美國銀行 (BAC) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you very much for standing by and good morning.

Welcome to the Countrywide Financial Corporation second-quarter 2005 earnings conference call.

If I may have your full attention please, please note that, during this teleconference, Countrywide's management may make forward-looking statements within the meaning of federal securities laws regarding their beliefs, estimates, projections and assumptions with respect to, among other things, the Company's future operations, business plans and strategies, as well as industry and market conditions, all of which are subject to change.

Actual results and operations for any future period may vary materially from any past results discussed during this teleconference.

Factors which could cause actual results to differ materially from historical results or those anticipated include but are not limited to those items described on the last slide in the written presentation that accompanies this teleconference and other risks detailed in documents filed by the Company with the Securities and Exchange Commission from time to time.

The company undertakes no obligation to publicly update or revise any forward-looking statements.

At this time, ladies and gentlemen, all of your phone lines are muted or in a listen-only mode.

However, after today's presentation, there will be opportunities for your questions, and we certainly encourage your participation at that time. (OPERATOR INSTRUCTIONS).

As a reminder, today's call is being recorded for replay purposes.

We do ask that you stay online at the conclusion of today's meeting to receive the replay information.

With that being said, let's get right to this quarter's agenda.

Here now is your host, Countrywide's Chairman and Chief Executive Officer, Mr. Angelo Mozilo.

Please go ahead, sir.

Good morning and welcome to Countrywide's earnings teleconference call for the second quarter of 2005.

I recommend that all of our listeners view the presentation which accompanies this discussion.

The presentation can be found on our Web site at www.Countrywide.com, on the Investor Relations homepage.

Turning to Slide 2 of the presentation, you will see today's agenda.

First, I'll give you an overview of our performance during the second quarter and first half of 2005.

Next, I will provide a review of our mortgage banking segment and other key business segments.

Then I will conclude the presentation with our revised 2005 earnings guidance.

After the presentation, we will open the lines to take any of your questions.

Turning to Slide 3 of the presentation, you'll see a list of our key operational highlights.

The second-quarter consolidated fundings were 121 billion, our third-highest quarter on record, which throughout the first half fundings totaled to $213 billion.

This included record purchase volume of 61 billion for the quarter and 102 billion through six months.

As of June 30, our pipeline of mortgage loan applications was 77 billion, the highest since June of 2003.

Our total servicing portfolio reached 964 billion and bank assets were 65 billion.

Securities trading volume was 887 billion for the quarter and 1.7 trillion for the first half, up 9% over the first half of last year.

Net earned premiums from our insurance segment were up 15% for the quarter and 8% for the first half.

The chart on Slide 4 shows our consolidated earnings highlights for the same periods.

Net earnings in the quarter was 566 million (sic) and 1.3 billion for the first half.

On a diluted per-share basis, we recorded $0.92 for the quarter and $2.05 for the first half of 2005.

The year-over-year comparison showed declining results in earnings.

Various factors contributed to the change, the most significant of which are discussed in the earnings release and in this presentation.

The decline is exaggerated by two factors.

First, the second quarter of 2004 included high production margins on nonprime sales because the loans sold had been originated, securitized in the first quarter when nonprime margins were higher.

In addition, during the second quarter of 2005, management made an operational decision to capitalize on higher production volumes.

Accordingly, 15.7 billion of loans were funded by Countrywide Bank, which was 7.2 billion more than the last quarter and an additional 1.8 billion in home equity loans.

Home equity loan volume was retained in mortgage banking company's inventory.

Had this incremental $9 billion in loans been sold in the second quarter, the Company estimates that it would've realized an additional pre-tax gain of 150 million or approximately $0.15 per diluted share.

As a result of these factors, the year-over-year comparisons for return on average equity appeared to decline sharply, coming in at 20% for the second quarter compared to 35% for the same quarter in 2004.

Despite these factors, it should be noted that our return on equity for the second quarter of 2005 was still well within our long-term target ROE range and exceeded the average for the S&P 500, which is 16.6% according to Bloomberg.

Slide 5 shows the breakout of pre-tax earnings among our various business segments.

Mortgage banking pre-tax earnings were 526 million for the second quarter and 1.3 billion for the first half.

Mortgage banking results in the second quarter of 2005 were impacted by lower margins in the production sector, partially offset by stronger results in the servicing sector, something that should be noted.

I will explain this in more detail shortly.

Our Banking segment continued its robust growth with pre-tax earnings advancing 111% for the quarter and 108% for the first half of 2005, when compared to the same periods of 2004.

This growth has been fueled by asset growth as well as a very efficient cost structure for deposit gathering.

Capital markets' profitability was up 17% for the quarter, due primarily to increased activities in its broker-dealer business but down 7% for the first half due to a year-over-year decrease in MBS-related trading volume, reduced net interest spreads resulting from a flattening of the yield curve, and higher expenses from investments in development of new products and distribution channels.

The insurance was up for both the quarter and the first half on a year-over-year basis, mainly due to an increase in net earned premiums.

Global operations' pre-tax earnings declined as a result of lower levels of new loan processing volumes from its joint venture partner, Barclays Bank.

Let's take a closer look at the Countrywide and Mortgage Banking segment on Slide 6.

Production sector pre-tax profits for the quarter were 409 million, down 58% from the second quarter of last year.

This decrease was primarily attributed to the decline in production margins, which will be discussed in more detail later on the following slide.

Loan servicing sector pre-tax earnings, however, were $89 million, an improvement of $64 million or 254% from the last year's second quarter.

Second-quarter 2005 service sector earnings were aided by a year-over-year increase in servicing fees and escrow balance benefits, which I will explain in more detail in a moment.

Let's take a closer look at production sector margins.

Slide 7, we profile the production sector margin in a sequential quarterly basis.

Production margins declined from this period from 93 to 40 basis points, a decrease of 53 basis points.

The primary contributing factor was a declining gain on sale revenue, including commissions and other fees, of 194 million or 15%.

The primary drivers of this decrease were lower pricing margins in the prime and nonprime product categories; two, a shift in channel mix towards lower-margin correspondent channel; and three and as previously noted, the decision to increase loan retention during the second quarter.

Also, while the pipeline has performed to expectations margins, second-quarter margins declined because hedging outperformance in the first quarter was not repeated.

It should be noted that while loans may be funded and securitized during a typical quarter, the gain on sale relating to such loans may be recognized in a subsequent quarter.

The impact of this phenomenon during the first quarter of 2005 was a net increase in gain on sale of 150 million.

The impact of this during the second quarter was -- of 2005 -- was a net increase in gain on sale of 26 million.

In addition, as noted above, an estimated 150 million in pre-tax gains would have been reported in the second quarter of 2005 had the discretionarily retained loans been sold in the quarter.

Moving to Slide 8, let's focus on the sequential decline and gain on sale margins in the prime market.

Prime gain on sale margins declined by a significant amount from 124 basis points in the first quarter of 2005 to 79 basis points in the second quarter of 2005.

But to what extent is this indicative of market conditions?

First-quarter prime gain on sale margins were well above the normal range seen during recent quarters and by far the highest over the last five quarters, as shown on the table.

By contrast, the 79 basis points prime margin in the first -- in the quarter was much more in line with recent history, only slightly below the levels achieved in the third and fourth quarters of last year, 2004.

Turning to Slide 9, let's take a look at the servicing sector.

It's an important slide to review.

Servicing sector pre-tax earnings in the second quarter were 89 million or 3.9 basis points.

The primary factor contributing to this increase was greater servicing fees.

Servicing fee income rose 195 million, or roughly 1 basis point, driven by a 31% increase in average portfolio size for the same period a year ago.

In addition, escrow balance benefits improved by 118 million or 5.7 basis points in the second quarter of 2005 versus the second quarter of 2004 as a result of higher short-term rates.

These results were partially offset by the aggregate impact of 174 million increase in amortization impairment of the mortgage servicing rights and other return is interest net of servicing hedge, which includes data or hedging costs.

Amortization expense, which is calculated based on rates at the beginning of the quarter, declined substantially.

This resulted from significantly higher interest rates at the beginning of the second quarter of 2005 compared to the one a year earlier, as the ten-year U.S.

Treasury yield was 386 at 3-31-04 as compared with 450 at 3-31 of '05, a difference of 64 basis points.

The parent, on the other hand, was up substantially due to a 56 basis points rally in the ten-year U.S.

Treasury yield during the quarter.

Impairment was substantially mitigated by hedge gains.

Slide 10 describes the Banking segment, which includes Countrywide Bank and our warehouse lending group.

This discussion will focus on Countrywide Bank.

At the end of June, assets at Countrywide Bank exceeded $65 billion, driven primarily by a robust origination market and Countrywide's decision to retain more loans in portfolio compared to the previous quarter.

This was the driver behind substantial year-over-year quarterly earnings growth.

Net interest margins were 2.08% for the quarter compared to 2.20 for the same period last year.

The reduced margin resulted from an increase in adjustable-rate loans in the Bank portfolio.

Some of these products carry lower teaser rates, which affect current-period margins.

Future periods are expected to benefit as interest rates reset.

However, future increases in production of these kinds of loans may have a similar lag effect.

