10-Q 1 0001.txt 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended May 31, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________________ to _________________ Commission File Number: 1-8422 ------ COUNTRYWIDE CREDIT INDUSTRIES, INC. ---------------------------------------------------------------- (Exact name of registrant as specified in its charter) DELAWARE 13-2641992 --------------------------------------------------------- -------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 4500 Park Granada, Calabasas, California 91302 ------------------------------------------------------------------------ (Address of principal executive offices) (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 the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Class Outstanding at July 13, 2000 ----- --------------------------- Common Stock $.05 par value 114,178,909 PART I FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS COUNTRYWIDE CREDIT INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (Dollar amounts in thousands, except per share data) A S S E T S May 31, February 29, 2000 2000 ------------------- ------------------- Cash $236,833 $ 59,890 Mortgage loans and mortgage-backed securities held for sale 2,517,167 2,653,183 Trading securities, at market value 2,144,249 1,984,031 Mortgage servicing rights, net 5,602,884 5,396,477 Investments in other financial instruments 5,152,439 3,562,458 Property, equipment and leasehold improvements, at cost - net of accumulated depreciation and amortization 408,661 410,899 Other assets 2,377,857 1,755,390 ------------------- ------------------- Total assets $18,440,090 $15,822,328 =================== =================== Borrower and investor custodial accounts (segregated in special accounts - excluded from corporate assets) $3,825,752 $2,852,738 =================== =================== LIABILITIES AND SHAREHOLDERS' EQUITY Notes payable $12,118,028 $ 9,782,625 Drafts payable issued in connection with mortgage loan closings 464,655 382,108 Accounts payable, accrued liabilities and other 1,121,247 997,405 Deferred income taxes 1,295,002 1,272,311 ------------------- ------------------- Total liabilities 14,998,932 12,434,449 Commitments and contingencies - - Company-obligated mandatorily redeemable capital trust pass- through securities of subsidiary trusts holding solely Company guaranteed related subordinated debt 500,000 500,000 Shareholders' equity Preferred stock - authorized, 2,500,000 shares of $0.05 par value; issued and outstanding, none - - Common stock - authorized, 240,000,000 shares of $0.05 par value; issued and outstanding, 114,146,330 shares at May 31,2000 and 113,463,424 February 29, 2000 5,707 5,673 Additional paid-in capital 1,187,304 1,171,238 Accumulated other comprehensive loss (68,368) (33,234) Retained earnings 1,816,515 1,744,202 ------------------- ------------------- Total shareholders' equity 2,941,158 2,887,879 ------------------- ------------------- Total liabilities and shareholders' equity $18,440,090 $15,822,328 =================== =================== Borrower and investor custodial accounts $3,825,752 $2,852,738 =================== =================== The accompanying notes are an integral part of these statements.
COUNTRYWIDE CREDIT INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED) (Dollar amounts in thousands, except per share data) Three Months Ended May 31, 2000 1999 -------------- -------------- Revenues Loan origination fees $ 84,294 $146,701 Gain on sale of loans, net of commitment fees 133,154 170,012 -------------- -------------- Loan production revenue 217,448 316,713 Interest earned 258,594 275,562 Interest charges (261,474) (246,034) -------------- -------------- Net interest income (2,880) 29,528 Loan servicing revenue 325,869 272,997 Amortization & impairment/recovery of mortgage servicing rights, net of service hedge (118,159) (146,845) -------------- -------------- Net loan administration revenue 207,710 126,152 Net premiums earned 62,005 5,691 Commissions, fees and other revenues 43,949 60,626 -------------- -------------- Total revenues 528,232 538,710 Expenses Salaries and related expenses 171,531 185,426 Occupancy and other office expenses 66,518 72,208 Guarantee fees 53,666 45,843 Marketing expenses 19,759 19,523 Insurance net losses 25,638 - Other operating expenses 60,195 46,236 -------------- -------------- Total expenses 397,307 369,236 -------------- -------------- Earnings before income taxes 130,925 169,474 Provision for income taxes 47,466 66,095 -------------- -------------- NET EARNINGS $ 83,459 $103,379 ============== ============== Earnings per share Basic $0.73 $0.92 Diluted $0.72 $0.88 The accompanying notes are an integral part of these statements.
COUNTRYWIDE CREDIT INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Dollar amounts in thousands) Three Months Ended May 31, 2000 1999 ---------------- ----------------- Cash flows from operating activities: Net earnings Adjustments to reconcile net earnings to net cash $83,459 $103,379 provided (used) by operating activities: Gain on sale of available-for-sale securities - (11,194) Amortization and impairment/recovery of mortgage servicing rights 104,895 (24,491) Depreciation and other amortization 20,049 15,752 Deferred income taxes 47,466 66,130 Origination and purchase of loans held for sale (14,546,038) (23,193,000) Principal repayments and sale of loans 14,682,054 22,711,136 ---------------- ----------------- Decrease (increase) in mortgage loans and mortgage- Backed securities held for sale 136,016 (481,864) Increase in other financial instruments (1,667,765) (289,922) Increase in trading securities (160,218) (556,952) (Increase) decrease in other assets (633,624) 21,235 Increase in accounts payable and accrued liabilities 123,842 157,417 ---------------- ----------------- Net cash provided (used) by operating activities (1,945,880) (1,000,510) ---------------- ----------------- Cash flows from investing activities: Additions to mortgage servicing rights, net (311,302) (432,368) Purchase of property, equipment and leasehold improvements, net (11,713) (27,043) Proceeds from sale of available-for-sale securities 2,070 49,360 Proceeds from sale of securitized service fees 22,338 - ---------------- ----------------- Net cash used by investing activities (298,607) (410,051) ---------------- ----------------- Cash flows from financing activities: Net increase in warehouse debt and other short-term borrowings 1,593,214 745,601 Issuance of long-term debt 934,736 717,000 Repayment of long-term debt (110,000) (75,315) Issuance of common stock 14,626 8,632 Cash dividends paid (11,146) (11,268) ---------------- ----------------- Net cash provided by financing activities 2,421,430 1,384,650 ---------------- ----------------- Net decrease in cash 176,943 (25,911) Cash at beginning of period 59,890 58,748 ---------------- ----------------- Cash at end of period $236,833 $32,837 ================ ================= Supplemental cash flow information: Cash used to pay interest $ 269,494 $ 246,724 Cash used to pay income taxes $ $ 7 5,262 Noncash investing activities: Unrealized gain (loss) on available-for-sale securities, net of tax $ (35,134) $ 3,178 The accompanying notes are an integral part of these statements.
