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Kickin' Ass and Takin' Names
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ON its way to becoming the nation's largest mortgage lender, the
Countrywide Financial Corporation encouraged its sales force to court
customers over the telephone with a seductive pitch that seldom
varied. "I want to be sure you are getting the best loan possible,"
the sales representatives would say.
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A Countrywide branch in Los Angeles.
Lucas Jackson/Reuters
Angelo R. Mozilo, chief executive of the Countrywide Financial
Corporation, remains undaunted as the mortgage market has cooled.
But providing "the best loan possible" to customers wasn't always the
bank's main goal, say some former employees. Instead, potential
borrowers were often led to high-cost and sometimes unfavorable loans
that resulted in richer commissions for Countrywide's smooth-talking
sales force, outsize fees to company affiliates providing services on
the loans, and a roaring stock price that made Countrywide executives
among the highest paid in America.
Countrywide's entire operation, from its computer system to its
incentive pay structure and financing arrangements, is intended to
wring maximum profits out of the mortgage lending boom no matter what
it costs borrowers, according to interviews with former employees and
brokers who worked in different units of the company and internal
documents they provided. One document, for instance, shows that until
last September the computer system in the company's subprime unit
excluded borrowers' cash reserves, which had the effect of steering
them away from lower-cost loans to those that were more expensive to
homeowners and more profitable to Countrywide.
Now, with the entire mortgage business on tenterhooks and industry
practices under scrutiny by securities regulators and banking industry
overseers, Countrywide's money machine is sputtering. So far this
year, fearful investors have cut its stock in half. About two weeks
ago, the company was forced to draw down its entire $11.5 billion
credit line from a consortium of banks because it could no longer sell
or borrow against home loans it has made. And last week, Bank of
America invested $2 billion for a 16 percent stake in Countrywide, a
move that came amid speculation that Countrywide's survival was in
question and that it had become a takeover target - notions that
Countrywide publicly disputed.
Homeowners, meanwhile, drawn in by Countrywide sales scripts assuring
"the best loan possible," are behind on their mortgages in record
numbers. As of June 30, almost one in four subprime loans that
Countrywide services was delinquent, up from 15 percent in the same
period last year, according to company filings. Almost 10 percent were
delinquent by 90 days or more, compared with last year's rate of 5.35
percent.
Many of these loans had interest rates that recently reset from low
teaser levels to double digits; others carry prohibitive prepayment
penalties that have made refinancing impossibly expensive, even before
this month's upheaval in the mortgage markets.
To be sure, Countrywide was not the only lender that sold questionable
loans with enormous fees during the housing bubble. And as real estate
prices soared, borrowers themselves proved all too eager to
participate, even if it meant paying high costs or signing up for a
loan with an interest rate that would jump in coming years.
But few companies benefited more from the mortgage mania than
Countrywide, among the most aggressive home lenders in the nation. As
such, the company is Exhibit A for the lax and, until recently, highly
lucrative lending that has turned a once-hot business ice cold and has
touched off a housing crisis of historic proportions.
"In terms of being unresponsive to what was happening, to sticking it
out the longest, and continuing to justify the garbage they were
selling, Countrywide was the worst lender," said Ira Rheingold,
executive director of the National Association of Consumer Advocates.
"And anytime states tried to pass responsible lending laws,
Countrywide was fighting it tooth and nail."
Started as Countrywide Credit Industries in New York 38 years ago by
Angelo R. Mozilo, a butcher's son from the Bronx, and David Loeb, a
founder of a mortgage banking firm in New York, who died in 2003, the
company has become a $500 billion home loan machine with 62,000
employees, 900 offices and assets of $200 billion. Countrywide's stock
price was up 561 percent over the 10 years ended last December.
Mr. Mozilo has ridden this remarkable wave to immense riches, thanks
to generous annual stock option grants. Rarely a buyer of Countrywide
shares - he has not bought a share since 1987, according to Securities
and Exchange Commission filings - he has been a huge seller in recent
years. Since the company listed its shares on the New York Stock
Exchange in 1984, he has reaped $406 million selling Countrywide
stock.
