Fire in the Belly

Countrywide has survived as the last major independent mortgage banker against competitors with deeper pockets and higher leveraging. The trick has been constantly improving productivity and being willing to reinvent itself when the competitive environment changed. Now a new bank and a huge cadre of newly hired commissioned salespeople are part of the winning strategy.

Mortgage Banking
January 2002

By Robert Stowe England


Those were pretty much the orders handed out in June 2000 at Calabasas, California-based Countrywide Home Loans Inc.

As of that date, the firm reversed a highly successful strategy that took the company from being one of dozens of small California companies in the 1970s to one of the top mortgage lenders in the nation.

The decision was made to begin to return to the practice of using commissioned salespeople for its retail channel to bring in new business, especially from Realtors and builders, but also from individuals. By year-end 2001, Countrywide had added 1,100 commissioned salespeople and is expected to add another 1,000 in 2002.

Countrywide had abruptly abandoned commissioned sales in 1974 to focus on developing brand-name awareness to distinguish the business from a number of other, small competitors. - The 180-degree turn in 1974 and then once again in 2000 is a hallmark of Countrywide's ability to radically re-imagine its strategy and is emblematic of why the company is widely seen as being more innovative and more flexible than its competitors. "I think the reason why Countrywide has survived and thrived is because we continue to mutate the company as the environment changes," says Angelo R. Mozilo, co-founder, chairman, chief executive officer and president of Countrywide Credit Industries Inc., Calabasas, the parent of Countrywide Home Loans.

Back in 1974, "if we had to spend the money building the brand, we couldn't afford to pay commissions. Something had to give," recalls Mozilo. "So we decided to go without a sales force and drive business into the local branches through advertising and building a brand. That was our strategy."

The decision to drop commissioned salespeople worked spectacularly well for 26 years. "We built a brand. We gained dominance. And at one point we became No. 1 in the country in originations. Clearly the strategy worked," Mozilo says.

In the last five years, however, the industry has been fundamentally altered by what Mozilo calls "massive" consolidation, with a few players dominating the industry. The top five, including Countrywide, have wrapped up 39 percent of originations and 41 percent of servicing, according to Inside Mortgage Finance. This elite group includes Bank of America Mortgage, Charlotte, North Carolina; Wells Fargo Home Mortgage, Des Moines, Iowa; Chase Home Finance, Edison, New Jersey; and Washington Mutual Bank, Seattle.

While Countrywide's brand-building strategy worked as long as it was one of the few nationally recognized brand names in mortgage banking, today its chief rivals are household names-except for Washington Mutual, which is rapidly building a brand-name awareness across the nation.

So, now Countrywide is facing competitors with strong brand-name presence and a strong sales force, and the reasoning that led to the 1974 decision no longer applies. "We felt it required us taking another look at our overall strategy, because a paradigm shift had taken place in the competitive sphere and we came to the conclusion that the best way to compete and increase market share-which was certainly our overriding objective-was to employ salespersons," says Mozilo.

The about-face defied Countrywide's corporate image and history. "It was like Nixon going to China," says Andy Bielanski, managing director of marketing at Countrywide Home Loans.

It would have been easy to continue down the path that made Countrywide so successful, but it would have been a choice rife with peril, Mozilo says. "What happens when the world around you is changing and you-for whatever reason-stick to a game plan that worked for you at one time but may not work in the new environment?" asks Mozilo. The corporate landscape is littered with companies that made this mistake, he points out, including such companies as Polaroid, Xerox, Kodak and Motorola.

A matter of leverage

Countrywide's about-face on commissioned salespeople is only one part of its effort to improve its return on equity (ROE), which measures how well the company is rewarding its shareholders.

ROE, which stood at 20 percent l0 years ago, has been declining in recent years and stood at 16 percent in Countrywide's fiscal second quarter (June, July and August 2001)-during one of the most favorable environments for the industry. This recent improvement, however, follows a long stretch of poorer results. 
In the fourth quarter of 2000 (December 1999, January and February 2000), Countrywide's ROE was only io.6 percent and averaged just 11.7 percent for all of 2000.