COUNTRYWIDE CREDIT INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (Dollar amounts in thousands) Three Months Ended May 31, 2000 1999 --------------- --------------- NET EARNINGS $83,459 $103,379 Other comprehensive income, net of tax: Unrealized gains (losses) on available for sale securities: Unrealized holding gains (losses) arising during the period, before tax 16,403 (54,891) Income tax benefit (expense) 19,799 (6,397) --------------- --------------- Unrealized holding (losses) gains arising during the period, net of tax (35,092) 10,006 Less: reclassification adjustment for gains (losses) included in net earnings, before tax (66) 11,194 Income tax benefit (expense) 24 (4,366) --------------- --------------- Reclassification adjustment for (losses) gains included in net earnings, net (42) 6,828 of tax --------------- --------------- Other comprehensive (loss) income (35,134) 3,178 ---------------- --------------- COMPREHENSIVE INCOME $48,325 $106,557 ================ ===============
The accompanying notes are an integral part of these statements. COUNTRYWIDE CREDIT INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Page 24 NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying consolidated financial statements have been prepared in accordance 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 footnotes 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 three months ended May 31, 2000 are not necessarily indicative of the results that may be expected for the fiscal year ending February 28, 2001. For further information, refer to the consolidated financial statements and footnotes thereto included in the annual report on Form 10-K for the fiscal year ended February 29, 2000 of Countrywide Credit Industries, Inc. (the "Company"). Certain amounts reflected in the consolidated financial statements for the three-month period ended May 31, 1999 have been reclassified to conform to the presentation for the three-month period ended May 31, 2000. NOTE B - MORTGAGE SERVICING RIGHTS The activity in mortgage servicing rights was as follows. ------------------------------------------------ --------------------------- Three Months Ended (Dollar amounts in thousands) May 31, 2000 ------------------------------------------------ --------------------- Mortgage Servicing Rights Balance at beginning of period $5,420,239 Additions 311,302 Scheduled amortization (108,240) Hedge losses (gains) applied 1,761 --------------------- Balance before valuation reserve at end of period 5,625,062 --------------------- Reserve for Impairment of Mortgage Servicing Rights Balance at beginning of period (23,762) Reductions (additions) 1,584 ---------------------- Balance at end of period (22,178) ---------------------- Mortgage Servicing Rights, net $5,602,884 ======================
COUNTRYWIDE CREDIT INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (UNAUDITED) COUNTRYWIDE CREDIT INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued) (UNAUDITED) Page 7 NOTE C - INVESTMENTS IN OTHER FINANCIAL INSTRUMENTS Investments in other financial instruments included the following. ------------------------------------------------------------ ----------------------------------------------------- May 31, February 29, (Dollar amounts in thousands) 2000 2000 ------------------------------------------------------------------- --- ----------------- --- ---------------- --- Servicing hedge instruments $2,102,907 $1,784,315 Mortgage-backed securities retained in securitization 826,148 775,867 Insurance company investment portfolio 516,661 520,490 Securities purchased under agreements to resell 1,659,164 435,593 Equity securities, restricted and unrestricted 47,559 46,193 ----------------- ---------------- $5,152,439 $3,562,458 ================= ================
------------------------------------------------------------------- Securities purchased under agreements to resell are classified as receivables. It is the policy of the Company to take possession of securities purchased under agreements to resell. The Company's agreements with third parties specify its rights to request additional collateral. The Company monitors the fair value of the underlying securities as compared with the related receivable, including accrued interest, and requests additional collateral as necessary. NOTE D - AVAILABLE FOR SALE SECURITIES Amortized cost and fair value of available for sale securities were as follows. ---------------------------------- ---------------- May 31, 2000 ---------------- - ------------------------------------ -- ---------------- Gross Gross Amortized Unrealized Unrealized Fair (Dollar amounts in thousands) Cost Gains Losses Value ---------------------------------- ---------------- - ----------------- - ---------------- -- ---------------- --- Mortgage-backed Securities retained in Securitization $834,317 $30,767 ($38,936) $826,148 Principal only securities 1,383,930 2,497 (73,857) 1,312,570 Insurance company investment portfolio 529,319 989 (13,647) 516,661 Equity securities 63,136 3,415 (18,992) 47,559 ---------------- ----------------- ---------------- ---------------- $2,810,702 $37,668 ($145,432) $2,702,938 ================ ================= ================ ================
NOTE D - AVAILABLE FOR SALE SECURITIES (Continued) ---------------------------------- ---------------- - ------------------------------------ -- ---------------- --- February 29, 2000 ---------------- - ------------------------------------ -- ---------------- --- Gross Gross Amortized Unrealized Unrealized Fair (Dollar amounts in thousands) Cost Gains Losses Value ---------------------------------- ---------------- - ----------------- - ---------------- -- ---------------- --- Mortgage-backed Securities retained in Securitization $760,619 $39,411 ($24,163) $775,867 Principal only securities 1,002,496 2,372 (52,028) 952,840 Insurance company investment portfolio 523,012 483 520,490 (3,005) Equity securities 63,136 3,193 (20,136) 46,193 ---------------- ----------------- ---------------- ---------------- $2,349,263 $45,459 ($99,332) $2,295,390 ================ ================= ================ ================
NOTE E - NOTES PAYABLE Notes payable consisted of the following. ------------------------------------------------------------ ----------------------------------------------------- May 31, February 29, (Dollar amounts in thousands) 2000 2000 -------------------------------------------------------------------- -- --- ---------------- --- ----------------- --- Commercial paper $ 526,795 $ 103,829 Medium-term notes, Series A, B, C, D, E, F, G, H and Euro Notes 8,800,060 7,975,324 Securities sold under agreements to repurchase 2,554,879 1,501,409 Unsecured notes payable 35,000 - Subordinated notes 200,000 200,000 Other notes payable 1,294 2,063 ----------------- ---------------- $12,118,028 $9,782,625 ================= ================
Commercial Paper and Backup Credit Facilities As of May 31, 2000, CHL, the Company's mortgage banking subsidiary, had unsecured credit agreements (revolving credit facilities) with consortiums of commercial banks permitting CHL to borrow an aggregate maximum amount of $5.0 billion. The facilities included a $4.0 billion revolving credit facility with forty-four commercial banks consisting of: (i) a five-year facility of $3.0 billion, which expires on September 24, 2002, and (ii) a one-year facility of $1.0 billion which expires on September 20, 2000. As consideration for the facility, CHL pays annual commitment fees of $3.8 million. There is an additional one-year facility, which expires on April 11, 2001, with a total commitment of $1.0 billion. As consideration for the facility, CHL pays annual commitment fees of $0.8 million. The purpose of these credit facilities is to provide liquidity backup for CHL's commercial paper program. No amount was outstanding under these revolving credit facilities at May 31, 2000. The weighted average borrowing rate on commercial paper borrowings for the three months ended May 31, 2000 was 6.10%. The weighted average borrowing rate on commercial paper outstanding as of May 31, 2000 was 6.89%. In addition, CHL has entered into a $1.1 billion asset backed commercial paper conduit facility with four commercial banks. This facility has a maturity date of November 21, 2000. As consideration for this facility, CHL pays annual commitment fees of $1.4 million. Loans made under this facility are secured by conforming and non-conforming mortgage loans. All of the facilities contain various financial covenants and restrictions, certain of which limit the amount of dividends that can be paid by the Company or CHL. NOTE E - NOTES PAYABLE (Continued) Medium-Term Notes As of May 31, 2000, outstanding medium-term notes issued by CHL under various shelf registrations filed with the Securities and Exchange Commission or issued by CHL pursuant to its Euro medium-term note program were as follows. --------------------------------------------------------------------------------------------------------------------------- (Dollar amounts in thousands) Outstanding Balance Interest Rate Maturity Date ---------------------- ---------------------------- ------------------------------------------- Floating-Rate Fixed-Rate Total From To From To ------------------------------------------- ----------- ---------- -------------- ------------- Series A - $143,500 $143,500 7.29% 8.79% Aug. 2000 Mar 2002 Series B - 251,000 251,000 6.65% 6.98% Mar. 2003 Aug. 2005 Series C 105,000 127,000 232,000 5.88% 7.75% Mar. 2001 Mar. 2004 Series D 75,000 385,000 460,000 6.05% 7.15% Aug. 2000 Sep. 2005 Series E 210,000 655,000 865,000 6.83% 7.45% Aug. 2000 Oct. 2008 Series F 311,000 1,344,000 1,655,000 6.16% 7.39% Oct. 2000 May 2013 Series G 5,000 581,000 586,000 5.35% 7.00% Oct. 2000 Nov. 2018 Series H 467,000 2,049,000 2,516,000 6.25% 8.25% May 2001 Oct. 2019 Euro Notes 679,600 1,411,960 2,091,560 6.10% 8.08% Jul. 2000 Jan. 2009 ------------------------------------------- Total $1,852,600 $6,947,460 $8,800,060
