Countrywide Profit Drops as It Retains More Loans

In today’s sizzling housing market, mortgage lenders like Countrywide Financial Corp. have made huge profits selling their loans to investors.

But a decision by the Calabasas-based company to sell fewer loans led it on Tuesday to report sharply lower earnings in the second quarter. Its results were also hurt by increased competition in mortgage lending as rival players battling for market share cut into Countrywide’s profit margins.

The nation’s largest mortgage lender said its profit for the April-to-June period fell 28% to $566.5 million, or 92 cents a share.

Although the company had warned this month that it would post a profit shortfall, the actual results still missed analysts’ already reduced estimates of 99 cents a share.

Countrywide’s report shows how lenders face growing challenges to maintain profit growth as the housing boom matures. Earlier in the cycle, Countrywide routinely met or beat analysts’ earnings estimates, leading to sharp rises in its stock in 2003 and 2004. But in 2005, its stock is down 2%.

Mortgage lenders typically earn profits not only from fees in making loans but also from payments received in selling the loans to companies such as Fannie Mae and Freddie Mac that package them into securities sold to investors.

But Countrywide said it decided to sell fewer loans, relinquishing immediate profit, in exchange for earning profit down the road from interest income on the mortgages.

That trade-off is “designed to provide a more stable earnings stream for shareholders,” Countrywide Chairman and Chief Executive Angelo Mozilo said in a statement.

The change is already producing results as interest income rose 7% to $533 million during the quarter, the company said.

Countrywide said it would have earned an additional 15 cents a share and would have reported higher loan-production profit margins if it hadn’t held on to about $9 billion of loans and had sold them into the secondary market.

Countrywide saw its loan volume increase in the quarter by 21% to $121 billion compared with the year-earlier period.

Unfortunately, the company didn’t expect how much continued low mortgage rates would stimulate heightened competition from rivals. As home prices have gone through the roof, lenders have scrambled to offer “interest-only” loans and other types of exotic mortgages that allow borrowers to afford more-expensive houses.

Another type of exotic loan is the increasingly popular “pay-option” adjustable-rate mortgage, which gives borrowers several choices of payments each month, including a minimum payment that actually boosts the size of the overall loan.

But heightened competition in pay-option loans cut into profit margins, Countrywide said.

“We’re not able to originate these loans at the pricing that we were able to do before,” Mozilo said during a conference call.

Mozilo said margins on prime mortgages made to the most creditworthy borrowers -- especially three-to-five-year hybrids that combine attributes of fixed- and adjustable-rate loans -- had been under pressure in the second quarter amid competition from such lenders as Wells Fargo & Co. and Bank of America Corp. But that pressure appeared to be easing in the current third quarter, he said.

There currently are more lenders than consumer demand warrants, Mozilo said. So “lenders need to be much more competitive on price,” particularly in sub-prime loans, which are made to less-creditworthy borrowers. He said competition from Ameriquest Mortgage Co. and New Century Financial Corp. squeezed sub-prime margins.

Countrywide earned $786.5 million, or $1.29, in the year-earlier quarter. Revenue in the latest period declined 7% to $2.31 billion, while expenses rose 15%.

Pretax profit at Countrywide’s core mortgage banking unit was halved during the quarter to $526 million from $1 billion.

Margins shrank to 0.4 percentage point from 0.93 point in the first quarter, a bigger decline than several analysts expected.

Still, the company’s overall results met at least some analysts’ targets.

“The quarter came in about as expected, and I was not disappointed in the quarterly performance,” said Michael McMahon of Sandler O’Neil Partners in San Francisco.

Countrywide shares fell 46 cents to $36.16.

The company also raised the low end of its 2005 earnings guidance. It now projects full-year profit of $3.85 to $4.60 a share, up from previous guidance of $3.60 to $4.60.