The main reason for the decline in ROE is a shift in the business mix between production and servicing, according to Keith McLaughlin, Countrywide's senior managing director and chief financial officer. "The good news is that this creates a more stable earnings stream," says McLaughlin. But historically, the returns on servicing have been less than the returns on new production, he says.

A decade ago, Countrywide had a higher portion of its business in production than in servicing. Production provides a higher return "simply because it's not a capital-intensive business like servicing is," explains McLaughlin. The company's investment in mortgage servicing rights (MSRs) requires a lot of capital. "So it's almost inherently a lower-return business."

To raise its ROE, Countrywide must grow its production and take a larger market share while reducing costs in production and servicing, according to Stanford L. Kurland, president and chief executive officer of Countrywide Home Loans. Further, the company must grow its nonlending businesses to make them a larger part of the overall earnings of Countrywide Credit Industries.

"While today Countrywide has [a] 70 percent/30 percent mix of lending activities and earnings versus nonlending activities, we see that in three to five years as moving to a 50/50 mix," Kurland says, even as the company continues to rapidly grow its mortgage banking core.

The attraction of being able to cross-sell other products and services to its 3 million mortgage customers is "one of the primary reasons we're looking to diversify," says Kurland. Countrywide feels it must maximize the revenues for customers-just as its competitors do-by offering them other products. Cross-selling strengthens the customer relationship and provides a greater economic return, Kurland says. One of Countrywide's key competitors, Wells Fargo, has reported that it now cross-sells about four products to each of its existing bank customers, and hopes to raise that to eight products in the coming years.

Cross-selling insurance and banking products Countrywide's first big foray into cross-selling came with its acquisition of Countrywide Insurance Services, Simi Valley, California, an insurance agency that began in 1969 when Countrywide first began operating. The agency offers homeowner's insurance, home warranties, disability coverage, auto insurance and life insurance to customers at the time they obtain a mortgage. Over the years, the insurance agency has accumulated 600,ooo customers, according to Carlos M. Garcia, senior managing director and chief of banking and insurance operations for Countrywide Credit Industries. "Almost all of these customers are from cross-sell," Garcia says.

In 1999, Countrywide went a step further into the insurance business when it purchased Balboa Life and Casualty, an insurance carrier based in Irvine, California. This company specializes in "forced-placed" insurance sold to financial institutions to protect them against losses on properties of their customers in the event that the homeowner's individual hazard insurance lapses. It also provides individual homeowner's insurance.

When Countrywide bought Balboa, it had si8o million in forced-placed insurance and individual homeowner's insurance combined. By 2001, it had doubled the overall business to $350 million. Countrywide expanded its business by using data-mining techniques to cross-sell to its existing customer base and locate additional customers.

By 2006, Countrywide expects to have si billion in individual homeowner's insurance policies from Balboa and another $500 million in forced-placed insurance policies sold to institutions, according to Garcia. This will help in Countrywide's larger goal of changing the mix of business from 70/30 to 50/50 in lending/nonlending.

With a good start to expanding the insurance business, Countrywide has turned to adding a range of banking products to its mix by acquiring a bank (see sidebar, "The Rollout of Countrywide Bank").
Kurland sees the long-range benefit from Countrywide's diversification as substantial. The new business activities it has begun in insurance and is set to begin in banking have what Kurland calls "high-growth rates and high-return rates."

The leverage disadvantage

Countrywide's key competitive disadvantage comes from its inability to raise its leverage to the levels that bank-owned mortgage banking companies enjoy, according to both company executives and outside analysts. "Countrywide operates with one hand tied behind its back, because its competitors can leverage more," says Mike McMahon, an equity analyst at Sandler O'Neill Mortgage Finance Corporation, Emeryville, California.

McMahon calculates that Countrywide's main bank-affiliated competitors-Wells Fargo, Bank of America, Washington Mutual and Chase-typically have only 8 cents of capital behind every dollar of assets (loans, MSRs and all other assets), while Countrywide has 33 cents of capital behind its MSRs.

