003 as compared to the quarter ended June 30, 2002.
Compensation expenses in the Mortgage Banking segment increased primarily due to growth in the level of loan production activity. In the Loan Production sector, compensation expenses increased $283.0 million, or 131%, as a result of a 76% increase in average staff to support 187% higher loan production. Salaries rose 76% and incentive bonus and commissions rose 170%. The relative increase in incentive bonuses and commissions reflects a shift towards a more incentive-based compensation structure within the Loan Production sector. In the Loan Servicing sector, compensation expense rose $12.1 million, or 25%, as a result of an increase in average staff of 23% to support a 49% increase in the number of loans serviced and a 242% increase in the number of loan payoffs.
Compensation expenses increased in all other business segments reflecting their growth.
In the Insurance segment, compensation expenses increased by $0.7 million, or 3%, as a result of an increase of 8% in average staff to support growth of 26% in net earned premiums and growth in the Insurance Segment’s third-party insurance tracking operation.
Banking segment compensation expenses increased by $9.8 million to accommodate the growth of the Bank’s operations, primarily in its labor-intensive mortgage document custodian business.
In the Capital Markets segment, incentive bonuses increased $7.8 million, or 33%, reflecting growth in revenues of 115%.
Compensation expenses for Corporate Administration increased $9.1 million, or 16%, in the quarter ended June 30, 2003 as compared to the quarter ended June 30, 2002 due to an increase in average staff of 21% to support the overall growth in the Company.
Occupancy and other office expenses for the quarter ended June 30, 2003 increased primarily to accommodate personnel growth in the Loan Production sector, which accounted for 61% of the increase, as well as in the non-mortgage banking businesses, which accounted for 24% of the increase in this expense.
Insurance claim expenses were $85.9 million, or 51%, of net insurance premiums earned for the quarter ended June 30, 2003, as compared to $59.9 million, or 45%, of net insurance premiums earned for the quarter ended June 30, 2002. The increased loss ratio was partially attributable to Balboa Life and Casualty, whose loss ratio (including allocated loss adjustment expenses) increased from 52% for the quarter ended June 30, 2002 to 54% for the quarter ended June 30, 2003, due to higher claims experience in both voluntary homeowners’ and lender-placed insurance lines. In addition, insurance claims expenses of Balboa Reinsurance, which are a function of expected remaining losses and premiums, increased $10.7 million over the quarter ended June 30, 2002. Expected remaining premiums have declined due to an increase in estimated prepayments within the portfolio of insured loans.
Other operating expenses for the quarter ended June 30, 2003 and 2002 are summarized below:
Quarter Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------- ----------------------- ------------------------
Insurance commission expense $ 29,003 $ 31,537
Professional fees 23,387 17,766
Software amortization and impairment 19,984 5,353
Travel and entertainment 15,646 11,701
Bad debt expense 7,536 19,634
Insurance 6,165 3,861
Taxes and licenses 3,176 2,862
Other 22,035 9,736
----------------------- ------------------------
$ 126,932 $ 102,450
======================= ========================
Insurance commission expense as a percentage of insurance premiums earned declined from 24% to 17% between the two periods due to reduced contingent commissions accruing to insurance brokers as a result of higher than anticipated insured losses from policies subject to the contingent commission arrangements.
Bad debt expense consists primarily of losses during the period arising from unreimbursed servicing advances on defaulted loans, credit losses arising from repurchased or indemnified loans and defaulted VA-guaranteed loans. The decline in bad debt expense is due to a reduction in the number of losses and reduced severity of such losses. (See the “Credit Risk” section of this Report for further discussion.)
Software amortization and impairment expense increased in the current quarter primarily as a result of capitalized software write-offs of $13.1 million related to software no longer in use.
The Company’s diluted earnings per share for the six months ended June 30, 2003 was $5.19, an 85% increase over diluted earnings per share for the six months ended June 30, 2002. Net earnings were $709.2 million, a 98% increase from the six months ended June 30, 2002. This earnings performance was driven primarily by the increased level of mortgage loans produced by the Company—$232.6 billion—as compared to $86.2 billion for the year-ago period, partially offset by a reduction in value of the Company’s MSRs and other retained interests.
Industry-wide, residential mortgage originations were approximately $1,951 billion during the first six months of 2003, up from approximately $1,089 billion in the first six months of 2002 (Source: Fannie Mae). Approximately 73% of the residential mortgages produced in the six months ended June 30, 2003 were refinances triggered primarily by historically low mortgage rates. The balance of mortgages produced related to home purchases. Partially fueled by the level of mortgage rates, activity in the U.S. housing market also reached record levels in the first six months of 2003.
The continuing high demand for mortgages drove not only high volumes but also high production margins. The combination of high volumes and margins yielded Loan Production sector pre-tax earnings of $2,092.2 million for the six months, an increase of $1,276.9 million from the year-ago period.
The high levels of mortgage refinances and home purchases resulted in significant prepayments within the Company’s mortgage loan servicing portfolio during the period. This, along with the expectation of continued higher-than-normal prepayments in the future due to historically low mortgage rates, resulted in significant amortization and impairment of the Company’s MSRs and other retained interests. The combined amount of amortization and impairment of MSRs and other retained interests, net of Servicing Hedge gains, was $2,379.6 million, resulting in a pre-tax loss of $1,390.4 million in the Loan Servicing sector for the current six months, $965.8 million more than the pre-tax loss in the year-ago period.
These factors combined to produce pre-tax earnings of $756.6 million in the Mortgage Banking segment for the six months ended June 30, 2003, an increase of 81% from the six months ended June 30, 2002.
The Company’s non-mortgage banking businesses also were significant contributors to the earnings performance in the six months ended June 30, 2003. In particular, the Capital Markets segment had pre-tax earnings of $211.2 million, as compared to $77.1 million in the year-ago period. This segment continued to benefit from robust activity in the mortgage securities market, as well as from a highly-favorable interest rate environment. In addition, the Banking segment increased its pre-tax earnings by $84.2 million over the year ago period, driven by growth in assets in Treasury Bank. In total, non-mortgage banking businesses contributed $389.2 million in pre-tax earnings for the six months ended June 30, 2003 (34% of consolidated pre-tax earnings), an increase of 156% from $152.3 million (27% of total pre-tax earnings) for the year-ago period.
The Company’s pre-tax earnings by segment are summarized below:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- --------------------------------------------- ------------------------ ------------------------
Mortgage Banking:
Production $ 2,092,211 $ 815,272
Servicing (1,390,421) (424,636)
Closing Services 54,855 28,426
------------------------ ------------------------
Total Mortgage Banking 756,645 419,062
------------------------ ------------------------
Other Businesses:
Insurance 61,773 48,421
Capital Markets 211,163 77,059
Global Operations 5,571 (1,775)
Banking 110,610 26,422
Other 128 2,179
------------------------ ------------------------
Total Other Businesses 389,245 152,306
------------------------ ------------------------
Pre-tax earnings $ 1,145,890 $ 571,368
======================== ========================
The Company’s mortgage loan production by segment and product is summarized below:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in millions) 2003 2002
- --------------------------------------------- ------------------------ ------------------------
Segment:
Mortgage Banking $ 217,406 $ 82,825
Capital Markets' conduit acquisitions 9,559 3,182
Treasury Bank 5,648 156
------------------------ ------------------------
$ 232,613 $ 86,163
======================== ========================
Product:
Prime $ 217,177 $ 77,096
Prime Home Equity 7,857 5,249
Subprime 7,579 3,818
------------------------ ------------------------
$ 232,613 $ 86,163
======================== ========================
MORTGAGE
BANKING SEGMENT
The Mortgage Banking segment is comprised of three distinct sectors: Loan Production, Loan Servicing and Loan Closing
Services.
Loan Production Sector
The Loan Production sector
produces mortgage loans through CHL’s three production divisions - Consumer
Markets, Wholesale Lending and Correspondent Lending, as well as through Full
Spectrum Lending, Inc.