=========================================== As of May 31, 2000, substantially all of the outstanding fixed-rate notes had been effectively converted through interest rate swap agreements to floating-rate notes. The weighted average borrowing rate on medium-term note borrowings for the three-months ended May 31, 2000, including the effect of the interest rate swap agreements, was 6.58%. As of May 31, 2000, there were $1,362 million foreign currency denominated fixed-rate notes issued pursuant to the Euro medium-term notes program outstanding. Such notes are denominated in Deutsche Marks, French Francs, Portuguese Escudos, Japanese Yen and Euros. The Company manages the associated foreign currency risk by entering into currency swaps. The terms of the currency swaps effectively translate the foreign currency denominated medium-term notes into U.S. dollars. Securities Sold Under Agreements to Repurchase The Company routinely enters into short-term financing arrangements to sell MBS under agreements to repurchase. The weighted average borrowing rate for the three-months ended May 31, 2000 was 6.02%. The weighted average borrowing rate on repurchase agreements outstanding as of May 31, 2000, was 6.57%. The repurchase agreements were collateralized by MBS. All MBS underlying repurchase agreements are held in safekeeping by broker-dealers or banks. All agreements are to repurchase the same or substantially identical MBS. NOTE E - NOTES PAYABLE (Continued) Pre-Sale Funding Facilities As of May 31, 2000, CHL had uncommitted revolving credit facilities with the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"). The credit facilities are secured by conforming mortgage loans that are in the process of being pooled into MBS. As of May 31, 2000, the Company had no outstanding borrowings under any of these facilities. NOTE F - FINANCIAL INSTRUMENTS The following table summarizes the notional amounts of derivative contracts included in the Servicing Hedge. -------------------------------------- -------------------- -------------------- ------------------ --------------------- (Dollar amounts in millions) Balance, Dispositions/ Balance, February 29, 2000 Additions Expirations May 31, 2000 -------------------------------------- -------------------- -------------------- ------------------ --------------------- Interest Rate Floors $50,500 - (2,000) $48,500 Long Call Options on Interest Rate Futures $15,000 5,000 - $20,000 Long Put Options on Interest Rate Futures $1,750 3,500 - $5,250 Long Call Options on MBS $8,561 - - $8,561 Capped Swaps $1,000 - - $1,000 Interest Rate Swaps $1,500 - - $1,500 Interest Rate Cap $2,500 - (1,000) $1,500 Swaptions $36,250 6,000 - $42,250 -------------------------------------- -------------------- -------------------- ------------------ ---------------------
Fair Value of Financial Instruments The following disclosure of the estimated fair value of financial instruments as of May 31, 2000 and February 29, 2000 is made by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. NOTE F- FINANCIAL INSTRUMENTS (Continued) May 31, 2000 February 29, 2000 (Dollar amounts in thousands) Carrying Estimated Carrying Estimated Amount fair value amount fair value Assets: Mortgage loans and mortgage-backed securities held for sale $2,517,167 $2,517,167 $2,653,183 $2,653,183 Trading securities 2,144,249 2,144,249 1,984,031 1,984,031 Items included in investments in other financial instruments: Principal only securities purchased 1,312,570 1,312,570 952,840 952,840 Mortgage-backed securities retained in securitizations 826,148 826,148 775,867 775,867 Insurance Company investment portfolio 516,661 516,661 520,490 520,490 Securities purchased with agreements to rese1,659,164 1,659,164 435,593 435,593 Equity Securities - restricted and 47,559 47,559 46,193 46,193 unrestricted Items included in other assets: Rewarehoused FHA and VA loans 279,371 279,371 336,273 336,273 Loans held for investment 184,724 184,724 177,330 177,330 Receivables related to broker-dealer activitie463,479 463,479 22,612 22,612 Liabilities: Notes payable 12,118,028 11,685,252 9,782,625 9,459,011 Securities sold not yet purchased 296,213 296,213 181,903 181,903 Derivatives: Interest rate floors 372,299 149,095 411,278 180,360 Forward contracts on MBS (11,425) 37,805 (11,080) (13,511) Options on MBS 79,671 34,084 75,950 32,415 Options on interest rate futures 18,169 9,803 8,921 6,032 Interest rate caps 30,405 21,514 47,348 39,088 Capped Swaps (8,031) (8,926) (5,619) (8,040) Swaptions 348,580 60,133 341,039 76,254 Interest rate swaps (8,814) (508,394) (23,228) (457,051) Short-term commitments to extend credit - 65,100 - 52,500 ---- ------------------------------------------------ --------------- -- ------------- -- ------------- --- -------------
The fair value estimates as of May 31, 2000 and February 29, 2000 are based on pertinent information that was available to management as of the respective dates. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. NOTE G - LEGAL PROCEEDINGS Legal Proceedings The Company and certain subsidiaries are defendants in various legal proceedings involving matters generally incidental to their business. Although it is difficult to predict the ultimate outcome of these proceedings, management believes, based on discussions with counsel, that any ultimate liability will not materially affect the consolidated financial position or results of operations of the Company and its subsidiaries. NOTE H - SUMMARIZED FINANCIAL INFORMATION OF SUBSIDIARY Summarized financial information for Countrywide Home Loans, Inc. was as follows. ---- ----------------------------------------- ---- ------------------------------------------------- May 31, February 29, (Dollar amounts in thousands) 2000 2000 ---- ---------------------------------------------- ------- -------------- ----------- -------------- Balance Sheets: Mortgage loans and mortgage-backed securities held for sale $2,517,167 $2,653,183 Mortgage servicing rights, net 5,602,884 5,396,477 Other assets 6,563,603 5,240,247 -------------- -------------- Total assets $14,683,654 $13,289,907 ============== ============== Short- and long-term debt $10,563,556 $9,224,956 Other liabilities 1,649,552 1,632,106 Equity 2,470,546 2,432,845 -------------- -------------- Total liabilities and equity $14,683,654 $13,289,907 ============== ==============
---- ---------------------------------------------- ------- -------------- ----------- -------------- --------- ----- ----------------------------------------- --- --------------------------------------------------- -------- Three Months Ended May 31, (Dollar amounts in thousands) 2000 1999 ----- --------------------------------------------- ------- --------------- ---------- --------------- --------- --------------- ---------- --------------- --------- Statements of Earnings: Revenues $356,945 $438,204 Expenses 271,790 305,021 Provision for income taxes 30,948 51,941 --------------- --------------- Net earnings $ 54,207 $ 81,242 =============== ===============