As the subprime mortgage debacle began to unfold this year, Mr.
Mozilo's selling accelerated. Filings show that he made $129 million
from stock sales during the last 12 months, or almost one-third of the
entire amount he has reaped over the last 23 years. He still holds 1.4
million shares in Countrywide, a 0.24 percent stake that is worth
$29.4 million.
"Mr. Mozilo has stated publicly that his current plan recognizes his
personal need to diversify some of his assets as he approaches
retirement," said Rick Simon, a Countrywide spokesman. "His personal
wealth remains heavily weighted in Countrywide shares, and he is, by
far, the leading individual shareholder in the company."
Mr. Simon said that Mr. Mozilo and other top Countrywide executives
were not available for interviews. The spokesman declined to answer a
list of questions, saying that he and his staff were too busy.
A former sales representative and several brokers interviewed for this
article were granted anonymity because they feared retribution from
Countrywide.
AMONG Countrywide's operations are a bank, overseen by the Office of
Thrift Supervision; a broker-dealer that trades United States
government securities and sells mortgage-backed securities; a mortgage
servicing arm; a real estate closing services company; an insurance
company; and three special-purpose vehicles that issue short-term
commercial paper backed by Countrywide mortgages.
Last year, Countrywide had revenue of $11.4 billion and pretax income
of $4.3 billion. Mortgage banking contributed mightily in 2006,
generating $2.06 billion before taxes. In the last 12 months,
Countrywide financed almost $500 billion in loans, or around $41
billion a month. It financed 177,000 to 240,000 loans a month during
the last 12 months.
Countrywide lends to both prime borrowers - those with sterling credit
- and so-called subprime, or riskier, borrowers. Among the $470
billion in loans that Countrywide made last year, 45 percent were
conventional nonconforming loans, those that are too big to be sold to
government-sponsored enterprises like Fannie Mae or Freddie Mac. Home
equity lines of credit given to prime borrowers accounted for 10.2
percent of the total, while subprime loans were 8.7 percent.
Regulatory filings show that, as of last year, 45 percent of
Countrywide's loans carried adjustable rates - the kind of loans that
are set to reprice this fall and later, and which are causing so much
anxiety among borrowers and investors alike. Countrywide has a huge
presence in California: 46 percent of the loans it holds on its books
were made there, and 28 percent of the loans it services are there.
Countrywide packages most of its loans into securities pools that it
sells to investors.
Another big business for Countrywide is loan servicing, the collection
of monthly principal and interest payments from borrowers and the
disbursement of them to investors. Countrywide serviced 8.2 million
loans as of the end of the year; in June the portfolio totaled $1.4
trillion. In addition to the enormous profits this business generates
- $660 million in 2006, or 25 percent of its overall earnings -
customers of the Countrywide servicing unit are a huge source of leads
for its mortgage sales staff, say former employees.
In a mid-March interview on CNBC, Mr. Mozilo said Countrywide was
poised to benefit from the spreading crisis in the mortgage lending
industry. "This will be great for Countrywide," he said, "because at
the end of the day, all of the irrational competitors will be gone."
But Countrywide documents show that it, too, was a lax lender. For
example, it wasn't until March 16 that Countrywide eliminated so-
called piggyback loans from its product list, loans that permitted
borrowers to buy a house without putting down any of their own money.
And Countrywide waited until Feb. 23 to stop peddling another risky
product, loans that were worth more than 95 percent of a home's
appraised value and required no documentation of a borrower's income.
As recently as July 27, Countrywide's product list showed that it
would lend $500,000 to a borrower rated C-minus, the second-riskiest
grade. As long as the loan represented no more than 70 percent of the
underlying property's value, Countrywide would lend to a borrower even
if the person had a credit score as low as 500. (The top score is
850.)
The company would lend even if the borrower had been 90 days late on a
current mortgage payment twice in the last 12 months, if the borrower
had filed for personal bankruptcy protection, or if the borrower had
faced foreclosure or default notices on his or her property.