The pre-tax earnings of the Loan Production Sector are summarized below:
Six Months Ended June 30,
----------------------------------------------------------------------------
(Dollar amounts in 2003 2002
thousands)
- ---------------------------- -------------------------------------- ------------------------------------
Percent of Percent of
Loan Loan
Production Production
Dollars Volume Dollars Volume
--------------------- --------------- -------------------- --------------
Revenues $ 3,398,664 1.56% $ 1,509,347 1.82%
Expenses 1,306,453 0.60% 694,075 0.84%
--------------------- --------------- -------------------- --------------
Pre-tax earnings $ 2,092,211 0.96% $ 815,272 0.98%
===================== =============== ==================== ==============
Increased demand for residential mortgages enabled the Loan Production sector to achieve significant growth in revenues and earnings in the six months ended June 30, 2003 compared to the year-ago period. This performance was enhanced by a significant increase in market share from the year ago period. Favorable market conditions enabled the Company to increase revenues earned on prime first mortgage loans, while high levels of productivity helped keep unit costs low. These factors combined to produce continued high profit margins (pre-tax earnings as a percentage of loan volume) for the Loan Production sector. The decline in revenues as a percentage of loan volume in the current period is attributable primarily to unsold loan production, which amounted to 12% of the loans produced during the six months, as well as to a shift in the origination and sales mix toward prime first mortgage loans, which generally generate revenues at a lower rate than home equity or subprime loans. Substantially all of the unsold loans were classified as held for sale at June 30, 2003.
Overall loan production for the six months ended June 30, 2003 increased 162% in comparison to the year-ago period. All divisions, in particular Correspondent Lending, contributed to the increase in origination volume. The increase was due primarily to a rise in non-purchase loan production of 246%. An increase in purchase production of 48% also contributed to the higher origination volume. The increase in purchase loans is significant as this is the relatively stable growth component of the mortgage market, with average annual growth of 8% over the last 10 years. (The non-purchase, or refinance, component of the mortgage market is highly volatile as it is driven almost exclusively by prevailing mortgage rates.)
The following table shows total Mortgage Banking loan production volume by division:
Mortgage Banking
Loan Production
Six Months Ended June 30,
------------------------------------------------
(Dollar amounts in millions) 2003 2002
- ------------------------------------------------------ ----------------------- -----------------------
Correspondent Lending Division $ 110,699 $ 33,479
Wholesale Lending Division 51,964 25,368
Consumer Markets Division 51,690 22,614
Full Spectrum Lending, Inc. 3,053 1,364
----------------------- -----------------------
$ 217,406 $ 82,825
======================= =======================
The following table summarizes loan production by purpose and by interest rate type:
Mortgage Banking
Loan Production
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in millions) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Purpose:
Purchase $ 51,434 $ 34,792
Non-purchase 165,972 48,033
----------------------- ------------------------
$ 217,406 $ 82,825
======================= ========================
Interest Rate Type:
Fixed Rate $ 192,198 $ 69,484
Adjustable Rate 25,208 13,341
----------------------- ------------------------
$ 217,406 $ 82,825
======================= ========================
As shown in the following table, the volume of Prime Home Equity and Subprime mortgages produced (which is included in the Company’s total volume of loans produced) increased 47% during the current period from the prior period:
Mortgage Banking
Prime Home Equity and Subprime
Mortgage Production
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in millions) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Prime Home Equity $ 5,504 $ 4,988
Subprime 5,640 2,618
----------------------- ------------------------
$ 11,144 $ 7,606
======================= ========================
Percent of total loan production 5.1% 9.2%
======================= ========================
Prime Home Equity and Subprime loans carry higher profit margins historically and the demand for such loans is believed to be less rate sensitive than the demand for prime first mortgage loans; consequently, Management believes these loans will be a significant component of the sector’s future growth as interest rates increase from their historical low levels.
A major source of intrinsic value derived from the Company’s MSRs is the Company’s ability to retain its customers when they either refinance their loans or purchase new homes. The Company successfully retained a significant percentage of the customers who prepaid their mortgages during the period. The overall retention rate for the six months ended June 30, 2003 was 42% as compared to 33% for the year-ago period. The retention rate increased for both purchase and refinance customers. The retention rate for purchase customers was 25% for the six months ended June 30, 2003 as compared to 18% for the year-ago period. The retention rate for refinance customers was 45% for the six months ended June 30, 2003 as compared to 39% for the year-ago period.
During the six months ended June 30, 2003, the Loan Production Sector operated at approximately 123% of planned operational capacity. The primary capacity constraint in the Company’s loan origination activities is the number of loan operations personnel it has on staff. Therefore, the Company measures planned capacity with reference to the number of its loan operations personnel multiplied by the number of loans it expects each available loan operations staff person to process under normal conditions. The Company has continued to increase the number of sales and operations staff in its loan production divisions to capitalize upon the current market environment. When loan volumes moderate, the operations staff (which includes a significant number of temporary employees) will be reduced. Concurrent with this reduction in operations personnel will be a reduction in productivity to more substantial levels that likely will result in higher overall unit costs. The Company plans to continue building its sales staff despite any potential drop in loan origination volume as a primary means to continue increasing the Company’s market share.
The Consumer Markets Division successfully grew its commissioned sales force during the period. At June 30, 2003, the commissioned sales force numbered 2,971, an increase of 487 during the six months. The primary focus of the commissioned sales force is to increase overall purchase market share. The commissioned sales force contributed $10.6 billion in purchase originations in the six months ended June 30, 2003, a 92% increase over the year-ago period. The purchase production generated by the commissioned sales force represented 69% of the Consumer Markets Division’s purchase production for the six months ended June 30, 2003. At June 30, 2003, the Consumer Markets Division had 4 centralized processing units and 24 regional processing centers nationwide. During the six months ended June 30, 2003, the regional processing centers handled 23% of the division’s total loan volume.
Like the Consumer Markets Division, the Wholesale Lending Division and FSLI continued to grow their sales forces as a core strategy to increase market share. At June 30, 2003, the sales force in the Wholesale Lending Division numbered 575, an increase of 22% during the six months. FSLI expanded its sales force by 604, or 59%, during the six months ended June 30, 2003.
Loan Servicing Sector
The Loan Servicing sector
reflects the performance of the Company’s investments in MSRs and other
retained interests and associated risk management activities, as well as profits
from subservicing activities in the United States. The Loan Servicing Sector
includes a significant processing operation, consisting of approximately 5,874
employees who service the Company’s 4.6 million mortgage customers. How
effectively this servicing operation manages costs and generates ancillary
income from the portfolio has a significant impact on the long-term performance
of this sector.
The following table summarizes the results for the Loan Servicing sector:
Six Months Ended June 30,
-------------------------------------------------------------------------
2003 2002
------------------------------------ -----------------------------------
Amount Percentage of Amount Percentage of
Average Average
Servicing Servicing
(Dollar amounts in thousands) Portfolio* Portfolio*
- --------------------------------- ------------------ ---------------- ----------------- ----------------
Revenues $ 1,274,641 0.511% $ 974,911 0.556%
Servicing Hedge gains 754,442 0.303% 131,974 0.075%
Amortization (919,774) (0.369%) (501,990) (0.286%)
Impairment (2,214,260) (0.889%) (710,899) (0.405%)
Operating expense (212,374) (0.085%) (196,147) (0.112%)
Interest expense, net (73,096) (0.029%) (122,485) (0.070%)
------------------ ---------------- ----------------- ----------------
Pre-tax loss $ (1,390,421) (0.558%) $ (424,636) (0.242%)
================== ================ ================= ================
Average Servicing Portfolio $ 498,178,000 $ 350,577,000
================== =================
*Annualized
The Loan Servicing Sector experienced continued losses during the recent period, driven by high amortization and impairment of the Company’s retained interests. The amortization and impairment charges reflect the loss in value of the Company’s retained interests primarily caused by the high level of actual and forecasted prepayments in the Company’s mortgage servicing portfolio. In general, the value of the retained interests is closely linked to the estimated life of the underlying loans, which in recent periods has declined primarily due to the decline in mortgage rates. The combined impairment and amortization charge was $3,134.0 million and $1,212.9 million during the six months ended June 30, 2003 and 2002, respectively.