Countrywide's leverage is constrained by the company's desire to maintain the single-A ratings "we feel we need in order to be able to access the capital markets at the optimum level," says McLaughlin. The single-A rating helps Countrywide borrow funds at a competitive rate. "Historically, in exchange for maintaining our single-A ratings, we've had to maintain a very conservative capital structure," McLaughlin says.
It has long been Countrywide's primary objective to convince the credit rating agencies (Standard & Poor's, Moody's Investors Service and Fitch) and the public capital markets that Countrywide warrants higher leverage than the agencies were prepared to accept for a single-A rating.

The credit agencies have been difficult to persuade, because they largely continue to view Countrywide as a monoline company and not as a diversified financial services company, McMahon says. Traditionally, the rating agencies attach more risk to monoline companies than to diversified companies and, thus, they tend to require a more conservative financial structure to classify the company's debt as a top-investment grade, McMahon explains.

McLaughlin does not believe the rating agencies fully recognize Countrywide's improved stability of earnings that comes from having more of its revenues and earnings from higher MSRs (a larger asset base of MSRs relative to the rest of the business) and from its nonlending businesses. He does, however, believe Countrywide has mde some progress in persuading the rating agencies. That progress can be seen in the higher leverage in its capital structure today when compared with lo years ago, a higher leverage that still allows the company to obtain a single-A bond rating, according to McLaughlin. Ten years ago, for example, the company had "zero leverage" on servicing, he says, whereas today Countrywide is leveraging its servicing investments by approximately three to one while still maintaining a single-A bond rating.
One of the reasons credit rating agencies are reluctant to allow more leverage of the MSR asset is because of the potential for sharp losses in MSR values when interest rates decline, according to McMahon.

Yet, Countrywide's hedging prowess is "a double-edged sword," says McMahon-"even though they have a long history of managing that asset successfully, going back lo years. Even though they have never had an earnings disappointment because of hedging an asset, the hedge is a difficult thing for an analyst on the outside to get his hands around," he says.

"I believe they're asking people to understand something that's difficult to understand," and while presumably the credit rating agencies enjoy access and information about the hedge to help them better understand it, "the bottom line is that hedging is very difficult even for professionals to get their hands around and come to an informed opinion [about]," McMahon says.

The technology advantage

To compensate for its inability to leverage its assets as much as its competitors, Countrywide has worked diligently to become more efficient than its competitors in running its mortgage operations. That competitive advantage in efficiency is reflected in Countrywide's high 1.9 ratio return on assets (ROA), which is a measure that shows how well the company performs without including leverage. (ROA is a return on assets ratio, which is net income divided by total average assets.)

The founders of the company, Mozilo and David Loeb, "realized very early that technology was going to be the thing that could give them an edge over a lot of their more traditional competitors-and it has," says Richard Jones, director of information technology at Countrywide Credit Industries.

Countrywide has increased its efficiency and its revenues by adding ancillary businesses, such as those grouped under a subsidiary named LandSafe Inc., Plano, Texas. This business handles appraisals, title insurance, credit reporting, home inspections and flood determination. At one point, like other mortgage lenders, Countrywide relied on other firms to provide these services. "They realized a few years ago that the size of Countrywide was large enough to do it in-house," McMahon says.

Countrywide's expansion into these businesses came at a time when the margins in mortgage banking began to decline due to consolidation, McMahon says, and they were seeking to increase their revenue per loan.
In the fiscal year ending February 28, 2001, Countrywide issued 1,742,000 credit reports and did 243,000 appraisals, 24,000 title reports, 603,000 flood determinations and 3,000 home inspections. These totals represent work done both for Countrywide and other companies that now use its closing services.
Countrywide "invented several technologies in this industry that are now copied or imitated by others," Jones says. It pioneered new technology in underwriting software and artificial intelligence, allowing branches to be autonomous of corporate headquarters in underwriting decisions and loan processing, he says. Countrywide's loan servicing system, which has evolved over 3o years, is "now pretty much the industry's best loan servicing system," says Jones.

