美國銀行 (BAC) 2003 Q2 法說會逐字稿

Good morning.

Welcome to the Countrywide Financial Corporation second quarter earnings conference call.

At this time all phone lines are muted or in a listen-only mode.

However, after today's presentation we will be taking questions, and we certainly encourage your participation at that time.(Caller Instructions.)

With that being said, here now is your host with our opening remarks, Countrywide's chairman, chief executive officer and president, Mr. Angelo Mozilo.

Please go ahead, sir.

Thank you.

Good morning, and welcome to Countrywide's earnings teleconference for the second quarter of 2003.

We strongly encourage all participants to view the second quarter earnings and performance report while listening to this call.

This report can be found on our web site at www.countrywide.com by clicking on investor relations and selecting presentations and earnings reports.

On page 2 of the earnings and performance report we provide an agenda for today's conference.

First I'll provide a brief overview of our results for the second calendar quarter, first half of 2003, the next topic is the highlighted presentation and review of the performance drivers of Countrywide after the refinance boom.

Issues to be addressed include competitive environment, servicing earnings, strategic positioning of our production operation, bank growth, our other diversification businesses, and low-cost fixed rate financing.

The presentation will conclude with updated earnings guidance for the full year 2003.

The theme throughout this presentation is that Countrywide's management is confident about its performance in the near term as well as after the refinance boom has ended.

Let's begin on page 3 with our first topic, overview of our performance during the second calendar quarter.

Earnings per diluted share increased 85% over the fiscal year to $2.74.

This marked the ninth consecutive quarter of record earnings.

This is also the 86th consecutive profitable quarter for the company dating backing to 1982.

Diversification earnings grew 181% over the prior year to 219m and were a key driver of consolidated earnings growth.

Operationally, our mortgage banking business continued to excel and establish numerous records.

Consolidated fundings reached a record of 130b for the quarter, more than triple our total last year.

Fundings for the month of June were over 48b dollars, our all-time monthly record.

Countrywide funded 29 loans on average during each minute of every working day in June.

The pipeline of applications in process grew to a record 82b.

Three and a half times larger than last year.

This indicates that fundings are likely to be robust again next quarter.

The servicing portfolio reached a new milestone of 559b as of June 30th with growth of 49% over last year.

Countrywide continues to lead the industry in organic portfolio growth.

In conjunction with our outstanding performance during the second quarter the Board of Directors raised our dividend to 14 cents per share, the fourth increase in the last five quarters.

We provide an overview of our performance during the first half of 2003 on page 4.

Earnings per diluted share increased 85% over the prior year to $5.19.

This means Countrywide is already earned 80% of the earnings per share received for the full year 2002 in just the first half of 2003.

Diversification earnings grew 156% over the prior year to $389m.

Total fundings reached a record of $233b for the first half and increased 170% over last year.

First half fundings of 232b are already 92% of the 252b funded in the full year of 2002 which was our all-time record year.

Moving to our next topic on page 5, we address Countrywide's performance drivers after the refinance boom.

We are now deep into the third quarter of this refinance boom.

The environment has presented Countrywide with unprecedented opportunities.

Our business model, predicated on organic growth, was well positioned for capitalizing on the opportunities presented to us.

The company's record-breaking performance during this period speaks for itself.

Nonetheless, market observers look beyond today's success and question our performance after the boom.

As during the refinance boom, Countrywide's business model has been structured to perform during the rigors of the post-refinance environment.

On page 5 we list the key drivers of our post-boom performance.

Nonetheless we believe that the competitive environment should we more favorable after this boom than in the past. the most significant factor, however, will be the dramatic turnaround in our servicing earnings.

The quarterly earnings could improve by over 1b dollars compared to the second quarter just ended.

Countrywide's production is well positioned to handle the downsizing of infrastructure as well as continue to grow market share after the boom.

Countrywide bank will be prominent in our post-boom performance as earnings increase due to asset growth.

The bank also improves our competitiveness as an adjustable rate lender after the boom, enhancing our existing access to deep security at the sayings market for performing arms.

Our other diversification businesses should continue to contribute significantly to earnings as well.

Finally, we have fixed rates on $14bb of debt as historical low and should provide us with lower funding costs after the boom ends.

I will now address each of these points in more detail to demonstrate our favorable posture for the post-boom performance.

We discussed the expected competitive environment after the boom on page 6.

Past refinance booms were marked by extended periods of Fed stimulus immediately followed by abrupt Fed constraint.

The result was a large increase in rates that occurred in a short time frame after the boom and created a difficult operating environment.

During this refinance boom, Fed stimulus has not yet resulted in the desired recovery in the economy.

But this boom has been extended longer than prior booms.

A soft landing scenario in the future is aided by an expressly accommodated standance by the Fed.

The total mortgage market estimates, however, $2 trillion in 2004, which is much larger than prior post-boom markets.

The total market was one trillion in 2000 and just over 600b in 1995.

More importantly, the purchase market is estimated to exceed 1.1 trillion next year, handily beating earlier levels.

The purchase market was 800b in 2000 and 550b in 1995.

Management believes post-boom pricing behavior should be more rational than in the past.

Market share consolidation has empowered today's industry leaders.

The top four now control 46% origination market, up from only 15% in 1995.

These lenders are large, public traded institutions that are closely regulated.

These management teams are likely to conduct themselves in a thoughtful and disciplined manner.

The rational outliers are less likely to have a significant effect on pricing.

Due to the more fragmented market in 1995, two constituencies retarget on pricing.

Independent mortgage companies, that were for sale, priced irrationally in order to build pipeline applications also threats that subsequently went out of business similarly created an unnecessary price war in adjustable rate mortgages because they had previously been stifle by a predominantly fixed rate market.

These conditions are not likely to be repeated after this boom.

Servicing earnings are expected to increase dramatically after the boom and are addressed on page 7.

Countrywide's servicing portfolio reached 559b at quarter end.

The portfolio grew by 107b during the first half of this year.

Countrywide has been a decisive leader in servicing market share growth during this boom while many of our competitors are having difficulty growing their portfolios at all.

Low rates are resulting in significant decline in Countrywide's capitalization rate.

The cap rate now stands at 92 basis points after excluding inventory, subservicing, bank-owned loans, the portfolio denominator.

One year ago the cap rate was 168 basis points.

This low valuation level bodes well for future servicing profitability.The key driver of the decline in cap rate was MSR payment that amounted to 1.5b net of the hedge in the first half of 2003.

This expense would be eliminated after the boom and help drive servicing margins up to an expected level of 12 to 15 basis points.

Applying at 15 basis points margin to today's portfolio, 559b results in quarterly servicing earnings of $210m.

The servicing loss during the second quarter was $836m.

Thus quarterly servicing pre-tax earnings improvement would be over $1b, assuming margins were 15 basis points.

Servicing of portfolio growth and MSR valuations are examined more closely on page 8.

Volume must be ramped up faster than prepayments in the low rates environment in order to sustain portfolio growth.

Many of our competitors have struggled with this issue.

The chart on the left-hand side of page 8 reflects net portfolio growth for Countrywide with $184b in the last year, more than two and a half times greater than the prior year.

It is noteworthy that Countrywide's funding over the last 12 months were 398b, which is a remarkable 70% of our $559b portfolio balance at June 30th.