The Bank continues to be successful in raising retail deposits, garnering 2.5 billion in additional deposits during the second quarter, primarily through its 70 financial centers.

Management continually evaluates the benefits of selling or retaining loans.

Sales of loans generate current-period gain on sale, while the retention of loans is designed to provide a more stable stream of net interest income over the life of such loans, as well as a greater base of future earnings.

In making the determination of whether to sell or retain loans, management considers, among other factors, earnings growth, current market and economic conditions and capital availability.

Management's decision in this regard will result in changes which may be significant in loan-retention levels and the size of the Company's loan portfolio as well as current-period earnings and production sector margins.

To summarize, management from time to time could forego a portion of gain-on-sale earnings for the sake of retaining loans and generating future net interest income, which is designed to provide a more stable earnings stream for shareholders over time.

Retention of loans in portfolio not only can enhance earnings stability to provide substantial economic benefit -- for example, on loans retained in the second quarter, net interest income in the first year alone is expected to be greater than the foregone gain on sale.

A more meaningful metric might be incremental earnings over market returns.

Management estimates that, on this basis, the payback period on the investment in these loans is 1.4 years for assets whose weighted average expected life is nearly 3 years.

Turning now to the capital markets segment on Slide 11, as you can see by this chart, conduit activities remain the largest component of capital market revenues.

Looking forward, capital markets will continue to emphasize growth in its new business lines.

The commercial real estate business, for example, continues to develop, funding 732 million in the second quarter and 1.3 billion year-to-date.

The commercial real estate pipeline at the end of the second quarter stood at 502 million.

On April 2 -- April 1 of 2005, the Tokyo branch was approved as a broker-dealer by the Financial Services Agency of Japan and approved to officially start conducting business in April 11 -- on April 11.

CFC Futures, Inc. was established in the first quarter of 2005 to engage in trading of futures contracts as an introducing broker.

During the second quarter, it began earnings fee income related to these activities.

Among other new initiatives, the capital market group has entered the private equity fund management business with the establishment of Countrywide Sunfish Management, known as CSM.

CSM and C-Bass, an independent private fund manager, jointly managed the 250 million Sunfish funds.

The Sunfish fund was established to invest in CHL nonprime residuals and Countrywide holds a 19% interest in that venture.

Now, let's review our revised 2005 earnings guidance on Slide 2.

The new range is 3.85 to 4.60, $4.60 per diluted share, up from the previous guidance of 3.60 to 4.60.

The key assumptions behind this guidance is that the average ten-year U.S.

Treasury yield of -- for 2005 will be within a range of 4 to 4.5.

With this in mind, our guidance assumes the relevant range for the size of the mortgage origination market to be 2.8 trillion to 3.2 trillion.

In addition, our guidance assumes mortgage banking pretax profits will range from 2.3 billion to 2.8 billion and the pretax earnings contribution from our other business segments will range from 1.7 billion to 1.9 billion.

Slide 13 shows more details behind the guidance.

Average consolidated reduction market share is expected to be within a range of 14 to 15%, implying value for Countrywide of 390 to 480 billion.

The range for pretax production sector is 40 to 55 basis points, which compares to the previous range of 40 to 70 basis points.

On the servicing side, the estimated average servicing portfolio balance is 970 billion to 990 billion.

The net pretax servicing margins for after impairment or recovery and hedge gains or loss is expected to be between 1 to 6 basis points.

The final slide contains a disclaimer regarding the forward-looking statements included in this presentation, which I encourage all listeners to review.

Before opening the line for your questions, I'd like to emphasize a few of the positives as we move into the second half of 2005.

Within Mortgage Banking, today's mortgage rates are still well below where they were at the end of the first quarter of 2005 and are still over 50 basis points below rates at the end of last year's second quarter.

Furthermore, we are in a seasonal peak period for purchased mortgage activity. (indiscernible) these circumstances should bode well for the future fundings as our pipeline of mortgage loan application in process stood at 77 billion entering the second half of 2005.

In addition, Countrywide continues to expand its mortgage origination capabilities not only through the addition of high-quality mortgage professionals to our own staff but also through creative, productive business alliances.

During the second quarter, Countrywide announced it had entered into an asset purchase and joint venture agreements with KB Homes, one of the most respected names in the home-building industry.

In our Banking segment, asset growth continues to drive earnings growth and management continually seeks to optimize the balance between loans retained in our bank portfolio and loans securitized and sold into the secondary markets.

Within capital markets, new business lines such as commercial real estate are beginning to make their presence felt.

We will now take your questions.

At this time, I would ask the operator to explain our question-and-answer protocol, and thank you very much.

Indeed, I'd be happy to. (OPERATOR INSTRUCTIONS).

Piper Jaffray, Bob Napoli.

Good morning.

A question I guess on production margins and the outlook for margins -- the decline in the quarter, if I understand the prime, it still looks like a pretty good margin level but the subprime was down 100 basis points.

I think that's the lowest level I've seen on the subprime side for a while.

Just on the guidance that is out there for margins in the back half of the year at the low end of production margin range, it would be in the '30s on production margins.

So can you talk a little bit I guess about that outlook, about the subprime portion and the competitive environment effect on margins?

Well, it is the competition that is affecting margins, as you would expect, Bob.

I think this -- in terms -- to be a little more specific, AmeriQuest, on the subprime side, as well as New Century, continue to put pressure on that sector.

There, I would say, at least from my perspective and what I'm dealing with everyday, is that's where the pressure is coming from primarily.

I think that my own sense is that that has stabilized.

You know, I think there is a good chance that we've seen the worst of what is happening, because one of the primary buyers from AmeriQuest has been Washington Mutual, and our understanding is -- and of course (indiscernible) is that Washington Mutual has either completely cut them off or has slowed down their buying of AmeriQuest product.

So my sense is that we have seen the worst of the pressure on the subprime.

On the prime, I would say that your assessment there is not exactly correct.

I think that there continues to be some pressure on prime.

Particularly you have to segment it out, particularly in the hybrid area, the five-year hybrid area seems to be a product that commercial banks like on their balance sheet.

So I would say that, generally on prime, the pressure has stopped but on that particular segment of the hybrid, the three and five-year hybrid, we still see pressures from the likes of Bank of America, Wells and in some regards, Chase.

I'm sorry, Angelo, do you expect -- I mean, that -- the gain on sale we saw this quarter, do you expect that margin to continue over the next couple of quarters?

I would say yes.

My sense is it's stabilized.

Stan, do you have a different view of it?

No, I think, on the subprime, we've seen considerable margin pressure over the last quarter.

It does seem to have stabilized from what we're looking at.

We also had a very significant drop in the yields during the quarter, which does have a negative -- tends to have a negative influence on our subprime margins because of the uniqueness of the hedging activities and the fact that their pipeline doesn't -- isn't treated as a 133 derivative, as most prime mortgages in our pipeline are.

So, there's a little bit of impact from hedging, but the majority of what we see in the subprime change is the result of greater competition.

We do have -- and during the quarter, we had -- short rates are increasing as well in that a significant portion of the subprime product is adjustable-rate product, and that's having an influence there as well.

I think also, Bob, that you have to expect that when you have the kind of margins -- looking back on it -- the kind of margins that everybody enjoyed on the subprime, that's where the pressure is going to be.

Everyone is going to try to jump into that pool, because that's where it appeared to be the greater profitability, so anytime you see product that has a margin larger than prime margins, that is where the industry is going to gravitate to.

Bob, I would like to emphasize that our production margins guidance is very conservative for the second half, in response to what we've seen.

We moved our guidance for production margins down to 40 to 55 basis points.

Our actual for the first half was 64, so the implication for the second half is 16 to 46 basis point margins.

So that's very, very conservative.

Fred Cannon representing KBW.

Thanks and good morning.

Just as a follow-up to the last question, I would be interested in what share of production was option ARMs and what you are doing with that in terms of putting option ARMs into the bank, and also how gain on sale is performing on option ARMs, and also just any comment on if you're seeing increasing negative amortization.

This is Stan.

In terms of our production, about 20 to 21% of our production was to pay option ARMs.

Then of course embedded in the pay option arm is the negative AM (ph).

The question is what percentage of those have been opting for the negative AM?

Yes, do you have any comment on that?

I happen to know the number for the bank.

It's been running about 17, 18% of the loans that they are originating are starting off with negative AM and we have seen, over the past quarters, increasing use of the negative AM feature.

But it is noteworthy that not all of those loans are negative AM and that they're not taking that option.

Just as a follow-up, now the gain on sale margins on the pay option ARM have continued to be strong through the second quarter.

Is there an outlook on that?

You know, pay option ARMs are an area where we are seeing considerable change in margins, so looking at our conforming activity, we've seen most of the interaction really coming -- or a significant part of the contraction in margins coming out of that product.

That product -- there's revisions and features of the pay option ARM program that are going through modifications and working to stabilize the margins on pay options.

Thank you very much.

Paul Miller representing Friedman, Billings, Ramsey.

I want to follow-up on the pay option ARM discussion because we've heard and we've seen a couple of companies really pay gain on sale margins and pay option ARMs (indiscernible) it very well, and some of the feedback that we're getting is that those pay option ARMs that don't have any prepayment penalties are some of the ones that are coming under the most pressure.