NOTE I - SEGMENTS AND RELATED INFORMATION The Company has six major segments that are grouped into Consumer and Institutional businesses. Consumer Businesses include Mortgage Originations, Mortgage-Related Investments and Business to Consumer ("B2C") Insurance. Institutional Businesses include Processing and Technology, Capital Markets and Business to Business ("B2B") Insurance. The Mortgage Originations segment originates mortgage loans through the Company's retail branch network (Consumer Markets Division and Full Spectrum Lending, Inc.) and the Wholesale Division. This segment also provides other complementary services offered as part of the origination process through LandSafe, Inc., including title, escrow, appraisal, credit reporting and flood determination services. The Mortgage-Related Investments segment consists of investments in assets retained in the mortgage securitization process, including MSRs and residual interests. The B2C Insurance Segment, through Countrywide Insurance Services, Inc., acts as an agent in the sale of insurance, including homeowners, fire, flood, earthquake, life and disability insurance, primarily to the Company's mortgage customers. The Processing and Technology segment activities include mortgage servicing, as well as mortgage subservicing and subprocessing for other domestic financial institutions and foreign financial institutions (through Global Home Loans, Limited). The Capital Markets segment purchases mortgage loans through the Correspondent Lending Division, acts as a broker/dealer specializing in mortgages and mortgage-related securities through Countrywide Securities Corporation ("CSC"), and as an agent (Countrywide Servicing Exchange, Inc.), facilitates the purchase and sale of bulk servicing rights. The B2B Insurance Segment includes the activities of Balboa Life and Casualty ("Balboa"), an insurance carrier that offers property and casualty insurance (specializing in creditor-placed insurance), and life and disability insurance, along with Second Charter, Inc., a mortgage reinsurance company. Included in the tables below labeled "Other" is the holding company activities and certain reclassifications to conform management reporting to the consolidated financial statements. NOTE I - SEGMENTS AND RELATED INFORMATION (Continued) ------------------------------------------------------------------------------------------------------------------------------------ For the three months ended May 31, 2000 Consumer Businesses Institutional Businesses ---------- ---------- --------- ----------- ---------- --------- --------- ---------- Mortgage-Related Processing Mortgage InvestmentsB2C and Capital B2B (Dollars in thousanOriginations Insurance Total Technology Markets Insurance Total Other Total ------------------ ---------- ---------- --------- ----------- ---------- --------- --------- ---------- -------- ------------ External revenues $210,553 $181,028 $9,401 $400,982 $ 6,667 $52,979 $68,369 $128,015 ($765) $528,232 Intersegment revenues - (63,407) - (63,407) 63,407 - - 63,407 - - ---------- ---------- --------- ----------- ---------- --------- --------- ---------- -------- ------------ Total revenues $210,553 $117,621 $9,401 $337,575 $70,074 $52,979 $68,369 $191,422 ($765) $528,232 ========== ========== ========= =========== ========== ========= ========= ========== ======== ============ Segment earnings (pre-tax) $27,554 $62,166 $1,060 $90,780 $10,505 $16,901 $14,248 $41,654 ($1,509) $130,925 Segment assets $2,073,776 $9,374,307 $50,691 $11,498,774 $159,483 $5,812,925$827,757 $6,800,165 $141,151 $18,440,090 ------------------ ---------- ---------- --------- ----------- -- ---------- --------- --------- ---------- -- -------- ------------ ------------------------------------------------------------------------------------------------------------------------------------ For the three months ended May 31, 1999 Consumer Businesses Institutional Businesses ---------- ---------- --------- ----------- ---------- --------- --------- ---------- Mortgage-Related Processing Mortgage InvestmentsB2C and Capital B2B (Dollars in thousanOriginations Insurance Total Technology Markets Insurance Total Other Total ------------------ ---------- ---------- --------- ----------- ---------- --------- --------- ---------- -------- ------------ External revenues $327,468 $122,664 $7,426 $457,558 $ 6,126 $64,327 $5,940 $76,393 $4,759 $538,710 Intersegment revenues - (54,729) - (54,729) 54,729 - - 54,729 - - ---------- ---------- --------- ----------- ---------- --------- --------- ---------- -------- ------------ Total revenues $327,468 $ 67,935 $7,426 $402,829 $60,855 $64,327 $5,940 $131,122 $4,759 $538,710 ========== ========== ========= =========== ========== ========= ========= ========== ======== ============ Segment earnings (pre-tax) $112,150 $16,020 $1,192 $129,362 $6,501 $28,045 $5,883 $40,429 ($317) $169,474 Segment assets $4,498,388 $7,299,581 $27,600 $11,825,569 $114,955 $5,183,810$33,924 $5,332,689 $206,349 $17,364,607 ------------------ ---------- ---------- --------- ----------- -- ---------- --------- --------- ---------- -- -------- ------------
NOTE J - SUBSEQUENT EVENTS On June 21, 2000, the Company declared a cash dividend of $0.10 per common share payable July 31, 2000 to shareholders of record on July 13, 2000. On June 27, 2000, the Company filed a $3.0 billion shelf registration with the Securities and Exchange Commission ("SEC") covering Series I Medium-Term Notes. The Company intends to use the proceeds from the sale of the medium-term notes for general corporate purposes, which may include retirement of indebtedness of the Company and investment in servicing rights through the current production of loans and the bulk acquisition of contracts to service loans. NOTE K - IMPLEMENTATION OF NEW ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize the fair value of all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. This statement will become effective in the fiscal year ended February 28, 2002. The Company has not yet determined the impact on the Consolidated Financial Statements upon the adoption of this standard. NOTE L - EARNINGS PER SHARE Basic earnings per share is determined using net income divided by the weighted average shares outstanding during the period. Diluted EPS is computed by dividing net income by the weighted average shares outstanding, assuming all dilutive potential common shares were issued. The following table presents basic and diluted EPS for the three months ended May 31, 2000 and 1999. ------------------------ -- -- ----- ------------------------------------ Three Months Ended May 31, -- -- ----- ------------------------------------ -- ----- ---- 2000 1999 --------- --------- --------- ---------- --------- --------- (Dollar amounts in Per-Share Per-Share thousands, except per Net Amount Net Amount share data) Earnings Shares Earnings Shares ------------------------ --------- --------- --------- --------- --------- ---------- Net earnings $83,459 $103,379 ========= ========== Basic EPS Net earnings available to common shareholders $83,459 113,792 $0.73 $103,379 112,751 $0.92 Effect of dilutive stock options - 2,316 - 4,762 --------- --------- ---------- --------- Diluted EPS Net earnings available to common shareholders $83,459 116,108 $0.72 $103,379 117,513 $0.88 ========= ========= ========== =========
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Page 29 FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q may contain forward-looking statements that reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including those identified below, which could cause actual results to differ materially from historical results or those anticipated. The words "believe," "expect," "anticipate," "intend," "estimate," "should" and other expressions which indicate future events and trends identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following factors could cause actual results to differ materially from historical results or those anticipated: (1) the level of demand for mortgage credit, which is affected by such external factors as the level of interest rates, the strength of the various segments of the economy and demographics of the Company's lending markets; (2) the direction of interest rates; (3) the relationship between mortgage interest rates and the cost of funds; (4) federal and state regulation of the Company's mortgage origination, mortgage servicing, capital markets and insurance operations; and (5) competition within the mortgage banking, capital markets and insurance industries. RESULTS OF OPERATIONS Quarter Ended May 31, 2000 Compared to Quarter Ended May 31, 1999 Revenues for the quarter ended May 31, 2000 decreased 2% to $528.2 million, down from $538.7 million for the quarter ended May 31, 1999. Net earnings decreased 19% to $83.5 million for the quarter ended May 31, 2000, down from $103.4 million for the quarter ended May 31, 1999. The decrease in revenues and net earnings for the quarter ended May 31, 2000 compared to the quarter ended May 31, 1999 was primarily due to a decline in prime loan originations attributable to a decline in loan refinancings. The decline was partially offset by increased revenue from mortgage-related investments and the B2B insurance segment, together with increased production of non-traditional loan products (home equity and sub-prime loans). The total volume of loans produced by the Company decreased 37% to $14.5 billion for the quarter ended May 31, 2000, down from $23.2 billion for the quarter ended May 31, 1999. The decrease in loan production was primarily due to a decrease in the mortgage origination market, driven largely by a reduction in refinances. Total loan production by purpose and by interest rate type is summarized below. -------------------------------------------- -- (Dollar amounts in millions) Loan Production Three Months Ended May 31, -------------------------------------------- --------------------------------------- 2000 1999 ------------- ---------------- Purchase $11,595 $11,722 Refinance 2,951 11,471 ------------- ---------------- Total $14,546 $23,193 ============= ================ ------------- ---------------- Fixed Rate $11,145 $21,611 Adjustable Rate 3,401 1,582 ------------- ---------------- Total $14,546 $23,193 ============= ================