Another key factor is that a lower MSR valuation will result in higher returns on servicing in the future.

In accordance with GAAP, Countrywide is cumulatively impaired its MSR by $8b and has amortized over 3b during this refinance boom.

As shown on page 8 the end result is that MSRs are currently booked at a lower of 92 basis points down from higher levels in the past.

Even if the entire 2.3 b impairment reserves is recovered, the cap rate would still be below 140 basis points.

Keep in mind that the weighted average coupon of our portfolio is down to a record low of 6.38%, implying monthly prepayment speeds after the boom ends.

On page 9, we detail how our production operations are strategically well positioned to deal with infrastructure downsizing and sustaining market share growth after the boom.

Countrywide's cost structure is more variable today than it has been in the past.

Temporary and contract personnel now number 3800 and provide tremendous flexibility in downsizing.

The cost of over 6300 commission incentive sales personnel is almost totally variable other than their benefits.

Our correspondent channel has been the internal volume leader and provided 48% of fundings year to date.

This channel is highly scalable and has the lowest production cost because of the stream lined scope of the correspondent funding process.

Branch space added during the boom accommodated our new sales force and should remain intact.

General speaking, we have relied on technology as a key component and facilitator of our growth plan.

After prior refinance booms Countrywide emphasized downsizing in market share, and market share consequently leveled off.

We now have a proactive plan to continue growing market share after the boom ends.

This plan is focused on the purchase market and is primarily driven by the commission incentive sales force.

Keep in mind that Countrywide has nearly doubled its purchase market share to 11% during this refinance boom.

Purchase market share growth will moderate the decline in overall market size.

We profile our bank on page 10, which will be a key component of consolidated earnings in 2004 due to asset growth.

The goals of our banking strategy are to diversify our earnings and funding structure.

Portfolio lending capability recharacterizes the gain on the sale of a loan in a current period into a spread income in future periods.

The bank also has full access to new liquidity sources (such as FHLB advances and retail deposits.

Countrywide has developed a prudent control and growth to the bank that has been approved by its regulators.

Total assets were 115m in May of 2001 when treasury bank was acquired.

You can see on page 10, the bank's total assets reached 13b as of June 30th.

The total assets have grown $8b this year.

Our regulator approved goal for the bank remains to reach 17b in assets at the end of this year.

Total assets are a key driver of the banking segment earnings.

The banking segment pre-tax earnings for the first half were 111m compared to 26m last year.

Include warehouse lending, the bank alone earned 26m in the month of June demonstrating its momentum.

Sustained asset growth will lead to continued earnings growth.

Our other diversification businesses should makes a significant contribution to 2004 earnings as illustrated on page 11.

For many years Countrywide's management focused diversifying the earnings and reduce differences in mortgage banking stifle.

The core strategy of the company is to leverage our world-class banking class form to grow our other businesses.

The chart on lower side shows consistent growth in earnings, including banking.

Diversification earnings for the first half of 2003 were up 156% over the first half of last year.

The pie chart on the right on page 10 reflects the 34% of our consolidate earnings for the first half came from diversification.

This percentage is noteworthy since our core mortgage banking business is experienced dramatic earnings growth.

On page 12, we address our capital markets businesses.

The growth in trading volume and earnings depicted here reflect the benefit of historic market size.

These businesses seek to use market share growth and increase third-party businesses to moderate the decline in market size.

The primary driver of capital market success is our securities broker dealer.

Countrywide Securities Corporation -- CSC has capitalized at a historical high level of trading in the secondary mortgage market.

Securities trading volume of CSC for the first half reached a record of 1.5 trillion dollars.

The capital market segment provided 18% of consolidated earnings during the first half of 2003.

Pre-tax earnings were $211m for the first half, up 174% for the prior year.

Moving forward to page 13, we next review our insurance businesses, which are noteworthy since their performance is less sensitive to the mortgage banking cycles.

The insurance sectors comprised of three separate companies.

Balboa Reinsurance, exclusively reinsurance primary mortgage insurance on Countrywide-originated loans.

Balboa Life and Casualty is our national insurance carrier that emphasizes property and liability insurance.

Countrywide Insurance Services is a national personal lines insurance agency that focuses on its core product and service competencies in homeowners and life insurance.

Balboa Reinsurance's earnings increase over the last year.

And its booked business grew in line with the servicing portfolio.

Reduced refinance activity after the boom will be positive and resulted in greater cash flows from the underlying mortgage insurance policies.

The carrier and the agency are both benefiting from streamlined operations and better alignment of their homeowners activity.

Revenues are growing in the core force order.

Homeowners and credit life business line.

The insurance segment provided 5% consolidated earnings during the fist half of 2003.

Pre-tax earnings were 62m for the first half, up 29% from the prior year.

This concludes our discussion of performance drivers for Countrywide after the refinance boom.

Management expects a more favorable competitive environment, dramatically higher servicing earnings, and the bank to lead our diversification efforts after the boom.

These factors spoke well for Countrywide future performance and form the basis for which management is confident through '04 and beyond.

Having concluded our review of Countrywide's post refinance performance it is worthwhile to examine the current state of the origination market.

Mortgage rates have risen over a full point over the last six weeks.

Does this mean the refinance boom is over?

No one knows for sure.

Nonetheless, prospects for the near term funding remain very strong as application activity has remained substantial.

On page 14 we present the MBA's purchase, refinancing total applications indices back to 2000.

Calendar 2000 because it pre-dates the current refinance boom.

The first column on the chart on the left side of page 14 is the average purchase application index.

The purchase index averaged 355 for calendar 2002, an all-time record, and increased to 379, on average for the first half of 2003.

It is most noteworthy that the latest reading on July 11 was 447, 26% higher than last year's record.

The second column in the chart on the left is the refinance index.

Despite the recent rise in mortgage rates, the application data for refinances also remains very strong.

After averaging 3400 in 2002 the refinance index averaged 7,000 during the first half of 2003.

The most recent reading was 6657 almost double last year's average.

These trends in both application markets are discernible in the graphs on the right side of page 14.

In conclusion, application activity remains strong and the refinance booms seems to have significant steam left in it.

We now turn your attention to the disclaimer on page 15 and conclude our presentation with earnings guidance for the full year 2003.

Countrywide Management provides annual earnings guidance in an effort to direct investors' attention to our longer term performance.

This guidance is included in our earnings press release and is intended to facilitate analysis of the company by third parties.

Management believes the company will report dilute earnings per share within the range of $13 to $15 per calendar 2003.

Second half earnings are expected to be substantially higher than first half actual earnings of $5.19 per diluted share because decline in productions earnings driven by higher rates should be more than offset by the increase in servicing earnings.

Production earnings are expected to decline in the second half but should be stronger in the third quarter than recent rise in rates may indicate.

Third quarter fundings should benefit from a record high beginning pipeline of $82b, and higher than expected purchase and refinance application since rates still remain relatively low.

Approximately 50% of all outstanding mortgages are estimated to still be in the money today, which will fuel refinances.

Reaching the apparent bottom end rates, customers early inspire (potential customers monitoring rate to finally lock in their commitment.

Application activity in July remains strong, averaging $2.5b per day compared to our all-time record of 3.2b last month.

Third quarter margins should likewise benefit from refinance boom pricing levels, most of which is already locked in the existing pipeline.