My question is, have you been originating loans with prepayment penalties, and are you modifying that type or part of their loan?

Secondly, how much prepenalty payments in your pay option ARM do you have in your own portfolio?

Well, we do have a prepayment penalty pay option ARM, and we promote that product as well as offering loans without prepayment penalty features as well.

I think that your -- or observation that you've heard in the market is consistent with what we're seeing that those loans, without prepayment penalties, are under greater pressure.

You know, I don't have the exact percentage of our make-up but a considerable portion of our production is with prepayment penalty.

Is with prepayment penalty?

Yes.

So, are you -- I mean, with the pressure coming on those, I guess you said with Fred's question that there's some modifications of these loans that are coming under pressure.

Are you pricing those loans differently?

Could we see a little bounce-back in the time gain on sale margins because of modifying those loans?

We are working on that and we anticipate that pricing and pricing exceptions and so forth will improve in the future.

Then Stan, I guess you don't know -- I mean I'm not trying -- you can follow-up on this but you don't know how many prepayment penalties are in your own portfolio on the pay option ARMs?

We will get you that number;

I just don't know it off the top of my head.

Raymond James, Mike Vinciquerra.

Good morning.

Two questions on the bank -- first of all, can you provide a little bit more color on expectations in terms of the net interest margin?

Maybe it's a question for Eric as far as, in 2008 now, we've got some loans that are -- you know, reprice over time but also I assume you are going to continue to add loans that are going to have teaser rates which may put pressure on the new side of things, so comments on that.

Second of all, can you comment on the provision that you're making for loan losses at the bank?

You added about almost 15 billion in loans during the quarter and I think your provision that I saw was about $17 million or about 12 basis points.

Any thoughts on how you guys are looking at that and if you should be being more conservative, giving maybe the uncertainties without adding all of the pay option ARMs to the balance sheet?

Thanks.

Well, I think, in the presentation, we talk about the potential for the net interest margin staying at a relatively low level for a period of time as we do add teaser rate loans to it, but that possibility does exist.

Even though the existing loans will be resetting, new loans could be put in as long as the pay option ARM remains a popular product.

So, that's a little bit of color.

Eric, do you want to talk about the reserves issue?

Specifically what was your question about the reserve, Mike?

(multiple speakers) -- we put in $17 million of reserves for the quarter.

I'm just trying to get a sense for how you guys plan to preserve going forward. 17 million you put 14.5 billion in loans this quarter, so that's about 12 basis points -- (multiple speakers).

(multiple speakers) -- the average FICO of these loans that are put in the portfolio are over 700.

The loan-to-value ratio is still around the 80% or a little south of that level, so these are very high-quality loans that were put into the bank.

That was one of the motivating factors in the second quarter, because we had a unique opportunity to do that (inaudible) the volume of our closing was so high of very high-quality loans.

So that's sort of the background that influenced the reserve issue.

But do you have any specific -- Eric, do you have any specific comments on the research issue?

Not at this point, Mike.

We will be working on that and get back to you later in the call on that.

Neil Abromavage with Deutsche Bank.

Just a follow-up question on the neg AM -- I guess as you look at your sort of book of pay option ARMs, where are the majority of customer payments coming in?

At what sort of pay option, if you will?

Then if you could just comment on trends in the correspondent channel.

Just to follow-up on the other question regarding prepayment penalties, about 72% of our production comes with a prepayment penalty.

That would -- you know, going back to the start-up of that program in 2003 for us, we initiated that program was -- about 18% of the production had prepayment penalties, so, you know, a significantly improved level.

Of loans with prepayment penalties, I think another important point was our pay option portfolio -- is it actually enjoys one of the lowest levels of delinquency in our entire portfolio, just over a 1% delinquency rate, and so it is a very high-quality product.

As I mentioned before, you know, the numbers that we have, in terms of loans that are negatively amortizing, it's about the 20% level -- (multiple speakers).

I don't think we have numbers on each of the four options.

I think your question is you want us to break down each of the four options of what percentage the consumer is using of each of those options?

Yes, or just where the majority of consumers have been paying recently and maybe how that compares to a quarter or two ago?

Where are you receiving the majority of payments, at what level?

I don't think we have that.

We don't have that data, do we?

No.

The data that we follow is the percentage of loans that are negatively amortizing.

We're only focused on that.

Eric, why don't you make note of that -- find out what percentage?

We will go back and look at what -- if I understand your question, the four options, take each of the options and what percentage is being used by -- of each of those options by the consumer.

Precisely.

Yes, that would be terrific.

Thank you. (multiple speakers).

Eric has made note of that, or Lisa has, and we will get back to you on that.

Now if you'd just like to comment please on trends in the correspondent channel, that would be terrific.

You know, that's a very price-sensitive channel.

There are two things that drive it.

One is capacity and the other is price.

So for example, an exaggerated example would be 2003, when everybody else was shut down because they just couldn't handle the volumes.

Because of Countrywide's technology, we were able to handle virtually infinite volumes during that period and pricing wasn't the issue, because we had the ability to close and we had the liquidity.

The second is, in an environment like this, what we are confronted with today, it's more of a pricing issue.

To the extent that we are a tick better than someone else in a particular product line, then we will attract the business.

So it's just a matter of constantly evaluating where the competition is and using our efficiencies to provide a better price to our correspondent customers and they will generally hit the bid.

Now, there's also another component of that, and that is our unique -- as I said, our unique technologies that help the correspondent customer do more business and where we reduce the amount of paperwork, more of electronic communication than paper communication.

Because they get locked into that system and like it, from time to time, they will forego a tick or two in order to have the efficient transfer of loans from them to us.

So, I would say the drivers are capacity, technology and price, and any of those things could cause us to be up or down in that correspondent channel.

Great.

Thank you very much.

Ed Groshans representing Fox-Pitt Kelton.

Thank you.

I just wanted to -- I was looking at the correspondent channel.

I guess you kind of answered it back.

Were the opportunities in the other channels the same in this quarter relative to other quarters, or were there just absolutely that much more in the correspondent channel that you saw?

I just -- (indiscernible) very distinct channels that have totally different drivers, so the issues that drive one channel don't drive another.

In the consumer-direct channel, the retail channel, it's not necessarily pricing alone; it's the size and the quality of your sales force that are out there in the field calling on real estate agents.

It's much less price-sensitive than the correspondent channel is.

The wholesale broker, which is the second channel, is again dependent on the quality of service that we render, making their life easier, and is more price sensitive than the retail but less price sensitive than the correspondent.

So they are all driven by different factors.

I couldn't give you one generic answer to your question.

Just two other questions.

Stan has something -- (multiple speakers).

(multiple speakers) -- part of the mix issue, that we are referring to in terms of gain on sale and correspondent loans, it really deals with the fact that a larger percentage of our wholesale production goes to the bank, just as a part of the mechanism of flowing activity to the bank and then our ability to retain mortgages.

So, the loans that are left in the Mortgage Banking style for sale, there's a greater portion of correspondent loans.

That's what you're seeing in the mix shift on gain on sale, one of the issues.

Okay, so along those lines then, by accelerating the -- added into the fact you accelerated or amplified that?

Right, the quantity of loans that were -- (multiple speakers).

Coming from wholesale.

(multiple speakers) -- that were sold that were correspondent mortgages.

I was under the impression that most of the channels was about a third correspondent, a third retail, a third wholesale.

Does that still hold true?

I think, at the end of the year, it will look like that.

Okay.

Then, can you just give us like, on the subprime, a lot of that product -- (multiple speakers).

(multiple speakers) -- (indiscernible) the point that Stan so that -- (indiscernible) because I think it's a very important point.

We had to set up specific technology to get loans transferred from the origination channel to the Bank.

The most expeditious channel to do that in was in -- for a variety of factors was in wholesale.

That's why you see a substantial amount of loans from wholesale.

You don't see it in that form going to the Bank; what you see is less gain on sale in that channel, because it's going to the Bank.

Okay.

Could you just -- in the subprime margins, they dropped pretty significantly.

I guess my question there is like, how much was less pricing or a decrease in the bid that Countrywide received as opposed to paying up a bigger price due to the correspondent channel, or what were the other issues that are putting the pressure in?

Was it all -- (technical difficulty)?

You know, it was primarily margins at the origination point -- very little change in actually the structure of transactions during the quarter.

Most of it is pricing upfront.

Eric Wasserstrom, UBS.

Two quick questions please.

On the capital markets business, I was a little surprised that the underwriting volume went down in the quarter, given the strength in the production volume.

Is that a correlation -- is that by made up (ph) that correlation or does that correlation typically hold?

To the extent Countrywide retains more loans and sells less loans into the secondary market, there's going to be less activity for the broker-dealer to sell.

So that is the corollary you see -- is we retain more loans, they have less to sell.

Great, thanks.

The other question I had is could you talk to a little bit about what has caused you to modify your target market share range for the year?

Well, in general, what you'll see is that the size of the market has been drifting up in our estimates and our share has been moderating; we were 14.5 to 15.5 with our prior guidance.

We moved it down to 14 to 15 to be conservative.

We were 14.3 actual in the first half, so the implication is that we will be 13.7 to 15.7 for the second half.

