Some days Countrywide chairman and chief executive Angelo Mozilo must feel a bit like Charlton Heston did in the movie The Omega Man. In that sci-fi cult classic, Heston was the last man on earth, sharing a city with zombie-like creatures who only came out at night and wanted in the worst way to snuff-out the planet's lone human.Today, Mozilo looks around the mortgage banking landscape and he sees competitors that are owned by either mega-banks or mega-corporations. Among the top five mortgage banking firms in the U.S., ranked by residential loan production, three are owned by commercial banks (Chase Manhattan Mortgage, Bank of America Mortgage, Wells Fargo Home Mortgage), one is a thrift (Washington Mutual), and then there's Countrywide Home Loans Inc., whose parent is the publicly traded Countrywide Credit Industries of Calabasas, CA. Ten years ago, Countrywide was competing against firms such as ARCs Mortgage, Margaretten & Co., North American Mortgage Corp., Prudential Home Mortgage, Lomas & Nettleton, Farragut Mortgage, Medallion Mortgage--all non-depositories. But all these firms are gone, most having been bought by banks. (The exception is Lomas, which went bankrupt.) And now there's increasing speculation that Countrywide will sell, too--that eventually it will be forced to sell because banks and thrifts have a huge competitive advantage when it comes to leveraging the economic value of housing receivables.Will Countrywide be forced to sell? In the late spring and early summer, speculation began to rise as some analysts noted in their research reports that Countrywide's stock was trading at just above its book value of $23 a share. These reports said that Countrywide would make a great acquisition for any bank looking either to expand its mortgage business or to improve its current lot in the industry by purchasing what is considered one of the best mortgage banking franchises in the U.S. In the first quarter, Countrywide's shares were hurt by rising interest rates and the belief in some circles that mortgage rates might actually hit 9%. When interest rates go up, residential production heads south. Because Countrywide's bread and butter is making home mortgages, it gets hurt worse than banks and thrifts, which have other lines of business to fall back upon.But in the late spring, interest rates actually fell slightly, and Countrywide's stock rose to about $31 a share. The reason: not falling interest rates, but increased speculation that eventually, some day, it would be bought by a bank. Will it? Countrywide chairman Angelo Mozilo isn't saying. He says that, because of his position as the chairman of a publicly traded company, he cannot say either way. In a late May interview with U.S. Banker, he coyly noted that, "We're for sale--everyday, on the New York Stock Exchange." But then in early July, he hinted that, well, perhaps, a sale might be an option for this last of the independents. "All options are open to us," he said. "There are a lot of opportunities available to us."Except for these comments he declined to elaborate further or confirm or deny reports that the lender had hired Goldman Sachs as its adviser.Takeover speculation actually gathered steam in mid-May when this magazine's sister publication, the American Banker newspaper, reported--as part of a large feature on Countrywide--that Mozilo "has started talking like a man who is willing to sell." The article was picked up by CNBC, and the company's share price spiked $6 on the day, closing at $34. Nowhere in the article did Mozilo say that Countrywide was actually for sale. But once broadcast on CNBC, the difference between the company being perhaps more open to the idea of a sale and actually being for sale was obliterated.But sources familiar with the company maintain that in mid-May Countrywide was definitely not considering selling out. Then in late June/early July, the company changed its mind. One problem if Countrywide were for sale is that it's so large in both production and mortgage receivables, only a handful U.S. banks could afford to buy it. When sale rumors surface, the usual suspects are either Bank of America Corp., Chase Manhattan Corp. or Wells Fargo & Co. All three own mortgage banking franchises that bear their names. And all three have turned into mortgage powerhouses by--you guessed it--purchasing either large mortgage banking firms or portfolios of receivables, called "mortgage servicing rights."Chase is the product of a merger between Chase Manhattan Corp. and Chemical Bank Corp., and it has been a large buyer of not only mortgage servicing portfolios, but franchises. Chase bought Margaretten & Co., one of the best non-depositories in the business, in the early 1990s. Bank of America is the product of a merger between BankAmerica Corp. and NationsBank Corp., both of which had large mortgage-banking franchises. Wells Fargo is the product of a merger with Norwest Corp.; in 1996, Norwest bought Prudential Home Mortgage Corp., a purchase which still stands as the largest mortgage banking acquisition in history. (Wells is rumored to be discussing a purchase of $80 billion in servicing rights from GE Capital Mortgage Services of Cherry Hill, NJ.)Countrywide, for the most part, has not grown its production and servicing by acquisitions. It has grown holistically by increasing its production network of retail branches (now