Funding levels and margins should moderate in the fourth quarter as the market shifts back to a purchase environment.

Servicing earnings should increase substantially, more than the decline in production earnings because of the net impairment of 1.5b experienced in the first half should not reoccur if rates are stable to rising from current levels.

This amount of net impairment reduced first half earnings by over $6.50 per diluted share.

Other diversification businesses are expected to be flat to modestly declining in the second half compared to the first half.

The estimates discussed in this presentation are subject to certain risks and uncertainties which would cause actual results to differ due to a number of facts including, but not limited to, those listed in the disclaimer on page 15.

As I have noted today, Countrywide has reported record earnings for the ninth straight quarter, and has upgraded the earnings guidance for 2003 from $13 to $15 per share and has raised its dividend for the 4th time in 5 quarters and stands well prepared for the post-boom refinance environment.

My final point is that Countrywide has achieved all of this while maintaining a conservative approach to a balance sheet valuation.

First MSRs are valued at only 92 base points, which is below their intrinsic value.

Second, the value of the pipeline of applications it processed is not included on our balance sheet, reflecting a more conservative accounting treatment than some others in our industry.

Third, we have accumulated 8b dollars in home equity loans in the mortgage company that have deferred the gain on sale from the current period into spread income in future periods.

These factors position Countrywide well for near-term and for long-term performance.

This concludes my formal remarks.

(Caller Instructions.)Thank you.

Our first question is from Mike Sinclair with Raymond James.

Go ahead.

thank you.

Gentlemen, congratulations on a fantastic performance in the quarter again.

My question actually is -- two here.

Number one, when I look at -- talking about the competitive environment post-boom and the pricing environment that you expect, you've said over and over again that you think it's going to be more rationale.

When we look at, for instance, commitments that come out from Fannie and Freddie on a weekly basis and compare those to rates in Freddie's surveys, it appears to us that the differential between those two numbers has compressed noticeably over the last several weeks indicating that obviously there's a lag in Freddie's survey but potentially lenders are already seeing their margin shrink or they're willing to take some pricing changes into their quoted prices in order to keep their volumes up.

Do you have any comment on that?

Am I just looking at things that are probably mismatched on a timing basis?

I don't know if they're mismatched.

I won't comment -- maybe one of my colleagues will comment on the survey you're looking at.

But margins were increased substantially, particularly during the April/May period, because nobody had capacity, and so you had an extraordinary increase in margins, which were not sustainable.

And what you're simply seeing today is that the -- the substantial increase that took place over and above normal margins, a portion of that is being given back because capacity is being developed.

But margins are at the healthiest level that we've seen on the consistent basis, including the current time.

That is a general comment.

Anybody else have any comments on that?

Yeah, my observation would be that we have seen margins come in a little bit in the industry, and we have you know, capability and surveillance of what's going on by competitor, so there has been a slight move in on margins, but as Angelo indicated, still, you know, they're at very healthy levels.

Again, not the type of movement, by the way, that we've seen in the past, post-refinance market.

Thanks very much for that.

Next we go to the line of Kevin St. Pierre with Sanford.

I would was hoping you could give us a little more information on the gain on sale.

If you could break it out for us by gains versus fees, if you could also give us the volume and the gains on the (HELOC subprime capital market.

Keith is going to work through this.

I have the numbers, breaking down the gain on sales we reported of 1.8b, that would be comprised of approximately 1.5b related to our prime first mortgages, approximately 170m related to sales of subprime during the quarter which amounted to 2.9b.

And then 61m related to the sale of workhouse government loan.

And that brings the total for the mortgage banking segment to about 1.766b.

Rounding out the total is capital market.

I'm sorry, did you say the volume of HELOC which were sold.

Sold no HELOC.

Next we go to the line of Mike McMann with the Sandler O'Neill.

Good morning.

In the past you've talked about ramping up the commission sales force.

I think you're a little over 6,000 now.

Did I hear correctly through one of your past presentations that the goal is to get to 15,000 by the end of next year which will help with the purchase market share?

Our next plateau will be 10,000, like to get to 15,000, we think that that's a minimum threshold for us to accomplish what we want to accomplish, which is to dominate the purchase market and to get our overall market share to the ultimate 30% by 2006, 2007, so those numbers are in line.

I think we'll have a great opportunity to grow that sales force, very frankly, during a -- you know, when this thing recedes, when these volumes recede, because the sales people will be much more available to us than they are now.

Thank you.

Next we'll go to the line of Leveque Dinegea with J. P. Morgan.

Please go ahead.

Angelo, question for you on the bank.

The bank assets went up to 17b from 16b previously.

So that's a little bit of an increase from the previous.

Is there a plan to -- do you think you're likely to increase '04 further?

Is that still up 22b?

The numbers are 13b now in assets.

We expect to go by end of year to 17.

We will be at 17b.

We've been approved by the regulators to go to that level.

We anticipate we'll meet that objective.

We are approved by the regulators to go to 22b in 2004.

If you look at our rate of growth, there should be no problem going from the 17b to the 22b.

That's 5b dollars.

You can see what our growth was this year.

So we are well on our way to achieve those objectives that we're approved to go to.

Okay.

But at this point, no further plans to try to increase the '04 goals?

The important thing for us is that our partners in this whole process, with the bank, are the OCC and the Fed.

So we're going to sit down with our partners, and together assess the capability, the soundness of the bank.

You know, its structure, how strong that structure is.

And if we believe that we're positioned to grow it further, we certainly will work with our partners to see if we can grow it further than the 22b dollars.

thanks.

Next we will go to the line of Kenneth Posner with Morgan Stanley.

Please go ahead.

Hi, Angelo.

If my calculations are correct, you are under return-on-equity of 25%.

Based on the guidance of the second half, probably be even higher.

And these are returns that the vast majority of financial institutions could only dream of.

In the normal time during 1990s last few years, Countrywide's return-on-equity has ranged from the low teens to the mid teens.

So my question is, as we get back into a normal environment post-boom, what kind of range of return-on-equity do you think the company is capable of, and importantly, is there -- has anything changed from the way the company, you know, looked a couple of years ago that would result in a different pattern of returns?

Let me comment on a couple of things.

One, we are not prepared to talk about any specific numbers going beyond the guidance I've given you.

However, this is a very different company today, and I'm an observer who has watched this company from day one.

We have a -- almost a 600b servicing portfolio coming out of this thing, a very solid portfolio, very low cap rate, a very low WACC in that portfolio.

A very strong -- we've never had a sales force before -- over 6,000 sales people.

This is a totally different company.

And I think using comparisons of return-on-equity any other comparisons to previous periods of Countrywide's corporate life would not be only not relevant but I think would not be the proper guidance going forward.

This is a structurally fundamentally, a very different company.

Can I ask, as a follow-up maybe getting at one corner of the difference, in the past you have a long track record of hedging the impairment risk in your servicing portfolio.

Quite successful in front of that.

Yeah, and I'm wondering, just given the phenomenal capability of your production business to profit from these refinance booms, whether you're going to need as much of the hedge or whether you still have the same size of a hedge today that was necessary in the past.

I'm going to have Stan, since Stan is the ultimate manager of this hedge, I'm going to have him comments on his thoughts on that.