During the six months ended June 30, 2003, the Servicing Hedge generated a gain of $754.4 million. This gain resulted from a decline in long term Treasury and swap rates, which indices underlie the derivatives and securities that constitute the essential component of the Servicing Hedge. Amortization and impairment, net of the Servicing Hedge, was $2,379.6 million for the six months ended June 30, 2003, an increase of $1,298.7 million over the six months ended June 30, 2002. In a stable interest rate environment, Management would expect no significant impairment and would expect to incur expenses related to the Servicing Hedge driven primarily by the composition of the hedge, the shape of the yield curve and the level of interest rate volatility.
During the six months ended June 30, 2003, the Company securitized a portion of its net servicing fees (“excess servicing”). Proceeds from the sale of a portion of these securities amounted to $306.2 million. The remaining interest-only security was classified as a trading security and included in “Investments in other financial instruments” at June 30, 2003. Management believes such securitizations enable the Company to improve the overall returns on its MSR investment and more efficiently manage its capital.
Despite the high level of prepayments, the Company increased its servicing portfolio to $559.1 billion at June 30, 2003, a 49% increase from June 30, 2002. At the same time, the overall weighted-average note rate of loans serviced for others declined from 7.3% to 6.4%.
Loan Closing Services Sector
The LandSafe companies
produced $54.9 million in pre-tax earnings, representing an increase of 93% from
the year-ago period. The increase in LandSafe’s pre-tax earnings was
primarily due to the increase in loan origination activity in the Loan
Production sector.
The Company’s other business segments include Capital Markets, Banking, Insurance and Global Operations. Pre-tax earnings from these other businesses increased $236.9 million in the six months ended June 30, 2003 over the six months ended June 30, 2002.
Capital Markets Segment
The Capital Markets segment
achieved pre-tax earnings of $211.2 million for the six months, an increase of
$134.1 million, or 174%, from the year-ago period. Total revenues were $331.2
million, an increase of $168.0 million, or 103% compared to the year ago period.
Total securities trading volume increased 73% to $1,451.9 billion. This
performance was driven largely by a highly favorable operating environment
consisting of a robust mortgage securities market, high mortgage securities
price volatility, and low short-term financing costs.
The following table shows pre-tax earnings by company:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ----------------------------------------------------- ------------------------ ------------------------
CSC(1) $ 167,643 $ 71,376
CAMCo 43,520 5,683
------------------------ ------------------------
$ 211,163 $ 77,059
======================== ========================
(1) Includes CSE, CCMI and CCM, Inc.
The following table shows the composition of CSC’s trading volume, which includes trades with the Mortgage Banking segment, by instrument:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in millions) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Mortgage-backed securities $ 1,377,719 $ 779,971
Government agency debt 48,753 31,904
Asset-backed securities 18,392 22,778
Other 7,026 4,277
----------------------- ------------------------
$ 1,451,890 $ 838,930
======================= ========================
The segment’s mortgage conduit activities generated $134.9 million in gross revenues during the six months ended June 30, 2003, compared to $47.8 million during the year-ago period. The combined amount of mortgage loans sold during the period that were acquired by the conduits totaled $17.3 billion.
Banking Segment
The Banking segment
commenced operations in calendar 2001. The segment achieved pre-tax earnings of
$110.6 million in the six months ended June 30, 2003, as compared to $26.4
million for the year-ago period. Following is the composition of pre-tax
earnings by company:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Bank $ 78,772 $ 18,692
CWL 38,333 7,740
Parent and allocated corporate overhead expenses (6,495) (10)
----------------------- ------------------------
$ 110,610 $ 26,422
======================= ========================
- ---------------------------------------------------------------------------------------------------------
The Bank produced pre-tax earnings of $78.8 million for the six months ended June 30, 2003, an increase of $60.1 million over the prior year period. The overall increase was primarily due to an increase in net interest income arising from growth in average earning assets and increased profit of $19.6 million resulting from document custodian services provided to CHL. Average earning assets increased to $8.7 billion during the six months ended June 30, 2003, an increase of $6.3 billion in comparison to the year-ago period. Asset growth was funded primarily by the transfer of custodial balances controlled by CHL from third party banks to the Bank, two capital contributions from CFC, Federal Home Loan Bank advances, and growth in the Bank’s retail deposit base. As of June 30, 2003, $6.5 billion of custodial balances controlled by CHL were placed as deposits in the Bank. The Bank’s annual pre-tax return on assets for the six months ended June 30, 2003 was 1.78%. The composition of the Bank’s assets was as follows:
(Dollar amounts in thousands) June 30, 2003 December 31, 2002
- ---------------------------------------- ----------------------- ------------------------
Cash $ 99,965 $ 163,547
Short-term investments 885,000 300,000
Mortgage loans, net 7,807,956 1,902,793
Investment securities classified as
available-for-sale 3,790,977 2,590,789
Other assets 507,424 153,690
----------------------- ------------------------
Total $ 13,091,322 $ 5,110,819
======================= ========================
CWL’s pre-tax earnings increased by $30.6 million during the six months ended June 30, 2003 in comparison to the year-ago period, primarily due to growth in average outstanding mortgage warehouse advances partially offset by a decline in the average net spread from 2.26% during the six months ended June 30, 2002 to 1.87% during the six months ended June 30, 2003. For the current six months, average mortgage warehouse advances outstanding were $4.1 billion, an increase of $3.3 billion in comparison to the year-ago period. The increase in warehouse advances was largely attributable to growth in the overall mortgage originations market.
Insurance Segment
The Insurance segment
pre-tax earnings increased 28% over the year-ago period, to $61.8 million. The
following table shows pre-tax earnings by business line:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ------------------------ -----------------------
Carrier Operations:
Balboa Reinsurance Company $ 43,498 $ 40,205
Balboa Life and Casualty 21,654 8,160
------------------------ -----------------------
65,152 48,365
Agency operations 6,363 5,882
Parent and allocated corporate overhead expenses (9,742) (5,826)
------------------------ -----------------------
$ 61,773 $ 48,421
======================== =======================
The following table shows net earned premiums for the carrier operations:
Six Months Ended June 30,
-----------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ -------------------- -------------------
Carrier Operations:
Balboa Life and Casualty $ 279,936 $ 213,318
Balboa Reinsurance Company 59,383 36,730
-------------------- -------------------
$ 339,319 $ 250,048
==================== ===================
The Company’s mortgage reinsurance business produced $43.5 million in pre-tax earnings, an increase of 8% over the year-ago period, due primarily to a 62% increase in net earned premiums that was driven by growth in the Company’s loan servicing portfolio, partially offset by a $20 million increase in insurance claims expenses. Insurance claims expenses are a function of expected remaining losses and premiums. Expected remaining premiums have declined due to an increase in estimated prepayments within the portfolio of insured loans.
The Company’s Life and Casualty insurance business produced pre-tax earnings of $21.7 million, an increase of $13.5 million from the comparable period in 2002. The growth in earnings was driven by a $66.6 million, or 31%, increase in net earned premiums during the six months ended June 30, 2003 in comparison to the year-ago period. The growth in net earned premiums was primarily attributable to growth in lender-placed insurance. The increase in premiums was partially offset by an increase in the loss ratio from 51% to 54%. In addition, pre-tax investment earnings increased by $4.8 million over the year-ago period.
Global Operations Segment
For the six months ended
June 30, 2003, the Global Operations segment’s pre-tax earnings totaled
$5.6 million, representing an increase of $7.4 million in comparison to the
year-ago period. Results in the current period were positively impacted by
growth in the portfolio of mortgage loans sub-serviced and the number of new
mortgage loans processed on behalf of GHL’s minority joint venture partner,
Barclays plc, partially offset by a software impairment charge of $6.5 million.
Gain on sale of loans and securities is summarized below for the six months ended June 30, 2003 and 2002:
Six Months Ended June 30,
-----------------------------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ---------------------------------------------- ----------------------------------- ----------------------------------
Percentage of Percentage of
Dollars Loans Sold Dollars Loans Sold
----------------- ---------------- ---------------- ----------------
Mortgage Banking:
Prime First Mortgages $ 2,791,657 1.48% $ 947,111 1.24%
Subprime Mortgages 234,767 5.71% 158,249 5.24%
Prime Home Equity Mortgages 1,279 3.27% 108,866 3.42%
----------------- ----------------
Production sector 3,027,703 1.57% 1,214,226 1.47%
Re-performing loans 127,359 6.97% 49,067 3.49%
----------------- ----------------
3,155,062 1,263,293
Capital Markets
Trading Securities (21,254) (32,199)
Conduit Activities 120,413 36,643
----------------- ----------------
99,159 4,444
Other 15,421 8,422
----------------- ----------------
$ 3,269,642 $ 1,276,159
================= ================
Gain on sale of loans and securities increased in the six months ended June 30, 2003 as compared to the six months ended June 30, 2002 primarily due to higher loan production and sales volume combined with higher margins on Prime First Mortgages. Margins on Prime First Mortgages were high in both periods on a relative historical basis, due largely to the very favorable mortgage market environment that prevailed during those periods.
