Countrywide Mortgage

October 16, 2005
The Mortgage Maker vs. the World
By JEFF BAILEY
SIMI VALLEY, Calif.
A touch of resentment - based on income, education, social class - motivates countless ambitious people, though few will admit to it once they become successful.
An exception is Angelo R. Mozilo, a founder and chief executive of the Countrywide Financial Corporation, a company that has soared from obscurity to become the nation's No. 1 mortgage lender - and, in the process, produced a personal fortune for Mr. Mozilo of about half a billion dollars. This year alone, his compensation is expected to reach $100 million.
Modest origins - a butcher's son from the Bronx who worked his way through Fordham University - drove Mr. Mozilo to push Countrywide past the mortgage businesses of far larger companies, including Citigroup, Wells Fargo and Washington Mutual. He readily admits to having a chip on his shoulder, a source of motivation that he has studied, channeled and sought in others, building a company that, too, is an overachiever.
The chip also contributes to Mr. Mozilo's feeling that he is entitled to his hefty pay package.
"Nobody called me when I was making nothing for years and years and said, 'Can I help?' " Mr. Mozilo said in an interview at a Countrywide loan processing campus that sprawls over a hillside in this Los Angeles exurb, across the road from a garbage dump. His pay, he added, "is based on my performance."
That performance has been impressive, particularly during the recent housing boom. Countrywide's loan volume quintupled over the last five years, and its profit grew even faster, to $2.2 billion last year. But the history of the mortgage industry is full of nasty surprises that sank or slowed once-strong companies - interest rate swings and frenetic refinancing make the business volatile and risky. That weighs on Countrywide's stock, which trades at a discount to other financial firms.
On the topic of being underappreciated, Mr. Mozilo doesn't require much encouragement. "I run into these guys on Wall Street all the time who think they're something special because they went to Ivy League schools," he said. For companies like his, "We're always underestimated. And we still are. I am. I must say, it bothered me when I was younger - their snobbery and their looking down on us."
A lithe, little guy with a jutting jaw, Mr. Mozilo looks like he has faced off against his share of bullies. Today, he dresses elaborately, as if to remind them of who came out on top. A perfectly folded hankie peeks out from the breast pocket of his blue suit; underneath is a crisp banker's shirt in blue with a white collar, and weighty cufflinks with the Countrywide logo. All is set off against a deep tan.
In an interview, he didn't wait for a question, sallying forth on his own. "Who I am: I was a messenger boy for a mortgage company in Manhattan," he began. "I was a 14-year-old boy. The people in this company know I did what they're doing. Getting kicked out of real estate offices - the 40th mortgage guy to walk through the door - that's the business. It has been a source of strength to me as a leader. Fifty-two years I've been doing this."
Mr. Mozilo is 66 and expects to retire at 68. He has recruited others with chips on their own shoulders to carry on at Countrywide after he leaves, and has set them loose on the staid banking industry with something to prove. His top two lieutenants graduated from California State University, Northridge, a decidedly un-Ivy League institution not far from here. Another comes from California State University, Long Beach. All told, the company now employs more than 50,000 people.
In truth, of course, graduates of less-than-elite colleges are well represented at many large financial institutions. At Wells Fargo, the big San Francisco-based bank, for instance, Richard M. Kovacevich, chief executive and a Stanford man, in August named as his No. 2 and apparent successor John G. Stumpf, who has an accounting degree from St. Cloud State University in Minnesota.
What sets Countrywide apart is the us-versus-them feeling that Mr. Mozilo draws from his life story and his ability to tap into the same feelings in others. Indeed, many of his employees are drawn to what he sells as a free-wheeling meritocracy, and they bring the chips on their shoulders with them.
"I did," said Brian Hale, who left Wells Fargo four years ago. A Countrywide managing director in charge of retail loan production, he is a graduate of the State University of New York at Plattsburgh. "In many organizations I compete with, that would disqualify me for the job I have at Countrywide," Mr. Hale said of his schooling. True or not, it motivates him.
"The key people I depend upon - that chip is so ingrained," Mr. Mozilo said. "They're sort of my apostles in that regard."
