As Countrywide goes, so goes the industry

Mortgage Banking, Nov, 2007 by Brenda B. White

Countrywide Financial Corporation, Calabasas, California, has gotten a tremendous amount of attention lately. The financial markets seem laser-focused on the company's every move. During periods in August and September, the markets were concerned about its viability. This is not the first time that the financial markets have been cruel to Countrywide.

Conversely, there have been other times in the company's history when the markets have been euphoric over its prospects. During each part of the economic cycle, whether peak or trough, Countrywide has been a proxy for the equity market's view of the mortgage banking industry. Another point worth mentioning is that over time, Countrywide's stock has moved inversely with the 10-year Treasury (see Figure 1).

Countrywide went public in 1969 and began trading on the New York Stock Exchange in 1985. As interest rates began to fall, a refinance boom made 1985 and 1986 very good years for the mortgage banking industry. Countrywide's stock performed well, moving from $2 in 1985 to $12 a year later. The equity market became enamored with the industry, and with Countrywide as one of the benchmarks, a rash of mortgage companies completed initial public offerings (IPOs).

A spike in rates in April 1987 caused many mortgage companies to suffer large secondary marketing losses that were so severe, many companies went out of business. The environment was so difficult that all of the companies that had completed IPOs disappeared. The lucky ones found merger partners.

Countrywide's stock suffered and dropped to $6 in 1987. This did not go unnoticed, and the Belzberg family took a 6 percent position in the stock and publicly stated they wanted to see the company sold. Countrywide co-founders Angelo Mozilo and David Loeb had a vision and great plans for the future of Countrywide, and had no interest in selling--especially given the depressed level of the stock price. I was working at Salomon Brothers at the time, and part of the team working on Countrywide's defense. It was very clear to me that the battle was one of survival. It is incredible to think how different the industry would have been if the company had been sold at that point in its history.

Well, the downturn did not last forever--it never does--and the difficult years of 1987 to 1990 led to the Federal Reserve cutting the discount rate seven times between July 1990 and July 1992 (see "The Allure of Mortgage Empires," by Brenda White and Jack Leventhal, in the October 1997 issue of Mortgage Banking).

Refinancings began to increase during 1991, and the price of Countrywide stock started to benefit handsomely--so handsomely that management teams of other mortgage companies and investment bankers started planning IPOs. From 1992 to 1993, the number of public mortgage companies increased from four to 15 (see "The Allure of Mortgage Empires," Mortgage Banking, October 1997). Countrywide was the benchmark off of which these IPOs were priced.

While at Salomon Brothers, I helped to take Margaretten Financial Corporation, American Residential Mortgage Corporation, Fleet Mortgage Corporation and others public. These stocks were all priced at multiples below the multiples at which Countrywide stock was trading. This was the case because Countrywide was viewed as the best in the business--and why would you pay more for another company than you would pay for the best? I remember trying to pitch one of the companies as better than Countrywide; we came close, but the IPO discount kept the pricing multiple below that of Countrywide's. At the same time, all of these IPOs got done because investors did not want to miss "the next Countrywide."

The industry prospered nicely during 1992 and 1993. The newly public companies, armed with fresh capital, achieved unprecedented levels of profitability. Not surprisingly, Countrywide's performance was extraordinary. However, the downside of the refinance boom was that prepayments caused Countrywide--as well as the other public companies--to announce significant write-downs.

As 1993 progressed, the series of write-downs and concerns about the sustainability of the refinance boom caused investors to be skeptical regarding the real value-creation capability of these companies. The investor apathy that set in resulted in mortgage-sector stocks trading at or below liquidation value.

[FIGURE 1 OMITTED]

April 1994 brought a swift and severe increase in rates. Secondary marketing losses followed by decreases in volume hurt all mortgage companies. During the first seven months of 1994, the 10-year Treasury had risen 155 basis points. The public companies were under a microscope as equity investors started to realize just how volatile the mortgage banking business could be. Stock prices, including Countrywide's, suffered and, in most cases, mortgage companies were trading at or below liquidation value.

Fortunately, commercial banks, which were experiencing a period of record profits, were feverishly competing to enter the mortgage business and believed that acquiring mortgage companies would be the best way to get a competitive edge. During this period, all the companies that had just gone public were sold to depository institutions. Many of the boards of these companies knew it would be difficult to survive the downturn as independent entities. At the same time, many boards decided that the premiums being paid by buyers were higher than any price their shareholders would see anytime in the foreseeable future.