Yes, Ken, we have a strategy whereby we rely partially on the macro hedge to supplement for the risk of impairment, and we have as well a -- the financial hedge.

To the extent that we're in very robust time and we're relying on the production to throw off earnings, we are able to reduce the financial hedges, as well as the fact that we rely, to a great extent, on optional coverage.

So, in other words, there is not a -- we don't have as great a loss on hedge positions as we do the improvement in the servicing asset in a backup.

And going forward, given the value of where we have the servicing asset booked, what's happened in the market, we can reduce the -- and have reduced the servicing hedge, and that speaks very well for reduced servicing hedge costs in the post-refinance boom market.

I hope that helps you with the -- you know, understanding the servicing hedge and how we're -- and a little bit how we're positioned, but we don't rely fully on the financial hedges, and we look forward to a lower cost of running the servicing hedge in the post-refinance market.

That does help.

Thank you, Stan.

Thank you, Ken.

Next we'll go to the line of Bob with Piper Jaffrey.

Please go ahead.

Two questions.

First, your guidance for the back half of the year, would that include any expectations of recoveries of some of the write-downs of mortgage servicing writes or just the lack of additional impairments?

Well, the guidance that we've given has no net recovery.

So to the extent that interest rates back up, we do have hedge positions that lose value, as they've gained value, as the market rallies, and there is a level of recovery that's anticipated to offset the changes in the hedge value.

But there's no -- but we're not predicting a net recovery or a recovery that exceeds the change in the value of the derivative.

Now, historically, you would get some kind of a net recovery, isn't that fair?

Say that again.

Historically, you would have some net benefit.

Oh, GAAP requires us to recover the value of the servicing asset.

We can't predict whether or not we'll have net recovery or not.

It depends on where interest rates end up, and historically, as you're saying, we have had net recovery.

Just in -- you know, I was commenting with regard specifically to your question as to whether or not we were providing that -- for that in our guidance, and I want to be very specific that our guidance doesn't include any net recovery, or recovery over the losses of the hedge.

It's very possible that that could occur.

Thanks.

And on the bank, your pre-tax income, return on assets, has averaged around 2.4% in the bank.

Is that a level that you think is a fair gate as you look into, you know, future years, or would you expect to see some changes in that?

Well, the return on assets I think is operating at about the level that we would anticipate on a go-forward basis.

Our spread is -- you know, versus our net interest revenue and margin is a little over 2% currently.

So you would view that as a sustainable number?

At least.

The spread is, you know, clearly sustainable.

We look for further ways to improve in terms of developing lower costs, deposits, and so there's an opportunity to improve our costs of funds.

Our return on assets is running in the current quarter at about 1.12%.

Just to, you know, clarify the numbers with the net interest margins just over 2.09.

Thank you.

Next we'll go to the line of Brad Ball with Prudential Securities.

Please go ahead.

Thanks.

Follow-up on the earlier question of production margins.

I wonder if you can give us a sense as to where you see production margins in a more normalized period, like say '04, production margins are 100 basis points this quarter, and you indicated they're above average and not likely to be sustained there, but looking in the past, production margins have fallen as low as 20 basis points.

I acknowledge the environment is different, but just a sense as to where you see them going in the seconds half in '04 would be very helpful.

First of all, looking at our margins versus the historic perspective, keep in mind that today our mix of product is very different.

We have sub-prime mortgages, and we have home equity lines of credit that have very significant margins on them.

Now, during the, you know, past quarters, we haven't sold home equity lines of credit, so that's actually folding down the actual margins that are achievable by the production divisions.

It is, you know, very likely that we could see margins move back from their current levels by a quarter to 3/8 of a point.

I think that's more likely, but I think when you factor in the changes in the mix of our business, you will see that that's a very, you know reasonable expectation.

That's very helpful.

Also, on the capital markets business, can you give us a sense as to, you know, what kind of a run rate we should look at for '04?

Obviously with the volume levels way above average this year we're running well above average, could we see that contribution be halved in future years?

I don't know if I would take a look at the total volume of transactions and equate that equally to the earnings of capital market, and let me tell you why.

One is that capital markets continues to pick up market share, so that even though the market will be, let's say, cut to a 2 trillion dollar level, from a 4 trillion dollar level cut in half, I don't expect that that would impact the earnings by half.

Here's the reason.

One is, they continue to grow their sales offers.

We recently opened up Chicago, Los Angeles, Florida, New York, and London.

We just opened up London.

We're opening up in Asia.

So they continue to grow their sales capability.

Secondly, they will enter at least one new major business going into 2004 which will have a significant impact on a variety of things going on at Countrywide but particularly on their earnings.

So I wouldn't take a static situation and say that if the market reduces it by a half they will go down a half.

I don't believe that to be the case.

They have a stunning track record, they are a very compelling company, an extraordinary management team, and I would expect even though the market may shrink by a half, I think they will have some shrinkage initially, but they will continue to grow earnings throughout 2003.

What is that new area of business?

We're not prepared to discuss it at the moment.

But it's a good question.

Thanks, guys.

Next we'll go to the line of Vincent Daniel.

Please go ahead.

Thank you.

Most of my questions have been answered.

Thank you.

We'll go to the line of Annette Frank with Friedman Billings.

This is Paul Miller.

Congratulations on a great quarter.

Hey, Angelo, but my calculations on your servicing portfolio, it's going to add close to $4 or $4.50to next year's numbers.

What about production?

Given a 2 trillion dollar market and probably lower margins, can you give us any clear indication of where you think productions ends up on a per-share basis in '04?

I'm not prepared to talk about any numbers.

We will be better prepared at the end of the third quarter to discuss this more definitively, but let me tell you, the way to look at this company is to -- is, today, again, this is a structurally very different company that existed before, and it gave us -- what gave us the opportunity to restructure was clearly the refinance bam.

But secondly, we're going to look at very substantial increases in market share come 2004, and so even though you will have a -- what I would consider -- what appears to be a substantial decrease in total mortgage transactions in the country, our share of that will increase, and, therefore, I would, at this juncture, my guess is that the impact on Countrywide's production operation in terms of earnings would not be as great as people might expect.

Right now I believe you're running right around 12% market share.

Do you believe it can go higher than that?

Oh, sure.

Don't forget, in 2001, it was 6% market share, less than 6% market share.

We've doubled it.

When I'm talking about a 30-percent market share, that's a real number that we're shooting for, because we believe in a consolidating market that the major player, the number one player, must have at least 30% market share to be the dominant force.

And so in order to get to 30 we've got to pass through 15 at some point.

You have driven your market share through the correspondence market, which you might have to back off going forward.

Right now I know it's a great environment for you.

So you're talking about real big market share gains both in the retail and whole sale market, correct?

That's absolutely correct.

However, I wouldn't -- I don't know if I would come to the same conclusion you come to relative to correspondent.

We have a technology in correspondence, which is unprecedented in the industry, and that technology has attracted an enormous number of banks, credit union, other mortgage banks through Countrywide because of the ease of doing business with Countrywide versus anyone else.

I'm not sure we would come to the same conclusion you do.

We expect correspondence to play a major role.

On the new production, what were you capitalizing new production on the MSR portfolio?

160.

Thank you very much.

Great quarter.

Thanks a lot.

Appreciate it.

Next to the line of Bruce Harding with Lehman Brothers.