I think it's in line with what we discussed in the past -- is that when we originally provided our guidance at the beginning of the -- at the end of the -- (inaudible) where it was in the fourth quarter of '04, was we anticipated higher rates.

As you can see by our guidance, we anticipate higher rates and therefore less competition.

Of course, consolidation, therefore less competitors and we would advance -- that's how we advance in market share, is by either the demise of our competitors or by consolidation.

Because the buying is so vibrant this first half of the year, that consolidation we anticipated didn't take place.

Do you have an expectation about when that consolidation may take place now?

When rates go higher.

Okay.

Just one last final thing on the capital market -- is the underwriting the richest-margin portion of that business?

That's fair to say.

Ken Posner representing Morgan Stanley.

A couple of quick questions -- can you give us an update -- and I apologize if I just didn't see it in the press release -- on the holdings of nonprime residuals on the balance sheet compared to last quarter?

We are looking it up.

While you're looking at that, maybe I could just ask, how does production margins for this quarter compare to your expectations going into the quarter?

You mean the guidance, right?

Stan, let me tackle the first part of your question.

You asked about the nonprime residual securities.

If you go to Page 13 of our press release, you will see that we have the nonprime residuals in two categories.

In Available For Sale, they were relatively flat from December 31 to June 30, 242 million at June 30, up from 238 million.

In the trading securities area, we are at 421 million, up from 188 million at December 31, so the combined balance at June 30 is about 663.

We had sales of about 250 million in residuals during the period, so that's why you see the balance at 663 at June 30.

Okay, great.

Then on the margins, I realize that it was in your guidance.

I was just wondering if the quarter shook out at all differently than what you expected going into it.

No, I think -- if look at -- remember (ph) the quarter is that we had a very significant drop in interest rates and we had an expansion in terms of volume of activity.

So going into the quarter, clearly we didn't anticipate the type of volume levels that we saw during the quarter.

We picked up volume and we believe market share during that period.

At the same time, it was the case that we saw a lot of pressure in terms of margins, particularly on the subprime side.

We can't forecast where margins are going to be, although I think it's been the anticipation of the entire market that we would see margins start to decline.

There's a lot of activity within the quarter; it would be hard for us or anybody to say that the quarter ended up as we anticipated just because it's such a much bigger market.

Thank you.

(inaudible).

Michael Cohen with Susquehanna Financial.

I have two sort of more strategic questions and then one more mundane;

I'll ask the mundane first.

What's the expected amortization for the third quarter, given that it set off interest rates at the end of the second quarter?

I'm sorry, it's 645.

Great, thank you, Stan.

Two sort of more strategic questions, first being can you talk a little bit more about specifically the decision to retain production, not necessarily in this particular quarter but in any particular quarter, when that gets dialed up or dialed down, in terms of is there a specific sort of spread you're looking at in terms of LIBOR to two-year treasury rates or LIBOR to three-year treasuries or what have you?

In other words, is there something formulaic that we should be looking at there?

Well there's elements of -- I will have both Eric and Stan participate in this.

We had stated that we wanted to increase the assets of the bank by $40 billion, net, so that's our target.

That's the primary element in the equation.

We look at, as we go through each quarter, we look at our production and look at how we're doing at the Bank and trying to make sure, at the end of the twelve-month period, that we beat that strategic objective or if we don't, we have to justify to ourselves why we haven't.

So that's the driver as we look at it.

We were behind the curve in building the bank assets going into the second quarter and therefore had the opportunity, in the second quarter, with all that volume, to catch up and in fact get ahead of the curve.

So that's the -- but it's constantly looked at each and every day.

Also in terms of the financial analysis, if you -- I will have Stan walk you through this, but the return to our shareholders is substantially higher by retaining the loans in the Bank than it is on a gain on sale.

Now the question you would ask is, why don't you do that?

Why don't you retain all the loans?

Because the fact is we are a growing company and we need equity and earnings to continue to grow the Company.

But I think it's important for the investor community to understand the value of what we did.

Stan, why don't you walk through that analysis of the -- by putting the 7.2 billion -- the 7.2 billion on the balance sheet at the bank, rather than selling it to the secondary market.

The numbers are quite compelling in terms of what we did although -- (multiple speakers).

I guess, Angelo, if I could just jump in, specifically to be specific with my question, is there something different about sort of the yield curve or that you saw in the second quarter that was more attractive, relative to the first quarter, to make you -- to make the decision to sort of accelerate the growth?

You know, our production is primarily that goes or that feeds into the Bank is adjustable rate, very low duration product, and the spreads that we've experienced from quarter to quarter are pretty consistent.

The primary change that we had in the second quarter was the expansion of our production resulting from a much more active market and the need for -- to advance the asset base of the Bank.

That's really the -- the primary driver was expanded production.

The return profile is still very healthy for the Bank.

Given our very good production in terms of adjustable-rate mortgage and HELOC activity, it makes sense for us to expand the volume of activity and to provide greater stability of earnings for the Company in the future.

You know, these loans, they have net interest margins that are over 2% or just slightly over 2% on average.

That is, you know, with a three-year life produces considerably more margin for the Company than immediate gain on sale.

So we think it's valuable for us to continue to grow the portfolio of the Bank.

You know, the kind of analysis that we are looking at is, if we give up a gain on sale -- in this case the incremental volume that we deliver to the bank had an estimated gain on sale of about $110 million, whereas the spread income that those same loans generate in the Bank will approach $450 million over their life.

So, it's a very quick pay-back period for us, and it adds to the soundness of the entire Company and it's very valuable for us to be able to deliver our quality production into the Bank.

That makes sense.

If I may extend that logic, at what point do then you extend that logic to your subprime production and decide to retain a portion of that?

We're not -- we don't have any intention of putting subprime production on our balance sheet or to be held in a bank.

Generally, we are driven to reduce credit exposure to subprime activity by selling whole loans or, as we securitize mortgages, for those to be credit-enhanced or to sell residuals outright or in the form of NIMs.

Right, but wouldn't you capture -- I mean the same way you capture a much larger percentage of the sort of value-creation by retaining prime loans, couldn't --?

It's true that one could argue that -- (multiple speakers).

We look our balance sheet differently; we're looking to hold only pristine product on the balance sheet, particularly the balance sheet of the Bank.

I think also you have to take into -- you don't have to do it, but we have to here -- take into consideration that we are relatively a new bank, just three or four years old.

The regulators, particularly with a newer bank, are deeply concerned about the quality of assets on a balance sheet.

We want to make certain that we don't create, we never create any angst on the part of regulators as to the quality of those assets.

I'm not saying that, five years from now, we won't do it but currently, as Stan pointed out, we want to keep that balance sheet as clean as we possibly can.

Great, thank you.

Moshe Orenbuch with Credit Suisse First Boston.

I noticed that, when you made the disclosures a week and a half ago, you talked about the loans that were originated by the Bank.

Have they been sold?

The gain on sale was substantially higher.

Is that because of the characteristics of those?

Is there something about those that is different and that's what you chose to put them into the Bank's portfolio?

You know, there's a consumer mix -- or not a considerable but part of the mix of loans that went to the Bank are HELOCs that have a higher gain on sale percentage.

I think that's what you're seeing in that number.

Hello?

Did you have any follow-up questions?

No thanks.

George Sacco representing JP Morgan.

On the residual, how much to date I guess of your subprime residuals have been transferred to Sunfish?

Going forward, how much capital will you have to hold against your investment or how will that work in terms of how much leverage you're allowed to have against your investment in Sunfish?

Then separately, has the flatter yield curve or how has the flatter yield curve affected your desire to do NIM securities?

Has it reduced the attractiveness at all of that?

With regard to Sunfish, we have a 20% equity interest in the fund, and the fund can get up to $250 million in terms of total assets.

They have the ability to buy our residuals as well as other residuals at market prices.

Understood, but how much is in there so far?

Have you started -- (multiple speakers)?

90 million is in Sunfish right now.

90?

That's correct.

For your 20% investment, how much capital do you have to hold?

Is it dollar-for-dollar against that investment or can you leverage that at all?

Well, the operative constraint would be the rating agencies.

Generally speaking, you're going to get 0 leverage on residual investments.

You're going to have to have 100% equity.

Okay.

Then the second question was the flatter yield curve and how does that reduce the attractiveness of the NIMs for you at all?

You know, we've been able to look at infrastructure, NIMs transactions, but you know, clearly the flatter yield curve had an impact on the spreads and the residuals and the timing to develop adequate cash flows in the residuals.

Should we expect you to maybe hold onto more of the residual then?

You know, it's not -- we're always looking to sell into NIM and we've been very successful at doing that and our activity has been considerable on that in the market.

So, we are not seeing any issue in our ability to distribute residuals directly, or in -- we've had several NIMs transactions.

At this juncture, we don't see anything positive about building residuals on our balance sheet.

Just touching back on the Sunfish, if you have to hold dollar-for-dollar capital against your investment in Sunfish, what is the benefit of transferring these residuals off the balance sheet?

Well, the residual on our balance sheet is 100%, so when we sell into the -- into Sunfish, it actually reduces that to 20%.

Oh, it's 20%, not -- Oh, I see.

20% of the -- (multiple speakers).

Oh, 20% of the investment, okay, I see.

So we are offloading 80% of what we otherwise would have to -- (multiple speakers).