totaling 550), using loan brokers to facilitate "wholesale" production, and by launching an Internet production effort that is one of the largest in the nation.But one acquisition that Countrywide is considering is the purchase of a small depository that would give it the ability to offer federally insured money-market accounts. Few details are known about the purchase, except that it's an East Coast institution that is in danger of failing. Those familiar with the deal say that Countrywide would use the depository as a way to gain access to the Federal Home Loan Bank system and its advance window. It also hopes to use the FHLB system's "mortgage partnership finance" (MPF) program.By using the MPF program, Countrywide would be able to sell loans not only to Fannie Mae and Freddie Mac, but to the FHLB system. One advantage of the MPF is that it supposedly allows lenders to dispose of mortgages in the secondary market more profitably than selling to Fannie or Freddie. One catch: The selling institution has to share more of the credit risk if the loans go into default. Countrywide could use the FHLB to dispose of not just conventional loans but also government-backed mortgages.In other words, it seems that Countrywide is now weighing its options. If it doesn't sell to a bank, it may wind up owning a small one with the idea of growing it over time.One reason non-depository mortgage banking firms have gone the way of the typewriter is the issue of leverage. Mortgage servicing rights, of which Countrywide has $253 billion, have an economic value. Servicing represents a cashflow stream on mortgages. On a Fannie Mae mortgage yielding 8.25%, for instance, the servicer of that loan receives 0.25% (25 basis points) for doing all the monthly paperwork.When a mortgage company begins amassing a large volume of receivables, the value of those receivables increases. Stock analyst Mike McMahon of Sandler O'Neill notes that, in the mid-1990s, the accounting rules changed for mortgage servicers. That's when the Financial Accounting Standards Board passed FAS 122, which allowed mortgage bankers to capitalize the value of their servicing.By declaring an economic value on servicing, a mortgage banker (be it a non-depository, bank or thrift) has to hold capital against that asset. The problem with being a monoline mortgage banker is that your core business is residential mortgages, a highly cyclical business. The key here is to keep the rating agencies happy--especially if your firm, like Countrywide, uses commercial paper borrowings to fund its operations. McMahon and analyst Kenneth A. Posner of Morgan Stanley Dean Witter (both follow Countrywide and like the stock) note that Countrywide has to hold so much capital against its receivables that it effectively has a leverage ratio of 2 to 1, whereas a depository with mortgage servicing can achieve a leverage ratio of 8 to 1."It's not so much the value of the servicing, it's the amount of equity that Countrywide has to hold against the servicing," says Posner. "Banks and S&Ls, being regulated institutions, are in a different situation. The rating agencies are okay with the fact that they hold less capital against their servicing."McMahon notes that because banks can hold less capital against their receivables, they can lose more money on their loan production operation than a non-depository can. (In mortgage banking, it generally is assumed that most residential lenders lose money on production but make it up on the servicing.) In other words, says McMahon, a bank can afford to "subsidize" its residential loan production because it holds less capital against servicing. Conglomerates like General Electric and General Motors that own mortgage banking firms are in the same boat as banks. Because they are diversified giants, the rating agencies treat them kindly when it comes to risk. This, he says, turns into a situation where a non-depository eventually will be driven to either sell to a bank or thrift, or exit the business entirely. Hence all the recent--and not so recent--speculation surrounding Countrywide. If all this is true, then it would seem likely that Countrywide should have sold a few years back, right? But, according to Posner, Countrywide has made up for the "capital disadvantage by having a great management team and a good operation. They're just really good at what they do--that's how they've gotten by." In its most recent fiscal year, ending Feb. 29, 2000, Countrywide earned more than $400 million.So, will Countrywide eventually sell, or will it become a depository itself and have to deal with all the regulatory headaches that go along with federal deposit insurance? It's tough to say. One thing's certain: Mozilo is quite aware of the fact that Countrywide has less leverage than banks, and he has already taken steps to diversify the businesses under the Countrywide umbrella. It now owns an insurance affiliate and has expanded its reach into capital markets, contract underwriting, title insurance, technology and other areas. It also lends overseas. Will it be able to diversify quickly enough to satisfy the bond rating agencies and be able to hold less capital held against its servicing? Will it buy a depository and solve all its competitive problems? Those close to Mozilo know this much: At 61, he's not ready for retirement.

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