Please go ahead.

Yeah, just -- to talk about the second half, in terms of advantages you may have from superior hedging of the pipeline and any comments that you're seeing either from your capital markets group or otherwise in terms of the risks of this, you know, very rapid run-up we saw in mortgage rates and the impact on the percentage of loans that actually close and just sort of remind us how you built a hedge that run up for the higher percentage of the pipeline that actually closes, and is that another competitive advantage for you that will continue to allow you to gain share in the second half if others were not, you know, prepared for that run-up in rates.

I think, Bruce, I'm going to have Stan comment on this.

You've been following the company for many, many years so you know how we operate and what our level of sensitivity is to changes like this and how we react to that.

But this will create, if this trend continues, and there's some great doubt that it will, but if it continues to rise at this exponential rate in terms of interest rate, you're going to have tremendous dislocation by those who have never seen anything like this, and that's a big advantage for us.

So overall, you know, you have everything from red light/green light, all kinds of nonsense that's been created during this environment.

That goes away.

That's a big advantage for us.

That's a much cleaner landscape for us to operate in, because if you're borne out of the refinance boom, then you also are extinguished by the lack of boom.

And you're correct that closings fundings will be accelerated.

A greater amount of the pipeline will close because people's cheeks will tighten up and will immediately recognize that they're advantage by closing now rather than waiting.

And I will have Stan address the hedge issues and how those are managed during this type of environment.

Sure.

First of all, we have tremendous history in this area in terms of models based on past history and performance of the pipeline of loans in process that give us very valuable tools in order to project the change in closing rates, both when interest rates rise and when interest rates decline, the type of fallout that we experience.

So these models allow us to be very accurate.

One of the important distinctions for Countrywide is that we are not what you would consider to be a typical -- or to be a Delta hedger, or actually a global hedge strategy whereby we actually cover the anticipated run-up in closing levels with optional coverage so that we don't experience the same issue that, for example, a Delta hedger in a declining market or a rates rising are chasing that market.

They're selling into the declining markets.

We have coverage that is in place in the form of options and so our hedges perform very, very well in the type of market that we've just experienced, where there's a very dramatic shift, because out of the money, you know, options and put option on mortgages back go deep into the money.

So our positions are, you know, structured exceptionally well.

We have tremendous history in this area, and there should be no concern.

Bruce, as Stan was pointing that out, it occurred to me, the history of Delta hedges is that obviously they do very well in a continuously lowering rate environment.

As rates begin to go the other way they give a lot back, and most of the major players who didn't survive over time were primarily because they were Delta hedging.

When the rates start rising, it's a difficult market to chase.

hello?

Yes.

If there were some form of systemic risk here, I'm reading some of the work of some of the mortgage research folks who are saying if we got another -- precisely because of what you're saying, and that's what I thought, that you have that advantage, that given that many don't and are chasing rates higher with their need to hedge the rise in rates by selling duration here, it's just exaggerating this rise in treasuries, is there any concern that there could be some systemic risk that banks all start selling their mortgages as well, and can Fannie and Freddie handle that?

Do you have an opinion?

I don't because I've never seen that kind of catastrophe.

In fact, I'll take you back to the time when you were in diapers and Fannie Mae was the only buyer in 1967, '68, they had to buy every single FHA loan originated in the country because of the lack of liquidity by the traditional secondary market.

Their capacity, I wouldn't say it's infinite, but they have enormous capacity.

I don't anticipate it happening, but I think it is a message, Bruce, from at least the, you know --

Ladies and gentlemen, please stand by.

We're having technical difficulties.

Please continue to hold.

Hello?

Shall we'll go to the line of Charlotte Chamberlin with Jeffreys and Company for the next question.

Angelo, good to have you back here.

Short AT&T.

Unbelievably confident people.

Unbelievable!

As one of your former number empires.

I know that -

You have a long memory.

Yes, yes.

I know you said that you don't want to give any more for the record guidance than you've already given but I was wondering if on a hypothetical basis, assuming 2b in mortgage origination in over 12-month period on the current steep yield curve, I was wondering what you think is kind of a ball park that Countrywide could not do, not for next year, but on a hypothetical basis, this set of interest rates and 2b, the MBA 2b.

The other question has to do with dry powder.

By that I mean, if things don't go as you expect, what are the sources of share buy-back or selling of servicing or whatever.

I don't know what's top of mind with you.

But what are the sources of dry powder that you could resort to, to basically enhance earnings growth?

Thanks.

Okay.

First of all, I think of you -- let me just give you a general number, hypothetical.

It's a 2 trillion dollar- our goal next year - is 15% market share, which I think is realistic.

Goal for this management team you are talking about $300b origination year for Countrywide.

Hypothetically, this is the number you could play with.

In terms of the dry powder, Countrywide we did 20 years ago, servicing, that of thing.

Those stages are gone.

This is a company that continues to build on its strength, and we have, as you can see by the balance sheet, we've accumulated a substantial amount of HELOC, and our balance sheet is ready for sale, but I think the real issue, as I pointed out in my presentation, is the kick we're going to get from servicing.

I think that for some reason that is misunderstood in this regard.

It's terribly underestimated.

As you can see by the substantial amount we took this year, that all goes away, goes into income.

That's a very powerful driver, 600b portfolio, probably 630bby the end of this calendar year.

So I consider it dry powder, I consider it the perfection of the macro hedge, which we've worked on for the last 30 years.

I think that macro hedge kicks in.

On the other side of the market, when rates rise, as it did when rates went down when the origination income was so powerful.

So you're going to see an enormous impact from our servicing sector as rates rise.

Okay.

Just one follow-up.

What's the unrealized gain on sale on the HELOC portfolio?

Charlotte, this is Keith.

We've got 6b in HELOC being securized and are sitting on our balance sheet, and the gain will be somewhere around 2 to 3 points.

2 to 3 points.

Thanks very much.

Next we'll go to the line of Mike with Raymond James.

Please go ahead.

Just to follow up, I wanted to ask about the balance sheet.

For instance, looking at your debt to equity, it's risen dramatically.

Obviously you don't have to hold as much capital against loans held for sale, but either Keith or Stan, can you give us an idea where the leverage is, I think right now is about 13 to 1.

In the past it's been anywhere from 5 to 8 to 1, but as MSR as a bigger percentage of the balance sheet -- as loans held for sale, can you give us a feel for --

Well, from following the company, I'll have him comment, but when you have the amount that Countrywide has experienced you're going to have a higher leverage number because the rating agencies in general permit a much higher leverage component on originations because of the tangible nature of that asset.

And -- but if you break it off, it's been very little change in the servicing component of the leverage.

So you expect that overall leverage will increase, as our volumes have increased and we have to (Inaudible) that, you know, those volumes -- you have an 81b pipeline prior to sale.

So you'd expect it to go higher, and I would expect lower, but I'll have my experts comment on that as volumes decrease.

Well, you know, primarily the leverage numbers are up as a result of the portfolio loans that we're holding for sale increase over the quarter, and then, as you know, other parts of our business that are afforded greater leverage have grown, such as Countrywide capital market and the bank, as well.

So we do -- we have increased leverage, you know in terms of the base foundation of the company from what it was several years ago, just the mix of business.