Improvements in servicing and other computer processing systems seem to come more rapidly at Countrywide, partly because system development is decentralized, according to Thomas Boone, senior managing director and chief operations officer for Countrywide Credit Industries and Countrywide Home Loans. At many companies-and even at Countrywide 15 years ago-he says, "if you wanted to change something in the foreclosure processing systems within servicing, for example, you would submit your request to a central data processing group and they would evaluate your request and they would put it in their queue of things to be done. Eventually it might get done if they thought it was worth doing," Boone says.

The problem with that conventional approach is that it did not involve the line business manager of foreclosure processing in the application development, Boone says. Decentralizing the development of the software in the business units, like the foreclosure unit, allows advances in that area to proceed in a more logical and timely manner. It also allows Boone to hold managers accountable for continual improvement in the process. After decentralizing software development, he says, "there was no longer a lot of a finger-pointing and people saying, `Well, I dreamed up the best process in the world but data processing never did a program for me,"' Boone says.

For more than a decade, Boone says, Countrywide has followed in the footsteps of such companies as Motorola in adapting a so-called six-sigma approach of continuously seeking to improve every area of the company. Goals are set on a daily basis for improvements, and managers are held accountable to those goals, Boone says.

Countrywide's focus on technology can be seen throughout the company. For example, e-commerce loan production is now 50 percent of overall production volume, according to Jones. This is a sharp increase from 17 percent in 1999. Most of this comes from the business-to-business (B2B) wholesale and correspondent lending channels, although 30 percent of the e-business comes from the retail channel.
As a result, Countrywide was the leading company in ecommerce mortgage production during the first half of 2001, according to Inside Mortgage Technology. Countrywide's ecommerce production was $25.6 billion, followed second by ABN AMRO Mortgage Group, Ann Arbor, Michigan, at $18.9 billion; Chase Home Finance at $4.9 billion; IndyMac Bank, Pasadena, California, at $6.4 billion; and First Union Mortgage Corporation, Charlotte, North Carolina, at $2.5 billion.

Countrywide has been exporting its technological prowess in originating, closing and servicing loans to the United Kingdom. The first step began with a 50/50 joint venture with Bexleyheath, Kent-based Woolwich plc, known as Global Home Loans (GHL). Later, Woolwich was acquired by London-based Barclays plc, and Countrywide became majority owner in the venture with Barclays. GHL provides origination and closing processing, as well as loan servicing to Woolwich, Barclays and other mortgage lenders.

Countrywide recently rolled out a new service in the United Kingdom called UKValuation Ltd., a joint venture with mortgage lenders Abbey National plc, London; Woolwich; Alliance & Leicester plc, Narborough, Leicester; Bradford & Bingley plc, Bingley, West Yorkshire; and Bristol & West plc, Bristol, Avon. The new venture will use automated valuation model (AVM) technology pioneered by Countrywide.

"We're getting our foothold into Europe through the U.K.," says Boone. "Our objective is to be able to leverage our businesses in the U.K. to Europe," and offer them throughout the European Community states.

It all comes back to focus

If you spend any time with Countrywide executives, you'll soon hear about the company's "focus" on the business as being an integral part of its success.

"Servicing is a relatively boring business," says Boone. "Most of our peers-at least from my impression-would just as soon not be in the servicing business. It's like it's a necessary evil of the mortgage banking business. They are saying, in effect, `We want to have our customers. We want to treat them well. We want to sell them banking products. But we would really just as soon not be in this servicing business,"' Boone says. This view leads Countrywide's competitors "to rely on outsourcing for a lot of the grunt work that goes into servicing and other parts of the business," he adds.

Countrywide has a starkly different approach, Boone says. "We embrace the business and we've made it fun and exciting by giving people the full autonomy to build and develop their own systems."

Countrywide's focus is on every single aspect of the business (not just servicing), and it is on all of its many boring and not-so-boring details. McMahon describes the situation this way: "Angelo goes to bed thinking about the mortgage banking industry and wakes up thinking about it." Executives at diversified financial institutions, by comparison, are thinking about several different kinds of businesses and not any single one, McMahon says.