The most they can hold is 250 million?

Yes.

We have a correction.

The current balance on Sunfish is 66 million, not 90 million.

Okay, thank you.

Lehman Brothers, Mark DeVries.

Have you seen any impact yet on your securitizations from the comments a couple of months back by Moody's and Fitch that they were looking to increase some of the credit-enhancement requirements?

You are referring to subprime specifically here?

Yes.

Yes, that was an adjustment we had seen in previous quarters, you know, increased OC levels.

The nominal effect may be 3 basis points experienced in the last quarter, relatively nominal.

Okay, so for the most part, it looks like that's stabilized -- the impact of that?

Yes.

Were you at all surprised by the extent to which your hedge gains offset the MSR impairment during the quarter?

We were very pleased.

Was there anything, factors you can point to that kind of drove the strong performance of the hedge during the quarter?

You know, they hedge basically is looked at and reviewed in that, you know, you have a sequence of events in the market where rates had risen in the first quarter, and we had held a significant position.

You know, very quickly during the second quarter we had rate coming down and we enjoyed the fact that we had expanded the coverage as rates had increased.

We do have -- you know, work within levels and tolerances in terms of what level of net impairment we will be exposed to.

We were fortunate in the second quarter that we were operating at a much smaller tolerance level.

Okay, thanks.

Representing Marsico Capital, Tom Marsico.

Thank you.

I was just trying to understand the pay option ARM market here just a little bit.

In the overall market, are we seeing the greatest volume increases in the pay option ARM market?

If that's the case and you're seeing increased use of your negative amortization feature in the pay option ARMs and we're also seeing the gain on sale of margins, the pay option ARMs is experiencing the greatest margin contraction and the largest volume increases or percentage volume increases in the Bank's portfolio is in pay option ARMs.

Is this representing an overall degradation of the business as you see it now, Angelo?

I don't think so, but I'm not certain.

I think you need more time, Tom, to determine how these loans are going to perform.

There's been two drivers and you've read a lot about it, about the interest-only and the pay option ARMs are certainly becoming the most popular products because it provides a lower payment, lower threshold for borrowers so they can get into the homes as values, with the exception of some areas, have continued to increase, although we're beginning to see that stabilize.

As Stan pointed out, it's our lowest delinquency product at the moment but generally, you have to wait some time for loans to mature, a year or two years, even three years, to determine how they're going to perform.

As I said, right now, the loans are performing very, very well, so I wouldn't label it as a degradation at all because there's no indication of that.

Instinctively, you might feel that way because they are so non-traditional, but we don't -- when you look at the numbers, the numbers clearly don't indicate that.

Right, but if we are looking at the secondary market for the ability to sell these mortgages in the market itself and you're seeing a margin contraction on gain-on-sale margins, wouldn't that be an indication to you that the attractiveness of these mortgages is less than traditional product?

No, Tom, I don't think -- that's not where the pressure is coming from.

It's not in the secondary market.

The pressure is coming from the origination.

As Stan pointed out earlier, it's the point of origination.

We're not able to originate these loans at the pricing that we were able to do it before.

Okay, I misunderstood;

I thought it was also on the gain on sale, too.

That's why you chose to -- (multiple speakers).

It comes down in the gain on sale.

If you're originating a product at 96 and selling at 100, then you've got a 400 basis point spread.

If you can't do it anymore and you originate at 99 and you are selling at 100, then you've got 100 basis point spread.

You know, it appears in the gain on sale area but it really emanates from our inability to originate it at higher margins.

You know, this product has become a very popular product with the consumer.

We entered the market.

There was, on a national scale, only a couple of players, and we enjoyed larger margins as really early entry and as other originators were getting prepared with their systems and capabilities of originating pay option ARMs.

So, we are seeing increased competition, which is something that we always expected as we saw the product gain popularity.

There are, you know, other fine-tuning elements of the features and the offer that we have on the loan product.

One that we discussed earlier is the expansion of the use of prepayment penalties, for example, to provide better economics for us.

We are always looking at and exploring those.

The product itself tends to be highest FICO, very good LTV product that's performing very well with delinquencies, as I mentioned earlier, just over 1%.

So that part of the process had change (ph) in the consumer preference and willingness to assume an ARM product.

If you taking an ARM product, why not have the most options available to you in terms of your payment?

I think it's fair to say and to the best of my knowledge, Tom, there is no back-up in the secondary market for that product.

Okay, and just a follow-up -- the majority of the pay option ARMs that have been originated still primarily in the California market?

It's more heavily concentrated in California.

20% of our production year-to-date has been pay option.

Of that 20%, probably between 50 and 60% of it comes from California.

Thank you very much.

Prudential Equity Group, Brad Ball.

In terms of your servicing performance during the quarter, it was very strong with a big impairment, offset by strong hedge gains.

But at the same time, your guidance for servicing pretax margins was narrowed somewhat.

I wonder if you could give a little color on your expectations for servicing in the second half.

Does it just purely reflect the numbers, Eric, where we are in the first half and where we are likely to be in the second half, or is there something else you see?

Well, we experienced an actual margin of 2.4 bips in the first half, and with guidance of 1 to 6 bips for the year, that implies basically 0, technically minus 0.4 of a bip, to 9.6 bips for the second half, so basically 0 to 10.

So we're giving you a pretty healthy range there because of the volatility of servicing earnings due to the accounting for servicing.

Obviously, as you've seen in our production forecast, we've expected a smaller market at the beginning of the year.

Rates have been lower than we expected.

We started the forecasting process with a range of 4 to 5 on the ten-year; the actual for the first half was basically 4.20.

So we have been operating at the lower range and frankly, throughout all of the guidance that we've given, look at the production margins, 16 to 46 bips implied for the second half, servicing 0 to 10 implied for the second half.

We're being very, very conservative.

Remember that the amortization is going to go up to 645, per Stan's prior notice, and it was I believe 482 for the second quarter, so there's a significant change there.

That has to do with rates at the beginning of the quarter.

Okay, but in terms of the rising rates that we've seen so far in the third quarter, one would expect that you would have some recovery of past impairment.

Could you just remind us again as to how you are accounting for the MSR assets between Lowcom (ph) and where you're applying FAS 133?

Well, we applied --.

Do you want to do this?

No.

We applied FAS 133 at the beginning of the second quarter, and it's roughly about 30% of the portfolio that falls under 133.

The impact of 133 wasn't felt in the second quarter because we had a rallying environment, so there will be more color to give you if in fact we stay in a sell-off environment in the third, perhaps into the fourth quarter.

So there isn't really any firm guidance that we can give you yet.

The one point that I did make is that roughly 30% of the portfolio is subject to FAS 133, so there isn't a whole lot of color to present there.

The impairment reserve I believe is at 1.4 billion, so there's obviously potential for recovery there.

(inaudible) what would cause us to go Lowcom (ph). (inaudible).

But the Lowcom issue would -- if you are not 133 and you have a problem with the hedge but not with the MSR, you can be constrained, where the MSR accretes in value but you can't book it.

So you've seen, from time to time, where the value was recovered in the MSR economically but accounting, because we were constrained at a lower cost of market, we couldn't reflect that.

We showed you schedules from time to time in the earnings teleconferences where the increment of market value over the book value has increased significantly from time to time, as much as, say, 650 million within a quarter.

Right.

Okay, thank you.

Robert Lacoursiere with Banc of America Securities.

I just want to return to the option ARM for one brief moment.

Could you provide to us the level of deferred interest revenue, the accumulated, and then we could track it quarter-by-quarter?

Then the second question is if you could comment on -- you talked about your ability to retain to portfolio; you talked about various different governors, including equity and profitability of that.

Could you also comment on how you view your ability to gather the deposits to fund it in that context?

Do you want to start with deferred interest?

Are you asking what the lost income is because of the teaser rates?

No, I'm asking how much is the deferred interest income?

So what customers -- while you recorded it as interest income, they haven't actually paid it to you.

In terms of the Bank, where we hold option ARMs, we can look to expand disclosure to show what negative amortization that we are experiencing during the period, which I think is what you're referring to.

Yes, because that is what it would turn out to be and we've accumulated balance from period to period.

With respect to servicing for others, I'm not certain what value that would really have to -- (multiple speakers) -- so we can work on expanding that disclosure.

We will make note of that.

Thank you.

In terms of the question about, I don't know if I fully understand your question about the liability aspect of it, but as we pointed out, you can see that the current 70 financial centers are very vigorous and they're obtaining deposits ,primarily money market and CD deposits.

Frankly, if we just keep on opening up centers, there's no problem in getting liabilities to offset the assets we are giving the bank.

That's -- (multiple speakers).

Perhaps if I could refine the question a little bit better, it was just in the context when you said you have a plan this year was net 40 billion increase in assets in the Bank, and you said one of the governors -- it's based on your capital.

I was wondering how -- if that 40 billion objective was also influencing and how much you think you could increase your deposit shares.

Well, keep in mind that deposits and FHLB advances are about equal at June 30.

We are about 30 billion, roughly speaking, in terms of deposits as well as FHLB advances, so there isn't exclusive 100% pressure on deposits to fund bank growth.

Charlotte Chamberlain, Jefferies & Company.