But I think, you know, that the leverage as volumes come down should, you know, clearly come down from the levels that they're at right now, they're somewhat peaked but, again, you have to look at the whole structural shift, the different Countrywide we have today where our securities company for example, operates at a 40/1 leverage, and our bank is about 11.5 to one, and inventory is afforded very decent leverage at about 15 to 1.

That's why you see the leverage up a little bit.

Again, we did hold back deliveries at the end of the quarter, which is causing the inventory to be a little bit higher than you would see in a post -- or significantly higher, actually, than you see in a post-refinance market.

What are you guys getting for leverage right now on a servicing side?

That's usually been at 2.5 to 1?

We're basically at 3 to 1.

Has not changed very much.

Those stats are helpful.

Thanks.

Next we'll go to the line of Joel Houck with Wachovia Securities.

I apologize.

I was cut off.

We were all cut off.

Based on the comment on pre-tax servicing of 210m and you're not assuming net recoveries, can I take that to mean that the 15-basis point, perhaps, run rate for foreign servicing would not include any recovery of impaired MSRs?

How should we think about that in terms of potential offset from hedge loss?

Just seems that the low rate environment, no assumption, while prudent on your part, perhaps might not be realistic from an economic perspective.

I want to clarify that we do anticipate, in a rising rate environment, that we will have recovery of the servicing asset, that's according to GAAP, again, the clarification is in terms of the guidance that we're giving, we're not assuming that there's recovery in excess of the loss on the corresponding hedge instrument.

Okay.

And how should we think about that potential?

For recovery in excess?

Yes.

You know, it's a function of where interest rates land at the end of the quarter and it's a function of very significant amount of testing of fair market value that we go through at the end of every quarter to determine what is the fair market value of our portfolio.

There are conditions that change, prepayment propensity, required OAS spread on servicing.

So it's hard to give you something that you could, you know, clearly predict with because we don't know exactly where rates are going to land or how those tests come out until we get to the end of the period.

But, you know, clearly in a rising rate environment, we don't anticipate, you know, to have impairment.

We anticipate having impairment recovery, and it's very likely that we could have impairment recovery that exceeds the hedge losses.

So one way to look at it in a rising rate environment it's an asymmetric risk in your trade-off, would that be a fair statement?

Should yes Just so the math is correct, you said a 2.3b reserve, I calculate a little over $10 a share after tax and reserve.

That's right.

Okay.

Thank you very much.

And next we'll go to the line of Edwin Groshans with Moor & Cabot.

Go ahead.

Hi.

Almost everything's been asked.

One thing I wanted to touch on was the branch expansion.

You said you had some branches out in Florida.

I want to get a sense are you looking at doing a national roll-out, or are you highlighting certain markets ?

Are you talking about bank?

Yes, bank.

I wanted to get a sense of what you're looking at there going forward.

We have 18 in place now.

We have about -- we opened up five in Florida, principally on the West Coast and Central Florida, Orlando, (Inaudible), we opened up Sarasota and Naples and Clearwater, just the West Coast.

We have not opened up the East Coast yet.

We'll open up next year.

We have about 24 on the drawing board for this year, so we've got about six more to go.

These are -- so everybody understands, these are 300 square feet in the establish office at Countrywide.

They've been there for years.

We just carve out a little area, put in the kiosk, put in one financial expert behind that kiosk and basically it's a CD factory-- I don't mean to belittle it, but it's basically a CD factory.

Florida has been -- they're 170% ahead of planned in Florida.

These new branches have been an enormous success for us.

What we plan to do over time is to continue to open up throughout the country, and, again, our success in Florida dictates.

Obviously the demographics there are special, and, therefore, we're going to have a concentration in Florida as we originally had in California, and, you know, we have 550 offices of Countrywide.

Could we have 550 branches of treasury bank?

Absolutely.

So our plan is to take it year by year, make sure that again, that we're comfortable with it, that our partners, the regulators are comfortable with the expansion plan.

But if you look over the horizon and so what is the potential, the potential is they could be in every single facility that Countrywide has ultimately.

Excellent.

Thank you.

Next we'll go to the line of Don Weider with Bear Sterns.

Please go ahead.

Hi.

I applaud you again for the dividend increase.

As you know, dividends are becoming more and more important by investors and managers today.

Two questions, what's your possible total employees?

About 33,000.

Angelo, if we continue to see rates go up and volume down and late in '04 that continues, what do you anticipate in consolidation, meaning mergers and buy-outs and drop-outs?

Do you anticipate there would be much or do you expect the major competitors now are pretty solid and will be around?

I think you'll have a fall-out.

I've never seen companies bourn out of refinance booms survive.

They will go.

And I think the majors will continue to consolidate.

I don't think Wells Fargo is finished, I think that they are (Inaudible) are finished, they're good at what they do and I think you're going to see massive consolidations.

I would expect that, like every other mature industry, that the top four or five players will control 70%, 80% of the business.

You think that would take place fairly quickly?

These extreme situations generally create a more rapid consolidation than you would have in a more normal environment.

So there's been an abnormal environment, and you're going to have abnormal behavior going forward.

Thank you, Angelo.

Appreciate your support.

Our next question is from Bob with Piper Jaffrey.

Please go ahead.

He's gone.

We'll go on to Joe Joelson with J M P.

Hey, guys.

Come a long way in the last 20 years.

Angelo, I'm just curious, you're not putting the servicing MSR in your bang, are you, the asset?

No.

What's the regulator's attitude right now in the banking industry as you guys see it now that you are in that business?

Not an issue with the regulators at all.

It's a matter of capital that you have to apply to the, and the size of the bank, there are advantages to Countrywide, substantial advantages to Countrywide, both in origination and servicing component of our business to be in the bank.

But the fact is, the size of those operations related to the size of the bank are out of whack currently, so you need a much larger bank to house, you know, an asset of the size of Countrywide's MSRs, but I think that the regulators, if you saw the joint letter put out by the Fed and the other regulators relative to MSRs and how you treat MSRs, they're beginning to understand that asset quite well, and the major players have been treated much more conservatively, so I hate like hell to speak for the regulators, They can speak for themselves, but I think that they clearly are -- they clearly are much more in tune with that asset, and it's also important to understand that, as I'm sure you realized that Countrywide, as a parent now regulated because we're a financial services holding company, is regulated by the Fed, and they are very comfortable, again, taking the liberty of speaking for them, because we have a lot of interaction on that, with the Fed relative to their understanding of the MSRs, the structure of the MSRs, and the valuation of those MSRs.

So I mean, one of the negatives which is different than what the guidance that you've given in terms of the fall-out of this environment and more rationale pricing, one of the negatives over the last, say, 10 years as the banks have tried to get more into your business is that they've mispriced their loans to pick up customers.

Are you sensing they're getting more rational about how they're pricing the servicing now?

Absolutely.

We've been through a couple of dips, and they've clearly been much more rational.

I think the difference being at least from my perspective these banks are fairly, to different degrees, but relatively sophisticated and not suicidal.

As I pointed out in my presentation, you had a period of time here where the thrifts, particularly the S & L's, were suicidal, and they did, you know, things that ultimately led to their demise.

I don't see that attitude existing at all with the major players.

If you look at their behavior, you look at the level of sophistication of the Bank of America's and the Wells Fargo's and the Chase's, this is a very, very different group of players.