Total loan production by Division is summarized below. -------------------------------------------- ---------------------------------- (Dollar amounts in millions) Loan Production Three Months Ended May 31, -------------------------------------------- --------------------------------- 2000 1999 ------------- ----------- Consumer Markets Division $4,042 $ 7,035 Wholesale Lending Division 4,062 7,122 Correspondent Lending Division 6,021 8,712 Full Spectrum Lending, Inc. 421 324 ------------- ---------- Total $14,546 $23,193 ============= ========
--------------------------------------------------------------------------- The factors which affect the relative volume of production among the Company's Divisions include the price competitiveness of each Division's various product offerings, the level of mortgage lending activity in each Division's market and the success of each Division's sales and marketing efforts. Non-traditional loan production (which is included in the Company's total volume of loans produced) is summarized below. -------------------------------------------- ------------------------------- Non-Traditional (Dollar amounts in millions) Loan Production Three Months Ended May 31, -------------------------------------------- --------------------------------- 2000 1999 ------------- --------- Sub-prime $1,440 $769 Home Equity Loans 1,131 717 ------------- ---------- Total $2,571 $1,486 ============= ==========
-------------------------------------------------------------------------------- Loan origination fees decreased in the quarter ended May 31, 2000 as compared to the quarter ended May 31, 1999 primarily due to lower production and a change in the Divisional mix. The Consumer Markets and Wholesale Lending Divisions (which, due to their cost structures, charge higher origination fees per dollar loaned than the Correspondent Division), comprised a lower percentage of total production in the quarter ended May 31, 2000 than in the quarter ended May 31, 1999. Gain on sale of loans also decreased in the quarter ended May 31, 2000 as compared to the quarter ended May 31, 1999 primarily due to decreased production and reduced margins on prime credit quality mortgages. These declines were partially offset by increased sales during the quarter ended May 31, 2000 of higher margin home equity and sub-prime loans. The sale of home equity loans contributed $21.6 million and $20.3 million to gain on sale of loans in the quarter ended May 31, 2000 and the quarter ended May 31, 1999, respectively. Sub-prime loans contributed $60.7 million to the gain on sale of loans in the quarter ended May 31, 2000 and $35.5 million in the quarter ended May 31, 1999. In general, loan origination fees and gain on sale of loans are affected by numerous factors including the volume and mix of loans produced and sold, loan pricing decisions, and movements of interest rates. Net interest expense (interest earned net of interest charges) of $2.9 million for the quarter ended May 31, 2000, is down from net income of $29.5 million for the quarter ended May 31, 1999. Net interest income (expense) is principally a function of: (i) net interest income earned from the Company's mortgage loan inventory ($20.6 million and $47.2 million for the quarter ended May 31, 2000 and the quarter ended May 31, 1999, respectively); (ii) interest expense related to the Company's mortgage-related investments ($86.8 million and $66.8 million for the quarters ended May 31, 2000 and May 31, 1999, respectively) and (iii) interest income earned from the custodial balances associated with the Company's servicing portfolio ($51.8 million and $43.1 million for the quarters ended May 31, 2000 and May 31, 1999, respectively). The Company earns interest on, and incurs interest expense to carry, mortgage loans held in its inventory. The decrease in net interest income from the mortgage loan inventory was primarily attributable to lower inventory levels combined with a lower net earnings rate during the quarter ended May 31, 2000. The increase in interest expense related to mortgage-related investments resulted primarily from an increase in amounts financed coupled with an increase in short-term interest rates. The increase in net interest income earned from the custodial balances was primarily due to an increase in the earnings rate from the quarter ended May 31, 2000 to the quarter ended May 31, 1999. During the quarter ended May 31, 2000, loan servicing revenue before amortization increased primarily due to growth of the loan servicing portfolio and improved performance of the residual investments. As of May 31, 2000, the Company serviced $261.9 billion of loans (including $6.8 billion of loans subserviced for others), up from $226.0 billion (including $2.3 billion of loans subserviced for others) as of May 31, 1999, a 16% increase. The growth in the Company's servicing portfolio since May 31, 1999 was the result of loan production volume and the acquisition of bulk servicing rights. This was partially offset by prepayments, partial prepayments and scheduled amortization. During the quarter ended May 31, 2000, the annual prepayment rate of the Company's servicing portfolio was 9%, compared to 21% for the quarter ended May 31, 1999. In general, the prepayment rate is affected by the level of refinance activity, which in turn is driven by the relative level of mortgage interest rates, and activity in the housing market. The weighted average interest rate of the mortgage loans in the Company's servicing portfolio as of May 31, 2000 was 7.7% compared to 7.4% as of May 31, 1999. The Company recorded MSR amortization for the quarter ended May 31, 2000 totaling $108.2 compared to $127.0 for the quarter ended May 31, 1999. The Company recorded recovery of previous impairment of $3.3 million for the quarter ended May 31, 2000 compared to $151.5 for the quarter ended May 31, 1999. The primary factors affecting the amount of amortization and impairment recovery of MSRs recorded in an accounting period are the level of prepayments during the period and the change, if any, in estimated future prepayments. To mitigate the effect on earnings of MSR impairment that may result from increased current and projected future prepayment activity, the Company acquires financial instruments, including derivative contracts, that increase in aggregate value when interest rates decline (the "Servicing Hedge"). In the quarter ended May 31, 2000, the Company recognized a net expense of $13.3 million from its Servicing Hedge. The net expense included unrealized net losses of $6.7 million and realized net expense of $6.6 million from the sale of various financial instruments that comprise the Servicing Hedge net of premium amortization. In the quarter ended May 31, 1999, the Company recognized a net expense of $171.4 million from its Servicing Hedge. The net expense included unrealized net losses of $182.8 million and net realized gains of $11.4 million from the sale of various financial instruments that comprise the Servicing Hedge net of premium amortization. The financial instruments that comprised the Servicing Hedge included interest rate floors, principal only securities (P/O Securities"), options on interest rate swaps ("Swaptions"), options on MBS, options on interest rate futures, interest rate swaps, interest rate swaps with the Company's maximum payment capped ("Capped Swaps") and interest rate caps. The Servicing Hedge is designed to protect the value of the MSRs from the effects of increased prepayment activity that generally results from declining interest rates. To the extent that interest rates increase, the value of the MSRs increases while the value of the hedge instruments declines. With respect to the floors, options on interest rate futures and MBS, caps, Swaptions and P/O securities, 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 Swaps contracts entered into by the Company as of May 31, 2000, the Company estimates that its maximum exposure to loss over the contractual terms is $1 million. With respect to the Capped Swaps contracts entered into by the Company as of May 31, 2000, the Company estimates that its maximum exposure to loss over the contractual terms is $2 million. Salaries and related expenses are summarized below for the quarters ended May 31, 2000 and 1999. ---- --------------------------- -- -- ------ ------------------------------------------------- ----- -- ---- ----- (Dollar amounts in Quarter Ended May 31, 2000 thousands) -- ------ ------------------------------------------------- ----- -- ---- ----- ---- --------------------------- -- Consumer Institutional Corporate Businesses Businesses Administration Total ---- --------------------------- -- ----------------- -- ---------------- -- ----------------- - ------------------ Base Salaries $59,799 $32,919 $25,007 $117,725 Incentive Bonus 21,508 8,160 4,454 34,122 Payroll Taxes and Benefits 10,023 5,128 4,533 19,684 ----------------- ---------------- ----------------- ------------------ Total Salaries and Related Expenses $91,330 $46,207 $33,994 $171,531 ================= ================ ================= ================== Average Number of 5,810 3,557 1,648 11,015 Employees ---- --------------------------- -- ----------------- -- ---------------- -- ----------------- - ------------------