The success of Countrywide might cause most executives to let up a bit. The stock has been among the best performers over the last 20 years. Profits exceed $2 billion a year. And, pulling further away from competitors, Countrywide expects to originate between $390 billion and $480 billion in mortgages this year, 14 to 15 percent of the nation's total. Its costs are among the lowest in the industry.
Countrywide lends directly to consumers and also buys loans from other lenders and from loan brokers. It packages most of the loans up and resells them at a profit.
Because it is primarily a mortgage lender, however, Countrywide's profits and stock price are vulnerable to interest rate swings, and thus its shares trade for about nine times its per-share earnings, a relatively low multiple. Its nearest competitor in the mortgage business, Wells Fargo, is a diversified bank that is less vulnerable to shifting rates. Its stock trades at about 14 times its earnings.
Mr. Mozilo bought a bank in 1991 - its assets doubled over the last year, to $91 billion - and Countrywide is hanging onto more mortgages, producing a stream of income to smooth the ups and downs of the refinancing market "so we can get a better multiple for the shareholders," Mr. Mozilo said. "Will we? I don't know. To this day, we are perceived as a proxy on interest rates."
While he is sanguine about the stock price, Mr. Mozilo remains volatile about so much else. Particularly irksome are calls by Alan Greenspan, the Federal Reserve chairman, to shrink Fannie Mae and Freddie Mac, the quasi-government institutions that buy huge numbers of mortgages from financial institutions, notably from Countrywide.
"Fannie and Freddie are a threat to his banks," Mr. Mozilo said of Mr. Greenspan, whose agency regulates big bank holding companies. By buying his mortgages and thus freeing up his capital to solicit even more business, Fannie and Freddie are a big reason Mr. Mozilo has driven Countrywide past the Citigroups and the Wells Fargos to the top of the mortgage heap. "If it wasn't for them," he said of Fannie and Freddie, "Wells knows they'd have us."
He can also be irked by his employees. Walking through a hallway past a worker who is away from his desk and talking on a cellphone, Mr. Mozilo said, "I hate that." The hallways are remarkably empty; workers are in their cubicles, which all have low partitions, so employees can be easily seen. Mr. Mozilo pays less attention to the cubicles' square footage. "Whether it's smaller or larger, they adapt, like fish to a fish tank," Mr. Mozilo said.
As Anne McCallion, the director of finance, observed, "Countrywide is not a paternalistic organization." Indeed, the company agreed to pay $30 million to settle a lawsuit filed on behalf of employees who say they weren't compensated for overtime.
The suit and other labor issues are one reason the company now prefers to add workers in Texas and other states with labor laws that are friendlier to employers. Standing beside Mr. Mozilo, Steve Bailey, the chief of loan administration, noted that Countrywide has 17,000 workers in California. "We should be out of California," he said.
Mr. Mozilo and a partner founded Countrywide in 1969, intent on building the first national mortgage company. After a $3 million stock offering failed, they raised $450,000. By 1983, with more of a track record, they raised $11 million by selling stock, but the deal limited Mr. Mozilo to only small raises to his salary, which was $345,000. The butcher's son had grown accustomed to a good living. "I had five kids," he said. "It was really hard."
As the 1980's wore on, the savings and loan crisis cleared away many of Countrywide's bigger rivals. And the rise of Fannie Mae and Freddie Mac allowed Countrywide and others to grow rapidly by selling their loans at a profit and recycling the capital into making new loans. In the refinancing boom of 1993, "we really came into our own," Mr. Mozilo said.
When boom turned to bust, Countrywide and others laid off workers. And with the likes of Wells Fargo, Citigroup, General Motors Acceptance and other larger companies piling into the national mortgage market, Countrywide briefly considered a takeover offer from Lloyd's Bank about five years ago. But the buyer backed away, Mr. Mozilo said, punctuating the story with, "Thank God."
Around that time, Countrywide invited Eric G. Flamholtz, a consultant and a management professor at the University of California, Los Angeles, to address a strategic planning retreat. When we met, Mr. Flamholtz said, Mr. Mozilo "gave me a limp handshake." But "when he heard I was from Brooklyn, he perked up."
The professor had a wacky notion that the mortgage market, where no lender had more than a 5 percent share, would inevitably and rapidly consolidate, leaving as few as three big players, one of them clearly dominant. He also said pricing wouldn't dictate the winner. "You win with infrastructure," he said.