Gosh, I thought I was going to break my star-one keys on my phone here!

Getting back to the residuals in Sunfish, since residuals are not a particularly liquid market, how do you determine the prices that Sunfish -- I assume that they buy them outright from you.

How these prices are determined?

You know, basically we are auctioning from a Countrywide home loans perspective, where (indiscernible) set out an auction, and they are included in that auction.

They are expressing a price to us.

There is a market, albeit it thin, and if they have a winning bid, they get a residual; if they don't, they don't get it.

When you say it's a thin market, I mean, is it likely that there's going to be anybody else but you offering these for sale?

Yes, there's other buyers and -- (multiple speakers).

No, no, sellers.

I'm sorry, what?

Any other sellers?

Well, yes, there are other sellers of residuals; there's other NIMs transactions as well, but there is a market and we do participate in the auction and pricing of those residuals, the ones that we produce.

Okay.

The rest of Sunfish -- you owned 20% of it; somebody else owns the rest of it.

Is it all equity, or is it partially leveraged?

The activities -- there's another 20% holder, you know, equity investor, and the entity does have the ability to leverage, although there is no -- they are not as fully invested yet.

Well, let me state it another way.

If G-d forbid this thing went bust, could you be wiped out by any more than your 20% holdings?

No.

Okay, so everybody else is an equityholder and it can borrow money but it's on its own balance sheet?

Correct.

Okay.

Then just a couple of clarifications -- you were talking about 72% originations have prepaid; they were original 18%.

Excuse me, were you talking about the banks at 72% of what's on their balance sheet -- (multiple speakers)?

No, the pay option of our production today -- we are originating.

About 70% of the pay option ARMs have prepayment penalties.

I was just referring to the kind of trend that we've been through in terms of developing a prepayment product.

Most of the market has moved to prepayment from --.

Okay, so and the Bank -- the Treasury Bank does have some of this pay option ARMs, right?

Yes.

okay.

Now, within the Bank, they also own HELOCs.

How much of -- what's the match between pay option ARMs and HELOCs in the Bank?

In other words, of the pay option ARMs, do 20% of them also have HELOCs on them?

Do you know how many of these pay option ARMs also either you have the HELOC on them or somebody else does?

I don't know the answer, specifically, to your question but the crossover is limited.

Okay, at Countrywide or just overall?

Limited at Countrywide.

We have underwriting policies (inaudible) about the combined LTB of the mortgages, whether the HELOC or the first mortgage, and it's just a question that I don't know the real exact specific crossover, albeit that there is a tiny crossover where there are pay option ARMs that have HELOCs.

Thanks very much.

Greg Alexander representing Ruane Cunniff.

I just wanted to ask, the wholesale business hasn't been growing quite as fast as the others; you kind of touched on it before.

But what do you think that reflected?

What are you looking at to make that summation?

Because I think, instinctively, I don't have the numbers in front of me but I don't -- (multiple speakers).

Just the year-over-year increases the last few quarters, it's -- I mean retail?

Basically, retail has grown more, of course.

And then more recently Corospline (ph) has grown.

So do you feel it is just because Iatoa (ph) have grown, or is something a little bit happening on the wholesale (multiple speakers)?

I don't think anything is happening there.

You know, we have -- I am sorry, you want to say something?

Well, just to give some numbers to this, Greg. 20 % of our fundings in 2004 were from wholesale, and 17% of 2005 year-to-date.

So it's not a significant change.

So you feel that your service and everything is -- (multiple speakers)

We have a very, very good operation there.

And they are continuing to do what retailer is doing, building the shelves for us, and opening up offices in local communities.

You know, I wouldn't place -- there's no trend at all.

I'm very pleased with the structure of the organization, as well as -- primarily the leadership is extraordinary.

So I don't think you'll see that trend continue.

Bennet Lindenbaum representing Basswood Partners.

Actually it is Adam Winewicker (ph) at Basswood.

Two quick questions.

First, the home equity (indiscernible) sales seem to be unable to go down, and it has actually gone up despite obviously the margins going down every other line.

I was wondering if you could just comment on why that's still at 4%.

Not that I am complaining, I'm just curious why it's so high.

And then the second question is, what percent of the deposits are brokered CDs?

Brokered CDs, it's very insignificant.

It has gone up now recently?

Brokered CDs have gone up.

I think they are -- about half their growth is coming from brokerage CDs.

If you add the total amount of liabilities of CDs.

But it's a small --.

22% of our CDs are brokered as of June 30th.

It's about 6.7 billion.

What was the other question -- was the --?

Home equity (multiple speakers)

Well, we discussed the fact that on the subprime side there are particular issues.

There were huge margins there, A plethora of lenders were attracted.

There's monoline and subprime REITs out there.

You've got New Century and AmeriQuest in a class of their own.

They've experienced tremendous growth.

With all of liquidity that has come in, with all of the lenders that are in the arena, there's much more lender supply than consumer demand.

And the lenders need to be more competitive on price.

So you're seeing the margins constrict a little bit in subprime.

I would say in prime that you're seeing a normalization of margins.

We've experienced tremendously high margins for a long time.

If you go back to the pre-boom area and you asked what normal margins are, we would have said something in the order of 40 to 50 basis points, and we are retreating to that normalized level.

Home equity, there's not a very deep market there.

We are generally the largest seller of home equity securities in the market.

And we're very sporadic because of our high retention desires.

So there's not a very deep market.

There's more of a scarcity factor.

And APS investors are going to be more attracted to that product.

The credit quality of our home equities should be emphasized here as well.

We are 730 FICO on these home equities, and that's extraordinary throughout the industry.

Just to follow up on one comment you made about the old view of normalized margins, 40 to 50 basis points.

I guess something I'm confused on is with the market now you are raising your forecast for the total size of the market to over 3 trillion in one scenario, yet the implied mortgage banking margins overall in the second half are something below 40, and maybe even low 30s.

With so much volume to go around, why would margins be so low now if presumably the real competition hasn't hit us yet?

First of all, I think you have to have perspective on it.

The capacity for this industry was built in 2003 when you had a very substantial -- you had production much higher than it is today.

So, you're still fighting that capacity issue that was established back then.

Stan, do you want to (inaudible)?

Your points are well taken.

We originally started forecasting the year at 2.3 to 2.8 trillion.

We expected more of a 4.5 tenure; we got a 4.20 for the first half.

The actual market size was 1.5 trillion, so that's why we've calibrated our range to be 1.3 to 1.7 trillion for the second half.

We have brought our market share estimate down and we've been extremely conservative on our production margin.

I mentioned earlier and I will repeat now that are actual production margins for the first half were 64 basis points.

That implies with our guidance of 40 to 55 for the year a range for the second half of 16 to 46 basis points.

So, implicit in our guidance is a continuing decline in the margins.

What we're trying to do is be conservative and be cognizant of trends that we observed in the second quarter.

Kristina Clark, representing Wachovia Securities.

I had two questions.

Can you please repeat how much in subprime residuals he sold during the quarter, and then how much, if any, you sold subsequent to the end of the quarter?

Then if you could talk a little bit about the KB Home acquisition or combination there, what attracted you to the business and what do you hope to get out of it?

Let me tackle the KB.

We have been -- we have some 300 various joint ventures with various partners of all sizes -- builders, real estate agents primarily -- so this is not a new business for us.

However, the size and scope of KB Homes is certainly different from what we've had as partners over the last several years.

We are a big player in the new construction business, in terms of not construction loans but permanent loans on new homes, so what was attractive to us was this would substantially increase that volume through our retail channel.

For KB Homes, I mean, I'm sure that Bruce Karatz will be having his when he has his call and maybe had already had his call, will explain that from their perspective.

I believe that they want to focus their energies, intellectual and financial resources on home building.

It was very different when they were building 3 or 4000 homes a year, to have a little mortgage Company and to be able to manage that mortgage company.

When you're doing 40 to 50,000 homes a year and you are looking for maximum penetration, it becomes much more challenging in terms of having the intellectual assets to conduct that business and enjoy a high penetration rate of your borrowers.

This is an attempt on KB Homes to get not only better penetration but at the day much better economics of owning a half than owning 100%.

That's what drove it from our end.

We have to increase market share.

This is one of the vehicles we're going to use, and you'll see us doing more of these transactions.

In terms of your other question concerning residuals --.

Our residuals sales during the second quarter were 250 million, and there's no color to give on the third quarter yet.

Glickenhaus & Company, Seth Glickenhaus.

I was just curious to know whether there were other homebuilders like the DH Homes (ph) that you might be negotiating with.

(Laughter).

We are in continuous negotiations with homebuilders throughout the country.

I'm not saying that these transactions will reach fruition, but we believe there's a trend here; we believe we are the best partner to have for homebuilders, again, where we -- even though they would not own 100% but they own 50%, that they will make a hell of a lot more money, at least the Pro Formas indicate that, by having us as a partner than doing it themselves.

So, hopefully other builders will recognize the economic benefits of these transactions and we will be a big player with them.

That's what I would imagine; that's why I asked the question.

I thought this could very well be the beginning.

Thank you very much.

Keep doing good work!

Bob Napoli with Piper Jaffray.

Good afternoon.

It was good morning when we started, but a question on a couple of things that haven't been hit yet.