---- --------------------------- -- -- ------ ------------------------------------------------- ----- -- ---- ----- (Dollar amounts in Quarter Ended May 31, 1999 thousands) -- ------ ------------------------------------------------- ----- -- ---- ----- ---- --------------------------- -- Consumer Institutional Corporate Businesses Businesses Administration Total ---- --------------------------- -- ----------------- -- ---------------- -- ----------------- - ------------------ Base Salaries $72,117 $22,770 $24,881 $119,768 Incentive Bonus 33,172 6,707 5,905 45,784 Payroll Taxes and Benefits 12,241 3,611 4,022 19,874 ----------------- ---------------- ----------------- ------------------ Total Salaries and Related Expenses $117,530 $33,088 $34,808 $185,426 ================= ================ ================= ================== Average Number of 7,095 2,597 1,804 11,496 Employees ---- --------------------------- -- ----------------- -- ---------------- -- ----------------- - ------------------
The amount of salaries decreased during the quarter ended May 31, 2000 as compared to the quarter ended May 31, 1999 primarily due to a reduction in staff in the consumer businesses due to the decline in mortgage originations. The decline was partially offset by an increase in institutional businesses as a result of a larger servicing portfolio and the acquisition of Balboa on November 30, 1999. Incentive bonuses earned during the quarter ended May 31, 2000 decreased primarily due to the decline in production volume. Occupancy and other office expenses for the quarter ended May 31, 2000 decreased to $66.5 million from $72.2 million for the quarter ended May 31, 1999. This was primarily due to the initiation of cost reduction measures in the production areas as a result of a decline in production. Guarantee fees represent fees paid to Fannie Mae and Ginnie Mae ("GSEs") to guarantee timely and full payment of principal and interest in the Company's agency MBS and to transfer the credit risk of the loans in the servicing portfolio sold to these entities. For the quarter ended May 31, 2000, guarantee fees increased 17% to $53.7 million, up from $45.8 million for the quarter ended May 31, 1999. The increase resulted from an increase in the servicing portfolio, changes in the mix of the portfolio guaranteed by the GSEs and terms negotiated at the time of loan sales. Marketing expenses for the quarter ended May 31, 2000 increased 1% to $19.8 million as compared to $19.5 million for the quarter ended May 31, 1999. Other operating expenses were $60.2 million for the quarter ended May 31, 2000 as compared to $46.2 million May 31, 1999. The increase was primarily due to the acquisition of Balboa on November 30, 1999. OPERATING SEGMENTS The Company's business strategy is primarily focused on six areas that are grouped into Consumer and Institutional businesses. Consumer Businesses include Mortgage Originations, Mortgage-Related Investments and Business to Consumer ("B2C") Insurance. Institutional Businesses include Processing and Technology, Capital Markets and Business to Business ("B2B") Insurance. The Mortgage Originations segment originates mortgage loans through the Company's retail branch network (Consumer Markets Division and Full Spectrum Lending, Inc.) and the Wholesale Division. This segment also provides other complementary services offered as part of the origination process through LandSafe, Inc., including title, escrow, appraisal, credit reporting and flood determination services. The Mortgage-Related Investments segment consists of investments in assets retained in the mortgage securitization process, including MSRs and residual interests. The B2C Insurance Segment, through Countrywide Insurance Services, Inc., acts as an agent in the sale of insurance, including homeowners, fire, flood, earthquake, life and disability insurance, primarily to the Company's mortgage customers. The Processing and Technology segment activities include mortgage servicing, as well as mortgage subservicing and subprocessing for other domestic financial institutions and foreign financial institutions (through Global Home Loans, LTD.). The Capital Markets segment purchases mortgage loans through the Correspondent Lending Division, acts as a broker/dealer specializing in mortgages and mortgage-related securities through Countrywide Securities Corporation ("CSC"), and as an agent (Countrywide Servicing Exchange, Inc.), facilitates the purchase and sale of bulk servicing rights. The B2B Insurance Segment includes the activities of Balboa Life and Casualty ("Balboa"), an insurance carrier that offers property and casualty insurance (specializing in creditor-placed insurance), and life and disability insurance, along with Second Charter, Inc., a mortgage reinsurance company. The Company's pre-tax earnings by segment is summarized below. -------------------------------------------- -------------------------------- Three months ended (Dollar amounts in millions) May 31, -------------------------------------------- ---------------------------------- 2000 1999 ------------- ----------- Consumer Businesses: Mortgage Originations $27,554 $112,150 Mortgage-Related Investments 62,166 16,020 B2C Insurance 1,060 1,192 ------------- ------------ Total Consumer Business $90,780 $129,362 Institutional Businesses: Processing and Technology $10,505 $6,501 Capital Markets 16,901 28,045 B2B Insurance 14,248 5,883 -------------- ------------- Total Institutional Business $41,654 $40,429 Other (1,509) (317) ------------- -------------- Pre-tax Earnings $130,925 $169,474 ============= ============== ---------------------------------------------------------------------------------------------
Profitability of Mortgage Originations Segment The Mortgage Originations segment activities include loan origination through the Company's retail branch network (Consumer Markets Division and Full Spectrum Lending, Inc.) and the Wholesale Division, the warehousing and sales of such loans and loan closing services. The decline in pre-tax earnings of $84.6 million in the quarter ended May 31, 2000 as compared to the quarter ended May 31, 1999 was primarily attributable to lower production and reduced margins on prime credit quality mortgages driven by a significant reduction in refinances. These factors were partially offset by increased production and sales of higher margin home equity and sub-prime loans. Profitability of Mortgage-Related Investments Segment Mortgage-Related Investment segment activities include investments in assets retained in the mortgage securitization process, including mortgage servicing rights, residual interests in asset-backed securities and other mortgage-related assets. The increase in pre-tax earnings of $46.1 million in the quarter ended May 31, 2000 as compared to the quarter ended May 31, 1999 was primarily due to an increase in servicing revenues resulting from servicing portfolio growth, a reduction in MSR amortization attributable to the decline in refinance activity and improved performance of the residual investments. These positive factors were partially offset by higher servicing expenses driven by the growth in the servicing portfolio, including the subservicing fee paid to the processing and technology sector. Profitability of B2C Insurance Segment B2C Insurance segment activities include the operations of an insurance agency, Countrywide Insurance Services ("CIS"), an insurance agency that provides homeowners, life, disability and automobile as well as other forms of insurance, primarily to the Company's mortgage customers. The decrease in pre-tax earnings of $0.1 in the quarter ended May 31, 2000 as compared to the quarter ended May 31, 1999 was primarily due to a slight decline in new policies sold. Profitability of Processing and Technology Segment Processing and Technology segment activities include mortgage servicing, as well as mortgage subservicing and subprocessing for other domestic and foreign financial institutions. The increase in pre-tax earnings of $4.0 million in the quarter ended May 31, 2000 as compared to the quarter ended May 31, 1999 was primarily due to growth in the servicing portfolio. Profitability of Capital Markets Segment Capital Markets segment activities include primarily the operations of Countrywide Securities Corporation ("CSC"), a registered broker-dealer specializing in the secondary mortgage market, and the Correspondent Lending Division ("CLD"), through which the Company purchases closed loans from mortgage bankers, commercial banks and other financial institutions. The decrease in pre-tax earnings of $11.1 million in the quarter ended May 31, 2000 as compared to the quarter ended May 31, 1999 was primarily due to CLD's decreased production volume attributable primarily to the decline in refinance activity. Profitability of B2B Insurance Segment B2B Insurance segment includes the activities of Balboa, an insurance carrier that offers property and casualty insurance (specializing in creditor placed insurance), and life and disability insurance together with the activities of a mortgage reinsurance company. The increase in pre-tax earnings of $8.4 million in the quarter ended May 31, 2000 as compared to the quarter ended May 31, 1999 was due to the acquisition of Balboa (on November 30, 1999) and increased mortgage reinsurance premium volume. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The primary market risk facing the Company is interest rate risk. From an enterprise perspective, the Company manages this risk by striving to balance its loan origination and loan servicing business segments, which are counter cyclical in nature. In addition, the Company utilizes various financial instruments, including derivatives contracts, to manage the interest rate risk related specifically to its committed pipeline, mortgage loan inventory and MBS held for sale, MSRs, mortgage-backed securities retained in securitizations, trading securities and debt securities. The overall objective of the Company's interest rate risk management policies is to offset changes in the values of these items resulting from changes in interest rates. The Company does not speculate on the direction of interest rates in its management of interest rate risk. As part of its interest rate risk management process, 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 scenarios including selected hypothetical (instantaneous) parallel shifts in the yield curve. Various modeling techniques are employed to value the financial instruments. For mortgages, MBS and MBS forward contracts and CMOs, an option-adjusted spread ("OAS") model is used. The primary assumptions used in this model are the implied market volatility of interest rates and prepayment speeds. For options and interest rate floors, an option-pricing model is used. The primary assumption used in this model is implied market volatility of interest rates. MSRs and residual interests are valued using discounted cash flow models. The primary assumptions used in these models are prepayment rates, discount rates and credit losses. Utilizing the sensitivity analyses described above, as of May 31, 2000, the Company estimates that a permanent 0.50% reduction in interest rates, all else being constant, would result in a $0.04 million after-tax loss related to its trading securities and there would be a $13.4 million loss related to its other financial instruments. As of May 31, 2000, the Company estimates that this combined after-tax loss of $13.4 million is the largest such loss that would occur within the range of reasonably possible interest rate changes. These sensitivity analyses are limited by the fact that they are performed at a particular point in time, are subject to the accuracy of various assumptions used including prepayment forecasts, and do not incorporate other factors that would impact the Company's overall financial performance in such a scenario. Consequently, the preceding estimates should not be viewed as a forecast. An additional, albeit less significant, market risk facing the Company is foreign currency risk. The Company has issued foreign currency-denominated medium-term notes (See Note E). The Company manages the foreign currency risk associated with such medium-term notes by entering into currency swaps. The terms of the currency swaps effectively translate the foreign currency denominated medium-term notes into U.S. dollars, thereby eliminating the associated foreign currency risk (subject to the performance of the various counterparties to the currency swaps). As a result, hypothetical 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. Inflation Inflation affects the Company most significantly in the areas of Mortgage Originations, Mortgage-Related Investments and Capital Markets. Interest rates normally increase during periods of high inflation and decrease during periods of low inflation. Historically, as interest rates increase, loan production decreases, particularly from loan refinancings. Although in an environment of gradual interest rate increases, purchase activity may actually be stimulated by an improving economy or the anticipation of increasing real estate values. In such periods of reduced loan production, production margins may decline due to increased competition resulting from overcapacity in the market. In a higher interest rate environment, mortgage-related investment earnings are enhanced because prepayment rates tend to slow down thereby extending the average life of the Company's servicing portfolio and reducing amortization and impairment of the MSRs, and because the rate of interest earned from the custodial balances tends to increase. Conversely, as interest rates decline, loan production, particularly from loan refinancings, increases. However, during such periods, prepayment rates tend to accelerate (principally on the portion of the portfolio having a note rate higher than the prevailing mortgage rates), thereby decreasing the average life of the Company's servicing portfolio and adversely impacting its mortgage related investment earnings primarily due to increased amortization and impairment of the MSRs, and decreased earnings from residual investments. The Servicing Hedge is designed to mitigate the impact of changing interest rates on mortgage related investment earnings. Seasonality The mortgage banking industry is generally subject to seasonal trends. These trends reflect the general national pattern of sales and resales of homes, although refinancings tend to be less seasonal and more closely related to changes in mortgage rates. Sales and resales of homes typically peak during the spring and summer seasons and decline to lower levels from mid-November through February. In addition, delinquency rates typically rise in the winter months, which results in higher servicing costs. However, late charge income has historically been sufficient to offset such incremental expenses. Liquidity and Capital Resources The Company's principal financing needs are the financing of its mortgage loan inventory, investment in MSRs and the trading securities of its broker-dealer subsidiary (CSC). To meet these needs, the Company currently utilizes commercial paper supported by the revolving credit facilities, medium-term notes, senior debt, MBS repurchase agreements, subordinated notes, pre-sale funding facilities, redeemable capital trust pass-through securities, securitization of servicing fee income and cash flow from operations. In addition, in the past the Company has utilized whole loan repurchase agreements, servicing-secured bank facilities, private placements of unsecured notes and other financings, direct borrowings from revolving credit facilities and public offerings of common and preferred stock. The Company strives to maintain sufficient liquidity in the form of unused, committed lines of credit, to meet anticipated short-term cash requirements as well as to provide for potential sudden increases in business activity driven by changes in the market environment. Certain of the debt obligations of the Company and Countrywide Home Loans, Inc. ("CHL") contain various provisions that may affect the ability of the Company and CHL to pay dividends and remain in compliance with such obligations. These provisions include requirements concerning net worth and other financial covenants. These provisions have not had, and are not expected to have, an adverse impact on the ability of the Company and CHL to pay dividends. The principal financing needs of CSC consist of the financing of its inventory of securities and mortgage loans. Its securities inventory is financed primarily through repurchase agreements. CSC also has access to a $200 million secured bank loan facility and a lending facility with CHL The primary cash needs for the B2B insurance segment are to meet short-term and long-term obligations to policyholders (payment of policy benefits), costs of acquiring new business (principally commissions) and the purchases of new investments. To meet these needs, Balboa currently utilizes cash flow provided from operations