During the six months ended June 30, 2003, the Company sold a small portion of Prime Home Equity Loans produced. As it has done in recent periods, the Company plans to securitize the remaining prime home equity lines-of-credit originated in its Mortgage Banking operation and hold those securities as long-term investments.
Capital Markets’ revenues from its trading activities consist of gains on the sale of securities and net interest income. In a very steep yield curve environment, which existed during both periods, trading revenues will derive largely or entirely from net interest income earned during the securities’ holding period. As the yield curve flattens, the mix of revenues will shift toward gain on sale of securities. The increase in Capital Markets’ gain on sale of loans related to its conduit activities was due to increased acquisitions and sales during the six months ended June 30, 2003 in comparison to the year-ago period.
In general, gain on sale of loans and securities are affected by numerous factors, including the volume and mix of loans sold, production channel mix, the level of price competition, the slope of the yield curve and the effectiveness of the Company’s associated interest rate risk management activities.
Net interest income is summarized below for the six months ended June 30, 2003 and 2002:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Net interest income:
Mortgage loans and securities held for sale $ 297,341 $ 279,723
Custodial balances (108,660) 9,495
Servicing sector interest expense (126,348) (177,544)
Re-performing loans 62,746 65,421
Capital Markets securities trading portfolio 200,883 139,097
Insurance segment investments 16,742 17,031
Banking segment loans and securities 123,930 31,672
Home equity AAA asset-backed securities 42,671 11,323
Other 14,728 6,532
----------------------- ------------------------
Net interest income $ 524,033 $ 382,750
======================= ========================
The increase in net interest income from mortgage loans and securities held for sale reflects an increase in the average inventory combined with a lower overall net earnings rate during the six months ended June 30, 2003. The Company finances the major portion of its mortgage loans and securities held for sale at prevailing short-term borrowing rates, which did not decrease in tandem with the decrease in mortgage rates when compared to the year-ago period.
Net interest income from custodial balances decreased in the current period due to the substantial increase in loan payoffs over the year-ago period. The Company is obligated to pass through monthly interest to security holders on paid-off loans at the underlying security rates, which were substantially higher than the short term rates earned by the Company on payoff float. The amount of such interest passed through to the security holders was $210.7 million and $68.6 million in the six months ended June 30, 2003 and 2002, respectively. In addition, the earnings rate on the custodial balances, which is tied to short-term rates, declined from 1.74% during the six months ended June 30, 2002 to 1.15% during the six months ended June 30, 2003. Average custodial balances increased by $8.8 billion, or 98%, over the prior period, due largely to the increase in loan payoffs.
Interest expense allocated to the Loan Servicing sector decreased due to a decline in short-term rates (a portion of the Company’s long-term debt is variable-rate), combined with a decrease in total sector assets.
Re-performing loans are reinstated loans that had previously defaulted and were consequently re-purchased from mortgage securities issued by the Company or others. Such loans are subsequently securitized and re-sold.
The increase in net interest income from the Capital Markets securities trading portfolio is attributable to an increase of 78% in the average inventory of securities held, partially offset by a decrease in the average net spread earned from 4.16% in the six months ended June 30, 2002 to 3.38% in the six months ended June 30, 2003. The decrease in the average net spread is the result of a flatter yield curve.
The increase in net interest income from the Banking segment was primarily attributable to year-over-year asset growth in both the Bank and CWL. The increase in assets was partially offset by a small decrease in the weighted average spread from 1.98% in the six months ended June 30, 2002 to 1.94% in the six months ended June 30, 2003. Average assets in the Banking segment increased to $12.8 billion during the six months ended June 30, 2003, an increase of $9.6 billion over the year-ago period.
The increase in net interest income from home equity AAA asset-backed securities is due to an increase in the average inventory of securities held.
Loan servicing fees and other income from retained interests is summarized below for the six months ended June 30, 2003 and 2002:
Six Months Ended June 30,
--------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Service fees, net of guarantee fees $ 896,557 $ 684,639
Income from other retained interests 173,356 93,682
Prepayment penalties 80,746 48,884
Late charges 70,623 61,169
Global segment subservicing fees 44,024 19,523
Ancillary fees 30,863 22,421
----------------------- ------------------------
$ 1,296,169 $ 930,318
======================= ========================
The increase in servicing fees, net of guarantee fees, was principally due to a 42% increase in the average servicing portfolio, partially offset by a reduction in the overall net service fee earned from 0.391% of the average portfolio balance during the six months ended June 30, 2002 to 0.360% during the six months ended June 30, 2003. The reduction in the overall net service fee was largely due to the securitization of excess service fees.
The increase in income from other retained interests was due primarily to a 28.6% increase in investment balances during the six months ended June 30, 2003 combined with an increase in the effective yield of these investments from 17.8% in the six months ended June 30, 2002 to 24.6% in the six months ended June 30, 2003. These investments include interest-only and principal-only securities as well as residual interests that arise from the securitization of nonconforming mortgage loans, particularly Subprime and Prime Home Equity loans.
Higher prepayment penalties in the six months ended June 30, 2003 correspond to the increase in Subprime loan payoffs during the six months.
The increase in subservicing fees earned in the Global segment was primarily due to growth in the portfolio subserviced. The Global subservicing portfolio was $95 billion and $58 billion at June 30, 2003 and 2002, respectively.
Impairment of retained interests and Servicing Hedge gains are detailed below for the six months ended June 30, 2003 and 2002:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- -------------------------------------------------------- ------------------------ -----------------------
Impairment of retained interests:
MSRs $ 2,094,429 $ 660,727
Other retained interests (permanent) 119,831 50,172
------------------------ -----------------------
$ 2,214,260 $ 710,899
======================== =======================
Servicing Hedge:
Hedge gains recorded through earnings $ 754,442 $ 131,974
------------------------ -----------------------
$ 754,442 $ 131,974
======================== =======================
Impairment of MSRs and other retained interests during the six months ended June 30, 2003 resulted from a reduction in the estimated fair value of those investments primarily driven by increased forecasted prepayments on the underlying mortgage loans due to the decline in mortgage rates. In addition to the impairment charge, the Company recorded MSR amortization of $919.8 million in the six months ended June 30, 2003.
During the six months ended June 30, 2002, mortgage rates declined, resulting in MSR impairment of $660.7 million. The Company recorded MSR amortization of $502.0 million in the six months ended June 30, 2002.
Rising mortgage rates in the future should result in an increase in the estimated fair value of the MSRs and recovery of all or a portion of the temporary impairment. The MSR amortization rate, which is tied to the expected net cash flows from the MSRs, likewise should reduce as mortgage rates rise.
During the six months ended June 30, 2003, long-term Treasury and swap rates declined, resulting in a Servicing Hedge gain of $754.4 million. During the six months ended June 30, 2002, the Servicing Hedge generated a gain of $132.0 million.
The Servicing Hedge is intended to moderate the effect on earnings caused by changes in the estimated fair value of MSRs and other retained interests that generally result from changes in mortgage rates. Rising interest rates in the future will result in Servicing Hedge losses.
Net insurance premiums earned are summarized below for the six months ended June 30, 2003 and 2002:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Balboa Life and Casualty $ 279,936 $ 213,318
Balboa Reinsurance 59,383 36,730
----------------------- ------------------------
$ 339,319 $ 250,048
======================= ========================
The increase in net insurance premiums earned is primarily due to an increase in policies-in-force.
Commissions and other income consisted of the following for the six months ended June 30, 2003 and 2002:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Global segment processing fees $ 37,522 $ 20,542
Credit report fees, net 39,444 25,722
Appraisal fees, net 35,093 18,122
Insurance agency commissions 26,412 29,205
Title services 24,727 17,204
Other 79,256 42,919
----------------------- ------------------------
$ 242,454 $ 153,714
======================= ========================
The increase in credit report, appraisal and title service fees is primarily due to the increased volume of mortgage loan originations in the Loan Production sector.