Is it fair to say that Countrywide has a passion for the mortgage banking business that does not seem to exist with the same intensity at its competitors? "Yes," says Mozilo, "I think there's a reason for it. First of all, we gave birth to this business. This is our baby. Secondly, we were not caretakers. We created it, grew it. Every brick that makes up this company, we set ourselves. So we have a sense of ownership and, as you say, passion for this company, for what it does. That is going to be difficult to replicate," Mozilo says.

"Every other mortgage company that we compete against was acquired. It was not incepted by the people who are running it now. They weren't there. They didn't go through the birthing process. I think your attitude toward your own children carries with it a greater degree of passion than does your attitude toward the children of others. I think what the competition has is the children of others. They bought company upon company, and that's why I think you sense a passion in this company. We call it concern. You can call it passionate concern or fire in the belly," says Mozilo.

It's that constant focus and concern about every detail of the business that has given Countrywide a return on assets that is significantly higher than its competitors, says McMahon.
While most banks do not break out the results for their mortgage banking operations, Wells Fargo-which McMahon identifies as one of the best mortgage banking performers in the business-does break out the results for that line of business, giving at least one benchmark against which Countrywide can be compared.

In 2000, Wells Fargo's mortgage banking business had $310 million in revenues, with an average ROA of 1.2. By comparison, in the fiscal year ending February 28, 2001, Countrywide had $374 million in revenues with an average ROA of 1.9. Countrywide's ROA was 50 percent higher than top-notch performer Wells Fargo, McMahon notes.

When it comes to ROE, however, Wells Fargo's 19.9 percent was far higher than Countrywide's 11.7 percent. And Wells Fargo needs only 8 cents of equity to back its assets, while Countrywide needs 16 cents (33 cents for its MSRs).

Thus, even with Countrywide's focused leadership, its technology advantage and its superior overall performance, it is not enough to fully compensate for the disadvantage it has in leveraging its assets.
A race against the clock?

McMahon contends that Countrywide is, in fact, in "a race against the clock" to implement its diversification program and raise its ROE. "Countrywide needs to continue to build these businesses and ultimately see that they provide a significant return, so the return of the company as a whole is consistently in the high teens," he says.

If Countrywide cannot achieve higher ROEs on a consistent basis, "then I think there will be shareholder pressure to enter into a new deal" and perhaps be acquired or merge with another company, McMahon says. The ideal partner, he adds, might be a European-based bank that can benefit from Countrywide's expertise while acquiring a prominent brand name in the United States. It was, in fact, during the period that Countrywide was seeing significant declines in ROE that reports surfaced that it was for sale.

"It was never for sale," says Mozilo. "I have said all along that Countrywide's strategic mission is to dominate the mortgage banking business and that we would evaluate all alternatives and methodologies to achieve that mission. As a result, people contacted us to see if arrangements could be made to achieve our goals by merger. But none of those options that we looked at met with our satisfaction," he says.
Mozilo is confident that Countrywide can reach its goal of having a 50/50 split in earnings between the core mortgage business and its nonlending activities within the next few years. Its new banking business is on course to reach 20 percent of Countrywide's earnings within three years, he says. That alone, all other things being equal, would go a long way toward allowing the company to reach its 50/5o goal, according to Mozilo.

By 2005, Countrywide's mix of business would "fit the classic definition of a diversified financial services company," says Mozilo, and, thus, presumably qualify for higher leverage. So here's a parting memo from Mozilo to S&P, Moody's and Fitch: Keep an eye on this baby.

Robert Stowe England is a freelance writer based in Arlington,Virginia.

Copyright ©Mortgage Bankers Association of America. All Rights Reserved. Reprinted With Permission. 




Robert Stowe England is an author and financial journalist who has specialized in writing about financial institutions, financial markets, retirement income issues, and the financial impact of population aging.

Visit Mind over Market:

Mind Over Market

Click Here>>