as well as maturities and sales of invested assets. The Company continues to investigate and pursue alternative and supplementary methods to finance its growing operations through the public and private capital markets. These may include such methods as mortgage loan sale transactions designed to expand the Company's financial capacity and reduce its cost of capital and the additional securitization of servicing income cash flows. In connection with its derivative contracts, the Company may be required to deposit cash or certain government securities or obtain letters of credit to meet margin requirements. The Company considers such potential margin requirements in its overall liquidity management. In the course of the Company's mortgage banking operations, the Company sells the mortgage loans it originates and purchases to investors but generally retains the right to service the loans, thereby increasing the Company's investment in MSRs. The Company views the sale of loans on a servicing-retained basis in part as an investment vehicle. Significant unanticipated prepayments in the Company's servicing portfolio could have a material adverse effect on the Company's future operating results and liquidity. Cash Flows Operating Activities In the quarter ended May 31, 2000, the Company's operating activities used cash of approximately $1.9 billion on a short-term basis primarily to support an increase in other financial instruments, primarily securities purchased under agreements to resale. In the quarter ended May 31, 1999, operating activities used cash of approximately $1.0 billion on a short-term basis primarily to support the increase in its mortgage loans and MBS held for sale. Investing Activities The primary investing activity for which cash was used by the Company was the investment in MSRs. Net cash used by investing activities was $0.3 billion for the quarter ended May 31, 2000 and $0.4 billion for the quarter ended May 31, 1999. Financing Activities Net cash provided by financing activities amounted to $2.4 billion for the quarter ended May 31, 2000 and $1.4 billion for the quarter ended May 31, 1999. The increase in cash flow from financing activities was primarily used to fund the change in the Company's mortgage loan inventory, other financial instruments and investment in MSRs. Prospective Trends Applications and Pipeline of Loans in Process For the month ended June 30, 2000, the Company received new loan applications at an average daily rate of $361 million. As of June 30, 2000, the Company's pipeline of loans in process was $9.5 billion. This compares to a daily application rate for the month ended June 30, 1999 of $490 million and a pipeline of loans in process as of June 30, 1999 of $14.7 billion. The size of the pipeline is generally an indication of the level of near-term future fundings, as historically 43% to 77% of the pipeline of loans in process has funded. In addition, the Company's LOCK `N SHOP(R) Pipeline as of June 30, 2000 was $3.5 billion and as of June 30, 1999 was $3.5 billion. Future application levels and loan fundings are dependent on numerous factors, including the level of demand for mortgage loans, the level of competition in the market, the direction of mortgage rates, seasonal factors and general economic conditions. Market Factors Loan production decreased 37% from the quarter ended May 31, 1999 to the quarter ended May 31, 2000. This decrease was primarily due to a smaller mortgage origination market, driven by reduced refinances. Home purchase related loan production was essentially unchanged during the same period. The prepayment rate in the servicing portfolio decreased from 21% for the quarter ended May 31, 1999 to 9% for the quarter ended May 31, 2000. This was due primarily to a decrease in refinances. The Company's California mortgage loan production (as measured by principal balance) constituted 20% of its total production during the quarter ended May 31, 2000 and 23% during the quarter ended May 31, 1999. Some regions in which the Company operates have experienced slower economic growth, and real estate financing activity in these regions has been impacted negatively. The Company has striven to diversify its mortgage banking activities geographically to mitigate such effects. The delinquency rate in the Company's servicing portfolio, excluding sub-servicing, increased to 4.12% at May 31, 2000 from 3.00% as of May 31, 1999. The Company believes that this increase was primarily the result of changes in portfolio mix and aging. Sub-prime loans (which tend to experience higher delinquency rates than prime loans) represented approximately 5% of the total portfolio as of May 31, 2000, up from 1% as of May 31, 1999. In addition, the weighted average age of the FHA and VA loans in the portfolio increased to 32 months at May 31, 2000 from 27 months in May 31, 1999. Delinquency rates tend to increase as loans age, reaching a peak at three to five years of age. Related late charge income has historically been sufficient to offset incremental servicing expenses resulting from increased loan delinquencies. The percentage of loans in the Company's servicing portfolio, excluding sub-servicing, that are in foreclosure increased to 0.35% as of May 31, 2000 from 0.27% as of May 31, 1999. Because the Company services substantially all conventional loans on a non-recourse basis, related credit losses are generally the responsibility of the investor or insurer and not the Company. While the Company does not generally retain credit risk with respect to the prime credit quality first mortgage loans it sells, it does have potential liability under representations and warranties made to purchasers and insurers of the loans. In the event of a breach of these representations and warranties, the Company may be required to repurchase a mortgage loan and any subsequent loss on the mortgage loan may be borne by the Company. Similarly, government loans serviced by the Company (23% of the Company's servicing portfolio as of May 31, 2000) are insured by the Federal Housing Administration or partially guaranteed against loss by the Department of Veterans Administration. The Company is exposed to credit losses to the extent that the partial guarantee provided by the Department of Veterans Administration is inadequate to cover the total credit losses incurred. The Company retains credit risk on the home equity and sub-prime loans it securitizes, through retention of a subordinated interest. As of May 31, 2000, the Company had investments in such subordinated interests amounting to $647.5 million. Servicing Hedge As previously discussed, the Company's Servicing Hedge is designed to protect the value of its investment in MSRs from the effects of increased prepayment activity that generally results from declining interest rates. In periods of increasing interest rates, the value of the Servicing Hedge generally declines and the value of MSRs generally increases. The historical correlation of the Servicing Hedge and the MSRs has been very high. However, given the complexity and uncertainty inherent in hedging MSRs, there can be no assurance that future results will match the historical performance of the Servicing Hedge. Implementation of New Accounting Standards In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize the fair value of all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. This statement will become effective in the fiscal year ended February 28, 2002. The Company has not yet determined the impact upon adoption of this standard on the Consolidated Financial Statements. Page 26 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.73 Deferred Compensation Plan Amended and Restated Effective March 1, 2000. 11.1 Statement Regarding Computation of Per Share Earnings 12.1 Computation of the Ratio of Earnings to Fixed Charges 27 Financial Data Schedules (included only in the electronic filing with the SEC). (b) The Company filed the following reports on Form 8-K: (1) June 1, 2000 under Item 5, containing Countrywide Securities Corporation's financial statements and report of independent certified public accountants for the period beginning March 1, 1999 and ending February 29, 2000. (2) June 27, 2000 under Item 5, containing the Selling Agency Agreement and form of notes used in connection with Countrywide Home Loans Medium-Term Notes Program Series I. (b) 27 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. COUNTRYWIDE CREDIT INDUSTRIES, INC. ----------------------------------- (Registrant) DATE: July 13, 2000 /s/STANFORD L. KURLAND -------------------------------------- Executive Managing Director and Chief Operating Officer DATE: July 13, 2000 /s/CARLOS M. GARCIA -------------------------------------- Senior Managing Director; Finance, Chief Financial Officer and Chief Accounting Officer (Principal Financial Officer and Principal Accounting Officer) CONFIDENTIAL DRAFT OF FEBRUARY 1, 1996 h:\rick\forms\variable.doc -2-