The increase in processing fees earned in the Global segment was due to growth in the number of loans processed.
The decrease in insurance agency commissions is due to branch consolidation and discontinuation of the agency’s home warranty and auto lines.
Compensation expenses are summarized below for the six months ended June 30, 2003 and 2002:
Six Months Ended June 30, 2003
----------------------------------------------------------------------------
(Dollar amounts in thousands) Mortgage Other Corporate Total
Banking Businesses Administration
- ------------------------------ ----------------- ----------------- ------------------ -------------------
Base salaries $ 350,033 $ 98,402 $ 83,755 $ 532,190
Incentive bonus and
commissions 504,668 84,075 22,826 611,569
Payroll taxes and benefits 191,665 34,930 32,636 259,231
----------------- ----------------- ------------------ -------------------
Total compensation expenses $ 1,046,366 $ 217,407 $ 139,217 $ 1,402,990
================= ================= ================== ===================
Average workforce, including
temporary staff 24,252 4,926 2,956 32,134
================= ================= ================== ===================
Six Months Ended June 30, 2002
----------------------------------------------------------------------------
(Dollar amounts in thousands) Mortgage Other Corporate Total
Banking Businesses Administration
- ------------------------------ ----------------- ----------------- ------------------ -------------------
Base salaries $ 252,441 $ 72,628 $ 47,362 $ 372,431
Incentive bonus and
commissions 211,998 56,704 14,691 283,393
Payroll taxes and benefits 78,797 23,335 44,193 146,325
----------------- ----------------- ------------------ -------------------
Total compensation expenses $ 543,236 $ 152,667 $ 106,246 $ 802,149
================= ================= ================== ===================
Average workforce, including
temporary staff 15,693 3,531 2,448 21,671
================= ================= ================== ===================
Compensation expenses increased $600.8 million, or 75%, during the six months ended June 30, 2003 as compared to the six months ended June 30, 2002.
Compensation expenses in the Mortgage Banking segment increased primarily due to growth in the level of loan production activity. In the Loan Production sector, compensation expenses increased $469.0 million, or 111%, as a result of a 72% increase in average staff to support 153% higher loan production. Salaries rose 68% and incentive bonus and commissions rose 140%. The relative increase in incentive bonuses and commissions reflects a shift towards a more incentive-based compensation structure within the Loan Production sector. In the Loan Servicing sector, compensation expense rose $21.1 million, or 22%, as a result of an increase in average staff of 20% to support a 31% increase in the number of loans serviced and a 173% increase in the number of loan payoffs. Compensation expenses in the Loan Closing sector increased $13.1 million, or 54% as a result of an increase in average staff of 35% to support increased activity in this sector.
Compensation expenses increased in all other business segments reflecting their growth.
In the Insurance segment, compensation expenses increased by $4.1 million, or 9%, as a result of an increase of 12% in average staff to support growth of 36% in net earned premiums and growth in the Insurance Segment’s third-party insurance tracking operation.
In the Capital Markets segment, incentive bonuses increased $23.1 million, or 44%, reflecting growth in revenues of 103%.
Banking segment compensation expenses increased by $19.3 million to accommodate the growth of the Bank’s operations, primarily in its labor-intensive mortgage document custodian business.
Compensation expenses in the Global Operations segment increased $14.7 million, or 59%, as a result of an increase in average staff of 44% resulting from the addition of a facility to process the additional volume of loans serviced in GHL.
Compensation expenses for Corporate Administration increased $33.0 million, or 31%, in the six months ended June 30, 2003 as compared to the six months ended June 30, 2002 due to an increase in average staff of 21% to support the overall growth in the Company and higher incentive bonuses earned based upon the Company’s increased profitability.
Occupancy and other office expenses for the six months ended June 30, 2003 increased primarily to accommodate personnel growth in the Loan Production sector, which accounted for 63% of the increase, as well as growth in the non-mortgage banking businesses, which accounted for 16% of the increase in this expense.
Insurance claim expenses were $173.9 million, or 51%, of net insurance premiums earned for the six months ended June 30, 2003, as compared to $111.2 million, or 44%, of net insurance premiums earned for the six months ended June 30, 2002. The increased loss ratio was partially attributable to Balboa Life and Casualty, whose loss ratio (including allocated loss adjustment expenses) increased from 51% for the six months ended June 30, 2002 to 54% for the six months ended June 30, 2003, due to higher claims experience in both voluntary homeowners’ and lender-placed insurance lines. In addition, insurance claims expenses of Balboa Reinsurance, which are a function of expected remaining losses and premiums, increased $20.0 million over the six months ended June 30, 2002. Expected remaining premiums have declined due to an increase in estimated prepayments within the portfolio of insured loans.
Other operating expenses for the six months ended June 30, 2003 and 2002 are summarized below:
Six Months Ended June 30,
-------------------------------------------------
(Dollar amounts in thousands) 2003 2002
- ------------------------------------------------------ ----------------------- ------------------------
Insurance commission expense $ 61,878 $ 57,901
Professional fees 44,247 33,954
Travel and entertainment 29,088 20,257
Bad debt expense 28,026 36,769
Insurance 13,935 7,261
Software amortization and impairment 29,588 10,831
Taxes and licenses 6,611 5,996
Other 38,697 21,873
----------------------- ------------------------
$ 252,070 $ 194,842
======================= ========================
Insurance commission expense as a percentage of insurance premiums earned declined from 23% to 18% between the two periods due to reduced contingent commissions accruing to insurance brokers as a result of higher than anticipated insured losses from policies subject to the contingent commission arrangements.
Bad debt expense consists primarily of losses during the period arising from unreimbursed servicing advances on defaulted loans, credit losses arising from repurchased or indemnified loans and defaulted VA-guaranteed loans. The decline in bad debt expenses is due to a reduction in the number of losses and reduced severity of such losses. (See the “Credit Risk” section of this Report for further discussion.)
Software amortization and impairment expense increased in the current period primarily as a result of capitalized software write-offs of $16.3 million related to software no longer in use.
The primary market risk facing the Company is interest rate risk. From an enterprise perspective, the Company manages this risk through the natural counterbalance of its loan production and servicing businesses. The Company also uses various financial instruments, including derivatives, to manage the interest rate risk related specifically to its Committed Pipeline, Mortgage Loan Inventory and MBS held for sale, MSRs, trading securities and other retained interests as well as a portion of its debt. The overall objective of the Company’s interest rate risk management activities is to reduce the variability of reported earnings caused by changes in interest rates.
Impact of Changes in Interest Rates on the Net Value of the Company's Interest Rate - Sensitive Financial Instruments
The Company performs various sensitivity analyses that quantify the net financial impact of changes in interest rates on its interest rate-sensitive assets, liabilities and commitments. These analyses incorporate assumed changes in the interest rate environment including selected hypothetical (instantaneous) parallel shifts in the yield curve.