And you're talking about big numbers.

If they misstep, if any of us misstep, you know, if you do something stupid, you are going to suffer enormous consequences very quickly.

Do you think any of this change in the value of servicing has to do with the GAAP rules for hedging it and what you have to run through your P & L?

Any comment on that?

I think the -- there's been a -- I think the pressure has been primarily -- I'm trying to think this through.

There's been regulatory pressure as to trying to figure out what this intangible asset is worth, and because of the rapid prepayment speeds which we saw, which were unprecedented, a high level of emphasis was put on what is that valuation, and I think if the industry leaned in a direction of being very conservative on that asset in order to bring calm to the -- to people who were concerned about it, so I think, obviously, these assets are -- this MSR asset is now valued on a global basis at a much, much more conservative level than ever in the history of MSR since they've been valued.

So I think it's the regulatory environment, the uncertainty of prepayment speeds, it's the pressure from investors on the street, from all kinds of angles a lot of investors placed on it, and I think it's where it should be, based on the current environment.

As you pointed out, our current coupon loans, you know, which are at very low levels, are being booked at a higher level, and I think that trend continue.

But I think it's, you know, we're very -- we looked at this a hundred different ways in terms of what that MSR should be valued at, and we're extremely comfortable where we are on that valuation.

Stan, any comments?

Yeah, one of the changes that we've seen over the last several years, I think that influences how everyone is valuing servicing, that the Fed is, you know, become very disciplined, and the OCC regarding what component can be attributed in the cash flow of servicing to its value.

One of the things that was basically eliminated over the last several years is the ancillary benefit of cross-selling.

So no bank today would have that type of item in their valuation of servicing, which, you know, creates a better market overall, given that the major servicers are a bank, and so that has seemed to improved, in our view, the long-term return.

Well, that's an unbelievable and positive event for you guys.

I'm not sure that that's fully understood out there, how much leverage you guys have with the franchise you've developed, if that pricing gets rationale.

Obviously, you know, there's a lot misunderstood based on the price of the stock.

But I would say this, that I think one of the validation of what Stan just said is that you're seeing no servicing acquisitions that reflect any kind of weird pricing that you -- that we can't figure out, in terms of why they paid that value for that servicing.

Those days are gone, and I think, as Stan points out also, the only attributable values to servicing today are actual cash flows, late charges, prepayment penalties, that kind of stuff.

There's no ancillary benefit.

And there's tons of ancillary benefits.

For example, 70% of home equity loans came from our own portfolio.

So zero value is attributed to that on our balance sheet.

So from a lot of perspectives, that's very positive, and so I think, again, you have not seen any kind of servicing transfer, even in an acquisition, where an entire company is acquired where you can -- we look at what they're paying for that servicing port, and it's very rationale.

That's enough questions for me, but congratulations again.

I remember 20 years ago when you were targeting a 1% market share, and we all didn't think you could get there.

So I don't think anyone should be sell you guys down on this.

Keep the faith.

Next we'll go to the line of Lauren with Sonic Capital.

Please go ahead.

Good morning, guys.

Good morning.

I'm sorry I missed the early part of the call, so --

That's okay.

We all missed it.

We were cut off.

Did you go over how much the sales were of the subprime and the HELOC were?

Again, we sold roughly 2.9b of sub-prime loans and realized a gain of about $170m.

We did not sell any HELOC in the second quarter.

There were obviously no gains recognized there.

And with respect to the hedging, did I hear correctly that you're going back to using hedge accounting, in terms of fair value hedges, or is that --

We didn't mention that.

You know, we have hedges obviously in place, but just given the quantity of the impairment reserves, it's unnecessary for us to designate hedge accounting.

I see.

And I still would like some more detail on the -- you know, the derivative hedges in terms of like how much are option matching and how much is a duration type thing.

It's still not completely clear, from your disclosures that kind of information, and it's very important for us to have a better sense of that.

We'll work on improving those disclosures.

I think that we have tried to provide greater and greater levels of information.

Right.

I guess we're concerned more about providing the right information as opposed to the volume of information.

Okay.

We'll work on that.

I think you know the kind of metrics that we would consider salient.

One last question.

With respect to the balance sheet, there was a very large increase in the sub-prime residuals.

Could you go over that for me, please?

Yeah.

As has been our practice now for sometime, we continue to utilize mortgage insurance for, you know, Fanny Mae credit enhancement on our sub-prime securities.

Recently we've modified those securities somewhat to rather than have a corporate guarantee as sort of a second layer of credit enhancement we have put in place excess or overcollateral I will sayings in the form of a residual as a second tear of credit enhancement.

So it's not really a fundamental change in what we're doing.

We're still laying off the predominant credit risk to MSRs or to Fanny Mae.

So there's really not a large impact or exposure?

No.

Fantastic quarter guys.

Keep on doing what you're doing.

Thanks.

Next we'll go to Vivek from J. P. Morgan.

Please go ahead.

Follow-up question.

On the arm portfolio, could you just clarify how much is short-term arms versus hybrids, and, also, Angelo, on your quest to increase market share should we expect that you'll become a bigger and bigger player in the jumbo market?

Are there any geographic markets that you are looking to fill in also?

I'll take the last part of the question first.

We are big player in jumbo.

We have no limit.

We make three, four, five-million dollar loans.

We don't consider ourselves handicapped in any way on that product.

We believe that we're as flexible as any portfolio lender in our ability to process those loans efficiently, and we are becoming known as a one-stop -- you know, it as an old term, but a one-stop shop, not just a conforming lender, but we're a major player in the jumbo market.

So we will continue -- in fact, if you look at where we're opening up our branches, many of them are in high-cost areas, and we're a major player in those areas, our brand is working well in those areas.

Now that capacity -- if capacity develops, you will see our advertising that will be pointed in that direction.

So I -- we're not handicapped at all.

In terms of the arm product versus the hybrid, you're talking about a pure arm versus a hybrid, do you know the -- Most of our arm production is hybrid.

Yeah, at this point, the consumer has clearly opted for a hybrid 3, 5, 7, even in some cases 10, a lot of them for some reason recently have opted for an interest-only type of product, which is new to me.

This is my fifth year doing this stuff, and there's a -- 50th year doing this stuff.

They have not wanted, generally speaking, a pure arm, an indexed arm that changes monthly or every six months.

That's been a rare loan.

That will change as interest rates rise you will see them opt more for that pure arm products because it gets them into the house at a cheaper execution.

Just a clarification, the jumbo, I know you've been pushing more, over time, given the locations you're opening, et cetera, we should probably expect the average loan size to keep creeping up a little bit?

It will.

It will increase by nature, just by momentum, because if you look at the average loan size, it has gone up steadily for the last 30-some-odd years, just by virtue of inflation, but you will see it.

It will be artificially pushing it up because of our participation in the higher-cost markets.

Thanks.

And next will be Jordan with Level Global Advisers.

Please go ahead. (Caller Instructions.)

We'll go to the line of Thomas Stevens with SAC Capital.

Go ahead.

My questions have been answered.

Thank you, Tom.

We'll go to the line of Ari Flotchet with millennium.

Please go ahead.

Hello.

Hi.

I'm sorry if you've talked about this, but can you talk about the level of mortgages -- went up significantly, is that something you expect to continue or is that just because you were unable to sell them or --

No, there's a very liquid market.