I just wanted to talk a little bit more about prepayments and where they are coming from today.

I mean rates have -- short-term rates obviously have gone up a lot; long-term rates haven't moved much but you'd think, at some point, the long-term rates have been around where they are at for quite a while -- that it would peter out on -- are people rebuying primarily from fixed-rate into these option ARMs, or where are you seeing the prepayments come from and what would be your outlook for prepayments, given that short-term rates are likely to move up a bit more over the next couple of quarters?

I would think -- this is again just intuitive; maybe we have some statistics to give you specifics but I think you have a different dynamic on your -- I believe relative to prepayments than we ever had in the history of the business.

That is that this business has been historically a 30-year fixed-rate business.

Now, over the last four or five years, you've had a big part of the business has been hybrids.

We've a three-year life, a five-year life.

That I think is going to accelerate prepayment speeds over time.

But I think there would be a few reasons why it would be fairly obvious why people are refinancing.

One is to consolidate debt; that's a big part of what people are doing today in order to get the tax deduction and in order to lower their payments from 18% down to some 6%.

As I said, and these things -- as these loans are resetting, there may be an economic opportunity for these people to refi (indiscernible).

I think you've hit the key points.

Hybrids will be the driver; subprime would be a big driver.

Keep in mind that 40% of our portfolio today is ARM product, which obviously prepays at a faster rate.

Is that what -- I mean, what is -- would you expect -- even with all that, you would think that prepayment speeds at least would be slowing, but they are still at very high levels.

Well, I mean, you've got to relate it to -- Bob, there's a direct relationship between fundings and prepayments.

You know, you've seen a substantial increase in volumes that's part of (indiscernible) so that I think you'll see, as rates rise and fundings decrease, within that funding group, there is always an intrinsic relationship between those fundings and, as I said, prepayments, so I would suspect --.

Yes, I understand that.

So I would suspect, Bob, that as you see long-term rates rise and therefore volumes would have an effect on volumes -- should have an effect on volumes -- you don't know, with all these products out there, whether it will or not, but it should -- you will see prepayments decrease.

You know, a couple of things just intuitively that you can see in the marketplace -- one is that, with fixed-rate mortgages staying low, they present an opportunity for refinancing out of ARM product, and at the same time, you have hybrid ARM product that is coming up to reset.

That's driving increased levels of refinancing, whether it's to an ARM or to a fixed-rate mortgage.

We enjoyed, again, considerable refinance activity in the second quarter.

As interest rates rise, obviously we expect prepayments to slow down, but there's these other kind of newer influences, one caused by the flatter yield curve, which has the potential to drive refinancing into fixed-rate product as well.

Bob, to put this in perspective, despite this growing preponderance of products that would increase speeds, we've seen a gradual decline.

Just to put it in perspective again, the realized CPR for 2003 was 37%, 24% in '04 and year-to-date is less than 22, again swimming against the tide of this growing cadre of products that would increase speeds.

So speeds are gradually slowing.

Do you expect that (indiscernible), again what you know now, to be like in the midteens in '06?

We haven't given any guidance on '06 yet, so I wouldn't speculate on that.

Two questions on the Bank and then I'm done, I guess.

Your long-term ROE target has been I think around 18% for the Bank.

Is there anything that you've seen that changes that target?

The second question on the Bank, and maybe this goes to the reserve levels -- you've had a policy of having mortgage insurance and/or wraps on loan-to-value above 80% I think on first liens and 90% on second liens.

Are you still using that same mortgage insurance credit protection strategy?

Is that why the provisions are -- one reason why provisions are as low as they are?

Well, we are continuing to use mortgage insurance where we have high LTVs.

I'm sure that that factor influences the reserves.

You know, the bank goes through the analysis as to what their exposure is.

I'm sure that has to be part of the equation.

The first question you asked was what --?

The long-term target ROE for the -- (multiple speakers).

That has not changed, has not changed.

Okay, thank you.

Bill Roy representing Jacobs Asset Management.

On the 1.4 billion of impairment, was there any write-down or write-up of the retained interest?

I calculated about 270 million.

No, you're talking about of residuals?

Right.

No, there was a net impairment on residuals.

They are going through the numbers now.

About $97 million of impairment on residuals.

97 million?

Yes, of impairment.

Okay.

On the $250 million sale of the resid, was there any gain or loss booked on that?

If there was, where would that have shown up?

There was a small gain, and it would've shown up in impairment of retained interest.

The gain was in the order of maybe 10 to $12 million.

$8 million.

Okay, so that did not flow through the gain on sale of subprime?

That was on the -- it's part of the 97 million?

Correct.

Okay.

Do you have your cost to originate in subprime business?

Yes, we have it.

What is that?

You know, Bill, we generally don't get into granular channel level disclosures of what costs are but obviously we track very closely the loans funded per production employee and what the costs are.

But for competitive reasons, we generally don't like to disclose what those costs are, just like we don't like to disclose what cross-channel pricing is.

Can you answer then, less granular (indiscernible) whether or not you are originating at a profit today, given that a lot of originators that we follow -- your competitors at least -- have costs -- all-in costs originates in the low 2% area -- (multiple speakers)?

We are originating loans at a profit.

There's no strategic change to maybe slow down on the accelerator and raise wax (ph) to originate more profitably or are you happy with the bottom-line return -- (multiple speakers)?

Aside from being happy or unhappy, it is what it is.

We have to play the hand we are dealt.

But I would say that it's still a very vibrant business and one that's very profitable to the Company.

So, we continue to expand our abilities to originate more of that product.

Bill, a couple of thoughts for you -- remember that subprime is 20% of the market and we do have our finger on the pulse of the issues that you are talking about.

We look at production profitability by channel, whether it's retail, broker or correspondence.

We also look at the returns on the residuals, so we are very, very focused on this but we realize that this is at or near the nader in the cycle for subprime.

On the other side of this, there will be some consolidation and profitability will improve again.

Okay, thank you.

I have one final question.

Were there any expenses deferred on the 9 billion of loans which were deferred that would have shown up in direct production costs -- that your costs, both on a dollar basis and on a basis point basis, looked very favorable, given the increase in production volumes?

Principle amount of loans retained.

We have the typical FAS 91 deferred costs.

There's nothing unusual in that or that relates differently to that 9 billion of loans.

We have -- you know, during the quarter, we do experience as a period cost those expenses which are not deferrable under FAS 91.

Those would have gone through P&L.

Okay, so there was some that was deferred but you don't know how much?

We don't know off the top of our head what the amount was that -- (multiple speakers).

It will be in the Q.

It will be in the 10-Q.

All right, thank you.

Neil Abromavage with Deutsche Bank.

That's okay;

I'm all set.

Thank you very much.

Ed Groshans with Fox-Pitt Kelton.

Thank you.

There was a couple of times earlier in the conversation you were talking about the hedging outperformance in the quarter relative to the second quarter.

I was wondering if you can give us some sense of what that outperformance was.

Then was it a better performance in the first quarter just because of the higher rate scenario or was there a change in the hedging strategy that resulted in less performance in the second quarter?

With regards to the pipeline and hedging activities, basically we have a short position on in the form of Put options that, when the market moved in the first quarter to higher levels, produced hedge gains that were -- and at that time, we mentioned very positive for the first quarter's activity.

We have also the same impact on some of the pipeline, particularly in the subprime arena, where we have short positions on and we have the pipeline of loans that we are hedging that aren't treated as derivatives -- in other words not marking that pipeline to market.

So it has -- you know, it spills between quarter-to-quarter, but so the first quarter was very positive from those two aspects on the pipeline.

Then just one more -- the article in the Wall Street Journal this morning talking about looser lending standards and named Countrywide as one company that had changed some of their standards to be in line with other products out there.

I was wondering if you could give us a sense of what's going on with Countrywide's underwriting?

What's that doing in the competitive field?

Then I know there's talk out there about the OCC looking into I/Os and hybrids and pay option ARMs also.

Well, I haven't read the article, so I don't know;

I can't speak to the credibility of the article.

I am not aware of any change of substance in underwriting policies.

If they are referring to the fact that we are participating in pay option and I/O product and they are defining that as a loosening of standards, if that is the definition, then that would be correct; we are a big player in the pay option and I/O product.

I'm not aware of any loosening of underwriting standards that creates a less of a quality of loan than we did in the past.

Stan?

I think it's also important to understand that we underwrite mortgages to the standards of the secondary market, or in the case of where we're holding loans and portfolio, to our own standards but have not loosened our standards relative to what the bank acquires to the extent that we have standards that reflect and pricing that reflects where we are able to deliver loans into the secondary market.

Since you read the article, any quote from a senior executive at Countrywide stating that we loosened our standards?

You know what?

I don't have the first name, but it's something along the lines of cutting FICO scores on some products by 20 points, just to -- it sounded like a balancing of what was acceptable in other products, not an actual -- it seemed like there was other products (sic) written to the same level.

We haven't read the article but I think I can only speak from the Company's perspective.

We don't view that we have taken any steps to reduce the quality of our underwriting regimen at all.

As Stan states, we are always making certain, to the best of our ability, that, at the end of the day, that mortgagor has the payment ability to make the payments and tailoring the loans accordingly.