THE prospect of a chance to dominate competitors seemed to reinvigorate Mr. Mozilo. Countrywide invested heavily in technology to lower its costs and quicken its service, then went on to announce a goal to capture 30 percent of the mortgage market. It accelerated the building of a network of 795 local offices to cater to real estate agents and home builders, who refer home buyers to mortgage companies. That network distinguishes Countrywide from competitors that rely more on phone banks. Can Countrywide respond more quickly to homebuilders and homebuyers trying to seal deals? "Even if I can't," said Mr. Hale, who runs retail loan production, "the perception of the Realtor and builder is I can."
The timing was great. Low interest rates led to a huge refinancing boom, which peaked in 2003. Soaring home prices also led consumers to stray in huge numbers from 30-year fixed-rate mortgages to adjustable-rate loans, interest-only loans and, more recently, "pay-option" loans that allow payments for a period of time that don't even cover the owed interest, resulting in a rising loan balance, or negative amortization. These mortgages tend to be more profitable than old-style loans. Nonprime loans, those made to less-creditworthy borrowers, brought it nearly four times as big a gross profit - 3.64 percent of the loan amount compared with 0.93 percent for prime mortgages - last year.
But as profits climbed, so did the complexity, and potentially the risk, of Countrywide's operation. Adjustable-rate loans accounted for 51 percent of Countrywide's mortgages last year, up from 14 percent in 2002. In this year's second quarter, pay-option loans, the ones that allow negative amortization, were 21 percent of Countrywide's total, versus just 3 percent a year earlier.
That volume of such loans has never been tested in a sharply rising interest-rate environment, a situation feared by some though not yet on the horizon. While Countrywide sells most of its loans, passing the credit risk to others, it had $15 billion worth of pay-option adjustable rate mortgages on its own books at the end of June, and almost one in five of them had experienced negative amortization. If delinquencies on those loans or others rise, Countrywide's ability to sell loans in the future could be damaged. For this reason, Wells Fargo has so far shied away from pay-option mortgages.
Others aren't as reluctant as Wells Fargo, and fierce competition - industry overcapacity, really - has this year squeezed profit margins sharply. In the second quarter, Countrywide's gross profit on loans sold plunged to 1.02 percent of the loan amount from 1.64 percent in the first quarter. In a Securities and Exchange Commission filing for the quarter, the company said, "We believe that industry consolidation should lessen irrational pricing."
But is pricing irrational, or is it merely now the norm in a highly efficient industry, one that Countrywide helped develop and one that delivers an abundance of capital to consumers who shop ever more wisely for the best deal? Asked if the thinning of margins will stop, Mr. Mozilo said, "It's going to ease for the balance of the year." But over the long term, "I don't think so," he added.
Countrywide, like other big financial companies, is diversifying, selling insurance and home equity loans, all in an effort to keep growing and boost profits.
MR. MOZILO, after pocketing about $70 million last year from salary, bonus and gains on exercising stock options, will probably hit $100 million in pay for 2005. He has already exercised more than three million options, selling the shares, this year. His cash bonus, $17.3 million last year, was the biggest among chief executives of all companies in the Standard & Poor's 500-stock index, according to Paul Hodgson of the Corporate Library, a corporate governance organization.
With huge slugs of options in recent years, and Countrywide's surging stock price "over the last three years, he has had a $500 million jump in worth," said Brian Foley, an independent compensation consultant in White Plains. With shareholders benefiting so, "you've got to give him his due," Mr. Foley said, but added, "When is enough enough?"
Countrywide's lead director and chairman of the board's compensation committee, Michael E. Dougherty, chairman of Dougherty Financial Group, a Minneapolis investment company, said of Mr. Mozilo: "He deserves every penny. He has a passion that only a founder has. I get e-mails time-dated from him at 2 a.m."
That's high praise, but Mr. Mozilo is resigned to being underappreciated. When he meets a stranger on the golf course he no longer calls himself a mortgage guy. "Now I say I run a financial services business," he said. "I don't know why. It makes me feel better. I guess status."
Before, he added, when he said he was in the mortgage business, "because of the way I look they say, 'Second mortgages? Sub-prime?' "