The following table summarizes the estimated change in fair value of the Company’s interest rate-sensitive assets, liabilities and commitments as of June 30, 2003, given several hypothetical (instantaneous) parallel shifts in the yield curve:
(Dollar amounts in millions)
Change in Fair Value
----------------------------------------------------------
Change in Interest Rate (basis points) -100 -50 +50 +100
---------------------------------------------------------------- ------------ ----------- ----------- ------------
MSRs and other financial instruments:
MSR and other retained interests $(2,107) $ (1,199) $ 1,349 $ 2,558
Impact of Servicing Hedge:
Mortgage-based 32 15 (13) (24)
Swap-based 880 378 (249) (407)
Treasury-based 1,115 362 (61) (21)
------------ ------------ ----------- -----------
MSRs and other retained interests, net (80) (444) 1,026 2,106
------------ ------------ ----------- -----------
Committed Pipeline 350 329 (530) (1,298)
Mortgage Loan Inventory 1,329 800 (1,078) (2,321)
Impact of associated derivative instruments:
Mortgage-based (1,900) (1,172) 1,676 3,654
Treasury-based (11) (15) 29 62
------------ ------------ -----------
Committed Pipeline and Mortgage Loan Inventory, net (232) (58) 97 97
------------ ------------ ----------- -----------
Notes payable and capital securities (527) (266) 283 562
Impact of associated derivative instruments:
Swap-based 55 28 (30) (64)
------------ ------------ ----------- -----------
Notes payable and capital securities, net (472) (238) 253 498
------------ ------------ ----------- -----------
Prime home equity line of credit senior securities 21 13 (17) (39)
Mortgage loans held for investment 55 32 (44) (99)
Insurance and banking investment portfolios 54 33 (46) (105)
Deposit liabilities (42) (20) 19 39
------------ ------------ ----------- -----------
Net change in fair value related to MSRs and other financial $(696) $ (682) $ 1,288 $ 2,497
instruments ============ ============ =========== ===========
Net change in fair value related to trading securities $20 $ 7 $ (3) $ (10)
============ ============ =========== ===========
The following table summarizes the estimated change in fair value of the Company’s interest rate-sensitive assets, liabilities and commitments as of December 31, 2002, given several hypothetical (instantaneous) parallel shifts in the yield curve:
(Dollar amounts in millions)
Change in Fair Value
----------------------------------------------------------
Change in Interest Rate (basis points) -100 -50 +50 +100
- -------------------------------------------------------------- ------------ ----------- ----------- ------------
Net change in fair value related to MSRs and other financial $ 45 $ (166) $ 522 $ 1,069
instruments ============ ============ =========== ===========
Net change in fair value related to trading securities $ 3 $ 2 $ (1) $ (6)
============ ============ =========== ===========
As shown in the sensitivity analysis above, the Company’s exposure to reductions in the fair value of its MSRs and other financial instruments attributable to declines in interest rates increased significantly from December 31, 2002 to June 30, 2003. From an enterprise perspective, the Company manages its interest rate risk through the natural counterbalance of its loan production and servicing businesses and through the use of financial instruments, including derivatives. During the six month period ended June 30, 2003, interest rates declined. In this environment, Management reduced its reliance on hedging instruments in favor of the benefits it expects would be realized through the increased profitability in the Loan Production sector in the event interest rates were to decrease further.
These sensitivity analyses are limited in that they were performed at a particular point in time, are subject to the accuracy of various assumptions used, including prepayment forecasts and discount rates, and do not incorporate other factors that would impact the Company’s overall financial performance in such scenarios, most significantly the impact of changes in loan production earnings that occur over time. In addition, not all of the changes in fair value would impact current period earnings. MSRs are carried at lower of cost or market; therefore, absent hedge accounting, the increase in the value of the MSRs that is recorded in current period earnings would be limited to recovery of the impairment reserve ($2.3 billion at June 30, 2003.) Debt is carried at cost; therefore, absent hedge accounting, changes in the value of debt are not recorded in current period earnings. Consequently, the preceding estimates should not be viewed as an earnings forecast.
Foreign Currency Risk
An additional, albeit less
significant, market risk facing the Company is foreign currency risk. The
Company has issued foreign currency-denominated medium-term notes. The Company
manages the foreign currency risk associated with such medium-term notes through
currency swap transactions. The terms of the currency swaps effectively
translate the foreign currency denominated medium-term notes into United States
dollars, thereby eliminating the associated foreign currency risk (subject to
the performance of the various counterparties to the currency swaps). As a
result, potential changes in the exchange rates of foreign currencies
denominating such medium-term notes would not have a net financial impact on
future earnings, fair values or cash flows.
Securitization
Substantially all mortgage loans originated by the Company are securitized and sold into the secondary mortgage market. As described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, the degree to which credit risk on the underlying loans is transferred through the securitization process depends on the structure of the securitization. The Company’s prime, first mortgage loans generally are securitized on a non-recourse basis, while its Prime Home Equity and Subprime Mortgage Loans generally are securitized with limited recourse for credit losses.
The Company’s exposure to credit losses related to its limited recourse securitization activities is limited to the carrying value of its subordinated interests and to the contractual limit of reimbursable losses under its corporate guarantees less the recorded liability for such guarantees. These amounts at June 30, 2003 are as follows:
(Dollar amounts in thousands) June 30, 2003
- ---------------------------------------------------------- ---------------------
Subordinated Interests:
Prime Home Equity residual securities $ 454,115
Prime Home Equity transferors' interests 266,781
Subprime residual securities 324,728
---------------------
$ 1,045,624
=====================
Corporate guarantees in excess of recorded reserves $ 63,818
=====================
The carrying value of the residual securities is net of expected future credit losses.
Related to the Company’s non-recourse and limited recourse securitization activities, the total credit losses incurred for the six months ended June 30, 2003 and 2002 are summarized as follows:
Six Months Ended June 30,
-------------------------------------------
(Dollar amounts in thousands) 2003 2002
- -------------------------------------------------------------------- --------------------- ---------------------
Subprime securitizations with corporate guarantee $ 18,621 $ 7,942
Subprime securitizations with retained residual interest 26,535 26,720
Repurchased or indemnified loans 14,890 7,925
Prime Home Equity securitizations with retained residual interest 6,942 3,453
Prime Home Equity securitizations with corporate guarantee 365 168
VA losses in excess of VA guarantee 1,248 1,426
--------------------- ---------------------
$ 68,601 $ 47,634
===================== =====================
Mortgage Reinsurance
The Company provides mortgage reinsurance through contracts with several primary mortgage insurance companies on mortgage loans included in the Company’s servicing portfolio. Under these contracts, the Company absorbs mortgage insurance losses in excess of a specified percentage of the principal balance of a given pool of loans, subject to a cap, in exchange for a portion of the pool’s mortgage insurance premium. Approximately $60.3 billion of mortgage loans in the Company’s servicing portfolio are covered by such mortgage reinsurance contracts. The reinsurance contracts place limits on the Company’s maximum exposure to losses. At June 30, 2003, the maximum aggregate losses under the reinsurance contracts was $323.6 million. The Company is required to pledge securities to cover this potential liability. For the six months ended June 30, 2003, the Company did not incur any losses under its reinsurance contracts.
Mortgage Loans Held for Sale
At June 30, 2003, mortgage loans held for sale amounted to $35.7 billion. While the loans are in inventory, the Company bears total credit risk after taking into consideration primary mortgage insurance (which is generally required for conventional loans with a loan-to-value ratio greater than 80%), FHA insurance or VA guarantees. Historically, credit losses related to loans held for sale have not been significant.
Portfolio Lending Activities
The Company also holds a portfolio of secured mortgage warehouse advances and mortgage loans held for investment, primarily in its Banking segment, which amounted to $12.2 billion at June 30, 2003. Management believes the allowance for related loan losses is adequate to absorb losses inherent in the loans held for investment at June 30, 2003.
Counterparty Credit Risk
The Company is exposed to credit loss in the event of nonperformance by its trading counterparties and counterparties to its various non-exchange-traded derivative financial instruments. The Company manages this credit risk by selecting only well-established, financially strong counterparties, spreading the credit risk among many such counterparties, and by placing contractual limits on the amount of unsecured credit risk from any single counterparty. The Company’s exposure to credit losses in the event of nonperformance by a counterparty is equal to the net unrealized gains associated with the counterparty’s open trades or derivative contracts, net of any available collateral retained by the Company, a custodian or the Mortgage-Backed Securities Clearing Corporation, which is an independent clearing agent.
The aggregate amount of counterparty credit exposure at June 30, 2003, before and after collateral held, was as follows:
(Dollar amounts in millions)
- -------------------------------------------------------
Aggregate credit exposure before collateral held $ 997
Less: collateral held (591)
---------------------
Net aggregate unsecured credit exposure $ 406
=====================
For the six months ended June 30, 2003, the Company incurred no losses due to the non-performance of any of its counterparties.
The following table sets forth certain information regarding the Company’s servicing portfolio of single-family mortgage loans, including loans and securities held for sale and loans subserviced for others, for the periods indicated.