Then I don't know, have you been working with the OCC?

I guess they're supposed to be coming out with some guidance on -- (multiple speakers).

You know, I think the -- (indiscernible) both the OCC and the and the fed.

They've expressed concerns, just general concerns over the products themselves, because they are untested products, the I/O and the pay option.

I can tell you, from my perspective, that I don't see anything wrong with the I/O product at all because of the way the loan is amortized and the duration of these loans.

There's very little impact on the amortization of the loan and I/O versus a standard amortization if you look at the four or five-year life of a loan today.

So you know, I think it's much ado about nothing, and I think that this will be proven out over time.

In terms of the pay option, that's a different kind of product.

It's very unique and it really depends upon how the mortgagor conducts themselves.

But again, there are limits into how deep they can go on a negative am and hopefully the limits have been set.

We will work for both the lender and the mortgagor.

But getting back to your original question, in discussions with the OCC both the fed, I think they are both on the same page.

They are concerned about it.

Safety and soundness issues are always primary with them; we understand that.

We're not privy to any specific guidelines they are going to be putting out relative to the number of these loans on the balance sheet, the percentage of your loans on the balance sheet, FICO scores or any of those things.

We have not seen any of it, except that they have -- they certainly have shot over the bow, starting with Greenspan and all the way down to the people we meet, that they are concerned.

What will emanate from that concern, I don't know.

Excellent.

Thank you very much.

Ken Posner with Morgan Stanley.

Just to follow on actually to the last question, one of the concerns I've heard from regulators is the inappropriate marketing of new products like option ARMs, for example, buyers that stress a 1% interest rate without letting the person know that really the real interest rate is higher than that.

So I guess the question that I have is what kinds of governance structure or controls do you have in place to make sure your people out in the field aren't inappropriately marketing the new products?

Well, first of all, there is a written disclosure that the borrower signs that hopefully -- we attempt to explain the elements of that product to them and they sign it that they understand how the product works.

There's also a disclosure which gives them the costs and the APRs and resets and which they are required to acknowledge.

You don't see that type of -- I'm kind of advertising you have (indiscernible) but you don't see any advertising Countrywide as that makes look like it's a product that comes straight from divinity.

We say no, we give them the facts.

So I guess, in addition to the signed form, I guess there's a concern and there's been survey data that has documented that, to some extent, less-educated folks, lower-income folks tend to be more trusting of ARM products without necessarily understanding how they actually work.

Are there other controls or structures in place to make sure that people aren't --?

I think that Stan pointed that out.

First of all, I can't speak for other lenders, and I won't speak for other lenders;

I can only speak for Countrywide.

That product has a FICO score exceeding 700.

You don't see the lower end of the economic spectrum with an unsophisticated people with that kind of FICO score.

So the people that Countrywide is accepting under this program, generally speaking, are of much higher quality and they are not of the ilk that you may be seeing someplace else in the country or for some other lender.

You know, one other point in addition to emphasizing the quality of these loans and their high FICOs is the fact that the loan is underwritten to the fully indexed rate.

So, you have to have the capability and willingness to repay the mortgage, along with the full disclosures that we are making.

So, you know, that tends to produce very high-quality mortgages.

Thank you very much.

Gadish Baku (ph) with RCG.

I just had a couple of follow-ups on questions that have already been asked.

First of all, Stan, did you say that all of the Treasury Bank production would come from wholesale channel or would it be to some proportion of it?

No, it's just a considerable portion of their production comes -- flows from wholesale and some comes from DMD (ph) and some comes from VLD (ph) as well.

It's just as we -- you know, with VLDs being the lowest margins activity, you know, to the extent that we are expanding the delivery of wholesale and retail production that flows into the Bank, it has an influence on the overall margins that we are showing in gain on sale.

That was my point, but not -- not -- they have loans that flow in from all of the channels.

You would say roughly what percentage would be from wholesale?

About 40% comes from wholesale.

Okay.

Then a relatively small percent from correspondent and the rest from consumer?

Of their total production, and I have to get some -- they have about -- about 18, 19% of their production comes from our retail operations and the rest is from CLD.

So 40% wholesale, 20% from retail, so that's 60, so another 40 from CLD?

Correct.

In terms of margins versus last quarter, the hedge outperformance, I heard two explanations.

One was the hedge outperformance too was the option ARM (inaudible) decline.

Can you apportion the two?

I guess it's really a first-quarter question.

You know, how much of the outperformance in the first quarter was option ARMs versus hedge performance?

You know, we've only talked about the hedge is being -- as outperforming in the first quarter for the reasons that I indicated, you know, just a significant short position that increased as Put options came in the money in the first quarter.

That was the real distinction between quarters, between the first and the second quarter.

Finally, if I take the servicing sector report and you report the impairment of retained interest, and I subtract from that -- you know, you don't have the Q yet for this quarter, but if I go back to past quarters and I subtract from that the MSR impairment or gain, I get steady losses basically going back four or five quarters in the other retained interest I assume.

Can you just talk to that?

I don't really know why that would be the case -- and whether those have been offset by hedge gains or --?

Do you know what he is talking about?

Is that retained interest other than MSR, it seems like they have pretty steady losses?

Yes, we do have, by the way, hedges that are put on and that are included in our overall hedge position that offset a part of that.

The issue with the impairment has been twofold.

You have had rates that were low that were driving higher prepayments.

You've also had the short squeeze on the subprime residuals.

You basically got a fixed-rate collateral for 80% of the asset side, and you've got a variable pay-through rate, so you're going to see some short squeeze as the short-term rates go up.

So that's created a little bit of noise and caused some underperformance that you observed in the subprime residuals lately.

Part of that would be hedged?

Yes, that's correct.

Thank you.

David Chamberlain with PIMCO.

My questions have been answered.

Thanks.

Andy Wagstaff (ph) with Touchstone Investments.

Thanks for taking my question.

You guys said that 20 to 21% of the production year-to-date was the pay option ARMs.

Can you tell me what it was, what the production was in the second quarter as a percentage of the 121 billion?

Was it meaningfully different or the same?

It was 21% in the second quarter; it was 18% in the first quarter.

Okay.

Then what percentage of the loans that you guys are retaining on the balance sheet are the pay option ARMs?

(indiscernible) the Bank.

That's correct.

The Bank has got about 15 billion of pay option ARMs.

15 billion.

How much did you retain in the current quarter of the pay option ARMs production?

They are looking it up.

Thank you very much Mr. Wagstaff.

Our final --.

Okay, that's fine.

We're running this to see if we can get the answer to that.

I apologize.

We had 9 billion of pay option ARMs in the Bank balance sheet versus 15 at June 30 -- 9 billion at March 31; 15 billion at June 30.

Thanks very much, guys.

Barry Cohen with Glenview Capital.

Thanks for taking the call.

A couple of quick questions, some of which will be repeating but I want to make sure I heard what I heard.

Did you suggest in the call that the gain on sale margins in the nonprime area appear to have stabilized?

That's my first question.

I made that comment that it appears, based upon what we're seeing now, it appears that it is stabilizing.

I mean, we can't -- we will know better by the end of the third quarter.

It appears now that we may have seen the worst of it I think were the exact words I used.

Thank you; that is my first question.

My second question is, do you believe that you are taking market share in the option ARM market?

I don't know.

Do we have any concept of that?

Well, there's not that many players out there that are offering that product, and I think that the consumers are showing an increased appetite for the product, so that market segment is growing substantially.

But that's a relatively new phenomenon.

I don't know whether or not we're taking market share.

I would say that, again, this is just instinctive and I think Stan made this point earlier -- is that, at the beginning, the inventor of this product I believe was World Savings and had a lot of success with it over many, many years.

Then they had that product pretty much to themselves then it became more of a mainstream product;

Countrywide made it more of a mainstream product.

Because we make it available on our correspondent channel, I think we have more competitors -- not think, I know we have more competitors than we had before.

So I guess that backdrop -- I don't think could say that we're taking market share.

If anything, I think that we may be -- the market is bigger, but I think our market share is probably either stable or declining in the current environment of that product.

What percentage -- when you look at the option ARM market, how much of that market is driven by refinancings do you feel versus purchase?

(inaudible) general, what's the percentage overall of refi versus purchase for the second quarter? 50-50, so probably if you look at the overall trend of 50-50, it's probably the same in that product.

My last question -- I appreciate it.

Do you have a -- can you give us a sense of the credit quality in the nonprime mortgage sector and if you have a view of whether the credit quality is stable or potentially -- not potentially -- or worsening?

I think it's stable.

Again, (indiscernible) going in and auditing individual loans and underwriting, but I do participate every day in originations myself, and it keeps me apprised of what's happening.

I think that that situation has stabilized.

I don't see any deterioration in the quality of those loans being originated.

Eric, do you have a (inaudible)?

I would echo those sentiments.

We are running over 80% premier in A-.

We operate at the very top end of the nonprime credit spectrum.

The FICO scores have remained very steady, just over 600.

I appreciate your help.

Have a good day.

With that, Mr. Mozilo and our host panel, I will turn the call back to you.

Okay, I want to thank everybody for participating and thank the crew here for hanging in there for two hours for this question period and we look forward to meeting again on the -- towards the end of the third quarter.

Thank you very much.

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