They have a lot of people who are salivating out there for this product, so it's not a matter of liquidity in the market.

This is a choice that management made during this period, to hold for spread income versus gain on sale.

Do you have any comments on that?

Yeah, the growth on mortgage inventory is real in sync with the growth, and he thinks that's what you should expect.

It should correlate closely with level of production.

If production should go up, you should see it increase, if it were to decline, you should see the inventory decline.

In the slideshow you talked about how you would be getting -- I don't know the exact words you used, but the point was that, you know, as we come out of this refinance boom that you would be more active in the arm.

I wasn't sure I understood how you thought that would, from a mechanics standpoint, how you thought that would be played out.

Again, as I previously stated, we are -- you can't dictate to the consumer what they want.

They dictate to us what they want.

And what historically has happened, as rates rise, because the average consumer is looking to get into that home at the cheapest possible cost, they will opt as long as there's a spread, in the yield curve, they will opt to go for a pure arm, and let's assume you have a dramatic increase in rates.

I'm not talking about the level we're at now.

But if you have a continuous surge of 20 basis points a day in ten years you're going to have people opt for the lower-cost execution, which is a pure arm.

And we accommodate that.

Back in fiscal '95, we were the largest arm lender in the United States versus any thrift.

So we are very flexible, and we make sure that we structure the company so that we can accommodate what the consumer wants at that point in time.

So it's not anything that we manipulate.

It's simply, if the consumer opts for arm loans, we're prepared, through the secondary market and through our bank to, provide them with very competitive arm product.

Just to be clear, there have been some that have come out and said that because you haven't had large arm share, really your own share, versus your own fixed rate, over this past, you know, 18 months, that that puts you at a disadvantage going forward, but you feel it's just a product choice.

It's poppy cock.

If you look at the vast majority of loans made, they're fixed rate or hybrids, they've opted for hybrids, and we've been a major player in that market.

As I pointed out, the fact that Countrywide, when it was a 100-percent arm market we were the largest player in the country, home, great western, all the people that were around at the time.

And, no, I think we've demonstrated that management is prepared for all seasons, and we have lots of arrows in our corporate, and we'll take the appropriate arrow out when the consumer points in that direction.

Excellent.

Thanks so much.

Our next question will come from Mikiko Copely of Endeavor Capital.

Hi, good afternoon.

I apologize if you covered this already.

I got cut off, like everyone else, but have you given us the range of origination market for this year that you base your guidance on?

We estimate, you know, it should be close to a 4 trillion dollar a year, 3.5, I think the estimates are somewhere between -- 3.3 to 3.7.

So you're comfortable with that guidance?

3.3 trillion to 3.7 trillion is the range that has been calculated for the purpose of this guidance.

Okay.

And in the hypothetical scenario where, say, ten-year rate goes down again, and refinance peaks up again and we end up having over 4 trillion market, is that possible, actually coming below the guidance, because of impairments you have to taking a gain

Look what happened this time.

Our earnings continued to rise.

The macro hedge that we've created function in both environments, and you can see that our earnings have been very substantial, have more than offset our impairment, the origination part of the business has more than offset our impairment and we would anticipate that the company, as years go on, and as we've demonstrated the last 36 years, each and every year the company gets stronger financially and operationally, so we would expect the performance ten years from now would be even better, particularly with technology, than was this past year.

Angelo, I would point out June 30th, the ten-year was a about a 350, and that's where our inventory valuation was set, which is about 70 basis points below where they are today, so they've got to fall that much before impairment becomes an issue

That's right.

If we end up having larger than 4 trillion we still have more up side?

Absolutely.

We'd like to see 6 trillion, 7 trillion.

We've always performed very well in that kind of environment.

Thank you very much.

Next we'll go to the line of Josh Adams.

Hi, Angelo.

Congratulations.

On the production component, we have a 2 trillion dollar origination market and you guys actually maintain a 15-percent share, and margins only come in by, let's say, 25 bps, or the 3/8's, I'm getting 2 and a quarterb dollars pre-tax earnings, which after tax becomes 1.4b on current shares outstanding, almost $10 in production earnings alone.

I'm trying to understand if I'm thinking about it correctly.

Do you want to comment on that particular question?

No, I don't think at this point we should connect all the dots.

Yeah, we don't have dot connectors here today.

Thank you.

Next we'll go to David Vokkel.

Please go ahead.

Yes.

Can you hear me?

Yes.

I'm sort of new to the games so this might be kind of basic.

The gain of the sale number 1.8b for the second quarter, what was the production of the prime loans that generated the 1.5b part of that?

And then I had a follow-up question.

The production was 115, roughly.

Now, we sold that, about 109b.

So you should relate the 1.5b to the 109b that was sold in that period.

The security gains that all cash, or what's the composition there?

That's the gain on sale, which includes the value attributed to the servicing writes we retained.

Do you break that out?

How much is cash and how much is capitalized MSR?

In our supplementary disclosure which we posted to the web, we break that out.

Is that available now?

Is it's on the web site.

Do you have it with you now?

No, I will get that.

It's on the web site now.

The other question was, how should I be thinking about the two numbers, the impairment of other retained interests versus the servicing hedge gains?

Because if I look at it a year ago, the difference in the June quarter was roughly -- a little over 100m, between 100m and 200mm, this year much larger, but does that call on your ability to hedge regarding the 800m differential?

How should I think about that?

I realize that's --.

Stan is going to answer that question.

You know what, during the you know this, this quarter, we had interest rates drop to record lows, and we had steep increase dramatically and we went through our calculations of estimating fair market value as we normally do, but we also went through and did certain refitting of our prepayment curves during the quarter, which was whereby we increased basically our -- the capacity of the loans to pre-pay very quickly, and that resulted in a major part of the impairment that was taken during the -- or it kind of looks like excess impairment that was taken during the quarter.

We look at hedging really both from the financial and from the macro hedge perspective, and, you know, it has worked very well throughout this entire refinance period as we had anticipated, but we did, as you can see from the impairment levels, you know, move to the 92 basis points, which was significant, about a 20-basis point drop from the previous quarter.

Thank you.

Next we'll go to the line of Eric if he would please state to company you're with.

Capital.

Just wanted to ask a question about Balboa Reinsurance, the private mortgage company.

As far as the size of the claims paid and so forth.

Have you seen any sort of up tick in the claims at Balboa insurance or not?

No, we have not, but we have to treat it as such that they take the private mortgage insurance, take the first hit on their (Inaudible), and then take the Catastrophic risk but we have not seen any increase.

We do anticipate that because of the rapid prepayments, that there will be a slow down, the income generator from the premiums, we have taken all that into consideration on the balance sheet, but not relative to claims.

Okay.

Then are the private mortgage insurance companies the customers of Balboa Reinsurance?

That's right.

We reinsure all of the majors, and minors, I guess, everyone we do business with, but as I pointed out in my prior presentation we only reinsure those loans that were insured -- that we originated and insured by the primary insurance company.

So it's only Countrywide product.

Okay.

Thank you.

And there are no further questions in cue.

Please continue.

Okay.

Well, there are no other questions in queue.

I want to thank everybody for participating this morning and look forward to talking to you at all at the end of the third quarter.

Thank you very much.

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