Six Months Ended June 30,
-----------------------------------------------
(Dollar amounts in millions) 2003 2002
- ---------------------------------------------------------- ----------------------- ----------------------
Summary of changes in the servicing portfolio:
Beginning owned servicing portfolio $ 441,267 $ 327,540
Add: Loan production 232,613 86,163
Purchased MSRs 2,633 1,764
Less: Servicing Transferred - -
Servicing Sold - -
Runoff (1) (128,907) (49,711)
----------------------- ----------------------
Ending owned servicing portfolio 547,606 365,756
Subservicing portfolio 11,518 9,076
----------------------- ----------------------
Total servicing portfolio $ 559,124 $ 374,832
======================= ======================
June 30,
-----------------------------------------------
2003 2002
----------------------- ----------------------
Composition of owned servicing portfolio at period end:
Conventional mortgage loans $ 444,126 $ 270,240
FHA-insured mortgage loans 43,938 46,392
VA-guaranteed mortgage loans 14,142 15,645
Subprime loans 27,159 20,238
Prime Home Equity loans 18,241 13,241
----------------------- ----------------------
Total owned servicing portfolio $ 547,606 $ 365,756
======================= ======================
Delinquent mortgage loans (2):
30 days 2.24% 2.72%
60 days 0.68% 0.81%
90 days or more 0.87% 1.10%
----------------------- ----------------------
Total delinquent mortgage loans 3.79% 4.63%
======================= ======================
Loans pending foreclosure (2) 0.47% 0.54%
======================= ======================
Delinquent mortgage loans (2):
Conventional 2.03% 2.31%
Government 11.91% 11.27%
Subprime 12.70% 13.29%
Prime Home Equity 0.69% 0.73%
----------------------- ----------------------
Total delinquent mortgage loans 3.79% 4.63%
======================= ======================
Loans pending foreclosure (2):
Conventional 0.21% 0.23%
Government 1.18% 1.08%
Subprime 2.71% 2.67%
Prime Home Equity 0.05% 0.05%
----------------------- ----------------------
Total loans pending foreclosure 0.47% 0.54%
======================= ======================
| (1) | Runoff refers to scheduled principal repayments on loans and unscheduled prepayments (partial prepayments or total prepayments due to refinancing, modification, sale, condemnation or foreclosure). |
| (2) | Expressed as a percentage of the number of loans serviced excluding subserviced loans and loans purchased at a discount due to their non-performing status. |
Management attributes the overall decline in delinquencies in the Company’s servicing portfolio primarily to the relative overall increase in the conventional and prime home equity portfolios, which carry lower delinquency rates relative to the government and subprime portfolios. Management believes the delinquency rates in the Company’s servicing portfolio are consistent with industry experience for similar mortgage loan portfolios.
During the six months ended June 30, 2003, growth in loan origination, banking and capital markets activities significantly increased the Company’s overall financing requirements. In response, the Company established a $15.2 billion facility that provides for the issuance of short-term notes and short-term callable notes secured by mortgage loans. In addition, the Company obtained an additional $0.9 billion in committed secured lines of credit and an additional $0.6 billion in uncommitted secured lines of credit. With these additional lines of credit, Management believes the Company has adequate financing capacity to meet its current needs.
In April 2003, the Company issued $500 million of trust-preferred securities. Trust-preferred securities receive varying degrees of “equity treatment” from rating agencies, bank lenders and regulators. See Note 11 to the Financial Statements for additional discussion.
In May 2003 the Company raised $150 million in common stock through a secondary offering. At June 30, 2003, the Company’s regulatory capital ratios were as follows:
June 30, 2003 December 31, 2002
------------------------- ------------------------
(Dollar amounts in thousands) Minimum Ratio Amount Ratio Amount
Required(1)
- ---------------------------------- ------------- ---------- ------------- -------- --------------
Tier 1 Leverage Capital 5.0% 7.7% $6,429,745 7.6% $4,703,839
Risk-Based Capital
Tier 1 6.0% 11.3% $6,429,745 12.2% $4,703,839
Total 10.0% 12.2% $6,922,800 13.6% $5,230,840
(2) Minimum required to qualify as "well-capitalized."
Cash Flow
Cash flow used by operating
activities was $12.3 billion for the six months ended June 30, 2003 compared to
net cash provided by operating activities of $3.8 billion for the six months
ended June 30, 2002. The reduction in cash flow from operations for the six
months ended June 30, 2003 compared to the six months ended June 30, 2002 was
primarily due to a $22.6 billion net increase in mortgage loans held for sale.
Net cash used in investing activities was $15.4 billion for the six months ended June 30, 2003, compared to $7.3 billion for the six months ended June 30, 2002. Cash flow used in investing activities in both periods was primarily attributable to investments in available-for-sale securities, loans held for investment and mortgage servicing rights.
Net cash provided by financing activities for the six months ended June 30, 2003 totaled $27.7 billion, compared to $3.9 billion for the six months ended June 30, 2002. The increase in cash provided by financing activities was comprised of a $17.5 billion net increase in short-term (primarily secured) borrowings, a $2.2 billion net increase in long-term debt, and a $3.1 billion net increase in bank deposit liabilities.
Total United States mortgage originations were estimated at approximately $2.5 trillion for 2002. Fannie Mae estimates the market at $2.0 trillion for the six months ended June 30, 2003. Fannie Mae, along with other forecasters, put the market for 2003 at between $3.3 trillion and $3.7 trillion. Such a market would be highly favorable for the Company’s loan production business and would place continuing pressure on its loan servicing business (including the Company’s investment in MSRs) due to continuing higher than normal mortgage loan prepayment activity.
The long-term consolidation trend in the residential mortgage industry continued in the six months ended June 30, 2003. According to the trade publication, Inside Mortgage Finance, the top five originators produced 51% of all loans originated during the first six months of calendar 2003, as compared to 47.9% for the six months ended December 31, 2002. Following is a comparison of market share for the top five originators, according to Inside Mortgage Finance:
Six Months Ended
Institution June 30, 2003 December 31, 2002
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Wells Fargo Home Mortgage 13.2% 13.4%
Washington Mutual 13.0% 12.2%
Countrywide 12. 9% 11.0%
Chase Home Finance 7.8% 6.4%
Bank of America Mortgage 4.1% 4.9%
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Total for Top Five 51.0% 47.9%
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The consolidation trend has carried over to the loan servicing side of the mortgage business. Following is a comparison of market share for the top five servicers, according to Inside Mortgage Finance:
Institution June 30, 2003 December 31, 2002
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1. Washington Mutual 10.7% 11.2%
2. Wells Fargo Home Mortgage 8.7% 8.8%
3. Countrywide 8.2% 7.0%
4. Chase Home Finance 6.4% 6.6%
5. Bank of America Mortgage 3.7% 4.1%
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Total for Top Five 37.7% 37.7%
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Management believes the consolidation trend in the residential mortgage industry will continue, as the industry market forces will continue to drive out weak competitors. The Company believes it will benefit from this trend through increased market share. In addition, management believes that irrational price competition—which from time to time has plagued the industry in the past—should lessen in the future.
Compared to the Company, the other industry leaders are less reliant on the secondary mortgage market as an outlet for adjustable rate mortgages, due to their greater portfolio lending capacity. This could place the Company at a competitive disadvantage in the future if the demand for adjustable rate mortgages increases significantly, the secondary mortgage market does not provide a competitive outlet for these loans and the Company is unable to develop a portfolio lending capacity similar to the competition.
The regulatory environments in which the Company operates have an impact on the activities in which the Company may engage, how the activities may be carried out and the profitability of those activities. Therefore, changes to laws, regulations or regulatory policies can affect whether and to what extent the Company is able to operate profitably. For example, proposed state and federal legislation targeted at predatory lending could have the unintended consequence of raising the cost or otherwise reducing the availability of mortgage credit for those potential borrowers with less than prime-quality credit histories, thereby resulting in a reduction of otherwise legitimate sub-prime lending opportunities. Similarly, certain proposed state and federal privacy legislation, if passed, could have an adverse impact on the Company’s ability to cross-sell the non-mortgage products offered by Countrywide’s various divisions to its customer base in a cost effective manner.
Certain statements contained herein, such as statements concerning management’s expectations regarding margin levels and the assumptions underlying the value of MSRs and other statements regarding matters that are not historical facts, are forward-looking statements (as such term is defined in the Securities Exchange Act of 1934, as amended). Words like “believe”, “expect”, “anticipate”, “promise”, “plan” and other expressions or words of similar meanings, as well as future or conditional verbs such as “will”, “would”, “should”, “could”, or “may” are generally intended to identify forward-looking statements.
Forward-looking statements give management’s expectation about the future and are not guarantees. There are a number of factors, many of which are beyond the Company’s control, that could cause actual results to differ significantly from management’s expectations. Some of these factors are discussed below.
Readers are cautioned not to place undue reliance on forward-looking statements. Forward-looking statements speak only as of the date they are made. The Company does not undertake to update them to reflect changes that occur after the date they are made.
General business, economic and political conditions may significantly affect the Company’s earnings.
The Company’s business and earnings are sensitive to general business and economic conditions in the United States. These conditions include short-term and long-term interest rates, inflation, money supply, fluctuations in both debt and equity capital markets, and the strength of the U.S. economy, and the local economies in which the Company conducts business. If any of these conditions worsen, the Company’s business and earnings could be adversely affected. For example, business and economic conditions that negatively impact household incomes could decrease the demand for the Company’s mortgage loans and increase the number of customers who become delinquent or default on their loans, or a rising interest rate environment could decrease the demand for loans.
In addition, the Company’s business and earnings are significantly affected by the fiscal and monetary policies of the federal government and its agencies. The Company is particularly affected by the policies of the Federal Reserve Board, which regulates the supply of money and credit in the United States. The Federal Reserve Board’s policies influence the size of the mortgage origination market, which significantly impacts the earnings of the Company’s loan production sector and the value of the Company’s investment in MSRs and other retained interests. The Federal Reserve Board’s policies also influence the yield on the Company’s interest-earning assets and the cost of the Company’s interest-bearing liabilities. Changes in those policies are beyond the Company’s control and difficult to predict.
Political conditions can also impact the Company’s earnings. Acts or threats of war or terrorism, as well as actions taken by the U.S. or other governments in response to such acts or threats, could impact business and economic conditions in the U.S.
If the Company is unable to effectively manage the volatility of its mortgage banking business, the Company’s earnings could be affected.
The level and volatility of interest rates significantly affect the mortgage banking industry. For example, a low interest rate environment typically results in loan prepayments that negatively impact the value of MSRs. The Company attempts to manage this risk through the natural counterbalance of its loan production and servicing operations. In addition, the Company also attempts to mitigate this risk through the purchase of financial instruments that generally increase in value when long-term interest rates decline. The success of this risk management strategy, however, is largely dependent on Management’s ability to predict the sensitivity of the MSRs and the loan production operations in various interest rate environments. The success of this strategy impacts the Company’s net income. This impact, which can be either positive or negative, can be material, particularly in the short term.
The Company’s accounting policies and methods are fundamental to how the Company reports its financial condition and results of operations, and they may require management to make estimates about matters that are inherently uncertain.
The Company’s accounting policies and methods are fundamental to how the Company records and reports its financial condition and results of operations. The Company’s management must exercise judgment in selecting and applying many of these accounting policies and methods so that not only do they comply with generally accepted accounting principles but also that they reflect management’s judgment as to the most appropriate manner in which to record and report the Company’s financial condition and results of operations. The Company’s significant accounting policies are discussed herein and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
The financial services industry is highly competitive.
The Company operates in a highly competitive industry that could become even more competitive as a result of economic, legislative, regulatory and technological changes. Competition for mortgage loans comes primarily from large commercial banks and savings institutions. Many of the Company’s competitors have fewer regulatory constraints, some have lower cost structures and others are less reliant on the secondary mortgage market for funding due to their greater portfolio lending capacity.
The Company faces competition in such areas as mortgage product offerings, rates and fees, and customer service, both at the retail and institutional level. In addition, technological advances and heightened e-commerce activities have increased consumers’ accessibility to products and services generally. This has intensified competition among banking as well as nonbanking companies in offering financial products and services, with or without the need for a physical presence.
Changes in the regulation of financial services companies could adversely affect the Company’s business.
The Company is heavily regulated by banking, mortgage lending and insurance laws at the federal, state and local levels, and proposals for further regulation of the financial services industry are continually being introduced. Congress and state legislatures, as well as federal and state regulatory agencies, review such laws, regulations and policies and periodically propose changes that could affect us in substantial and unpredictable ways. Such changes could, for example, limit the types of financial services and products the Company offers or increase the Company’s cost to offer such services and products. It is possible that one or more legislative proposals may be adopted or regulatory changes may be implemented that would have an adverse effect on the Company’s business. The Company’s failure to comply with such laws or regulations, whether actual or alleged, could expose the Company to fines, penalties or potential litigation liabilities, including costs, expenses, settlements and judgments, any of which could adversely affect the Company’s earnings.
Other Factors
The above description of risk factors is not exhaustive. Other factors that could cause actual results to differ materially from historical results or those anticipated include, but are not limited to:
Other risk factors are described elsewhere herein as well as in other reports and documents that the Company’s files with or furnishes to the Securities and Exchange Commission. There are also factors that may not be described in any such report or document that could cause results to differ from the Company’s expectations. Each of these factors could by itself, or together with one or more other factors, adversely affect the Company’s business, results of operations and/or financial condition.
In response to this Item, the information set forth on pages 50 to 52 of this Form 10-Q is incorporated herein by reference.
The Company’s management has conducted an evaluation, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act. Based on their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective in ensuring that material information relating to the Company, including its consolidated subsidiaries, is made known to the Chief Executive Officer and Chief Financial Officer by others within those entities during the period in which this quarterly report on Form 10-Q was being prepared.
| (a) | Exhibits |
| +10.83 | Third Amendment to the Company’s 2000 Executive Incentive Plan (incorporated by reference to Exhibit 4.1.9 to the Company’s Registration Statement on Form S-8, dated June 27, 2003). |
| +10.84 | Second Amendment to the Company’s Global Stock Plan (incorporated by reference to Exhibit 4.1.2 to the Company’s Registration Statement on Form S-8, dated August 5, 2003). |
| 10.85 | Third Amendment to Credit Agreement, dated as of June 13, 2003, by and among CHL, the Lenders thereto and Royal Bank of Canada, as lead administrative agent. |
| 10.86 | Third Amendment to Credit Agreement, dated as of June 13, 2003, by and among CHL, the Lenders thereto, Bank of America, N.A. as the Managing Administrative Agent and the co-administrative agent and JP Morgan Chase Bank as co-administrative agent. |
| 12.1 | Computation of the Ratio of Earnings to Fixed Charges. |
| 31.1 | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350. |
| 32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350. |
+ Constitutes a management contract or compensatory plan or arrangement.
Reports on Form 8-K
On April 15, 2003 the Company filed a report on Form 8-K attaching exhibits filed in connection with the issuance on April 11, 2003 by Countrywide Capital IV, a Delaware statutory trust, of 20,000,000 of its 6.75% Trust Preferred Securities (liquidation preference $25 per Trust Preferred Security) and by the Company and Countrywide Home Loans, Inc. of guarantees related thereto pursuant to the Registration Statement on Form S-3 (File Nos. 333-103623, 333-103623-01, 333-103623-03 and 333-103623-03).
On April 16, 2003, the Company filed a report on Form 8-K announcing its operational statistics for the month ended March 31, 2003.
On April 29, 2003 the Company filed a report on Form 8-K announcing information regarding its operations and financial condition for the quarter ended March 31, 2003.
On May 13, 2003 the Company filed a report on Form 8-K announcing information regarding its operational statistics for the month ended April 30, 2003.
On May 15, 2003 the Company filed a report on Form 8-K announcing a public offering.
On June 10, 2003 the Company filed a report on Form 8-K announcing information regarding its operational statistics for the month ended May 31, 2003.
On July 9, 2003, the Company filed a report on Form 8-K announcing its operational statistics for the month ended June 30, 2003.
On July 22, 2003 the Company filed a report on Form 8-K announcing information regarding its operations and financial condition for the quarter ended June 30, 2003.
On August 11, 2003, the Company filed a report on Form 8-K announcing its operational statistics for the month ended July 31, 2003.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
DATE: August 13, 2003
|
/s/ Stanford L. Kurland
Executive Managing Director and Chief Operating Officer |
|
DATE: August 13, 2003
|
/s/ Thomas K. McLaughlin
Senior Managing Director and Chief Financial Officer |