Such loans were made, former employees say, because they were so
lucrative - to Countrywide. The company harvested a steady stream of
fees or payments on such loans and busily repackaged them as
securities to sell to investors. As long as housing prices kept
rising, everyone - borrowers, lenders and investors - appeared to be
winners.
One former employee provided documents indicating Countrywide's
minimum profit margins on subprime loans of different sizes. These
ranged from 5 percent on small loans of $100,000 to $200,000 to 3
percent on loans of $350,000 to $500,000. But on subprime loans that
imposed heavy burdens on borrowers, like high prepayment penalties
that persisted for three years, Countrywide's margins could reach 15
percent of the loan, the former employee said.
Regulatory filings show how much more profitable subprime loans are
for Countrywide than higher-quality prime loans. Last year, for
example, the profit margins Countrywide generated on subprime loans
that it sold to investors were 1.84 percent, versus 1.07 percent on
prime loans. A year earlier, when the subprime machine was really
cranking, sales of these mortgages produced profits of 2 percent,
versus 0.82 percent from prime mortgages. And in 2004, subprime loans
produced gains of 3.64 percent, versus 0.93 percent for prime loans.
One reason these loans were so lucrative for Countrywide is that
investors who bought securities backed by the mortgages were willing
to pay more for loans with prepayment penalties and those whose
interest rates were going to reset at higher levels. Investors ponied
up because pools of subprime loans were likely to generate a larger
cash flow than prime loans that carried lower fixed rates.
As a result, former employees said, the company's commission structure
rewarded sales representatives for making risky, high-cost loans. For
example, according to another mortgage sales representative affiliated
with Countrywide, adding a three-year prepayment penalty to a loan
would generate an extra 1 percent of the loan's value in a commission.
While mortgage brokers' commissions would vary on loans that reset
after a short period with a low teaser rate, the higher the rate at
reset, the greater the commission earned, these people said.
Persuading someone to add a home equity line of credit to a loan
carried extra commissions of 0.25 percent, according to a former sales
representative.
"The whole commission structure in both prime and subprime was
designed to reward salespeople for pushing whatever programs
Countrywide made the most money on in the secondary market," the
former sales representative said.
CONSIDER an example provided by a former mortgage broker. Say that a
borrower was persuaded to take on a $1 million adjustable-rate loan
that required the person to pay only a tiny fraction of the real
interest rate and no principal during the first year - a loan known in
the trade as a pay option adjustable-rate mortgage. If the loan
carried a three-year prepayment penalty requiring the borrower to pay
six months' worth of interest at the much higher reset rate of 3
percentage points over the prevailing market rate, Countrywide would
pay the broker a $30,000 commission.
When borrowers tried to reduce their mortgage debt, Countrywide cashed
in: prepayment penalties generated significant revenue for the company
- $268 million last year, up from $212 million in 2005. When borrowers
had difficulty making payments, Countrywide cashed in again: late
charges produced even more in 2006 - some $285 million.
The company's incentive system also encouraged brokers and sales
representatives to move borrowers into the subprime category, even if
their financial position meant that they belonged higher up the loan
spectrum. Brokers who peddled subprime loans received commissions of
0.50 percent of the loan's value, versus 0.20 percent on loans one
step up the quality ladder, known as Alternate-A, former brokers said.
For years, a software system in Countrywide's subprime unit that sales
representatives used to calculate the loan type that a borrower
qualified for did not allow the input of a borrower's cash reserves, a
former employee said.
A borrower who has more assets poses less risk to a lender, and will
typically get a better rate on a loan as a result. But, this sales
representative said, Countrywide's software prevented the input of
cash reserves so borrowers would have to be pitched on pricier loans.
It was not until last September that the company changed this
practice, as part of what was called in an internal memo the "Do the
Right Thing" campaign.
According to the former sales representative, Countrywide's big
subprime unit also avoided offering borrowers Federal Housing
Administration loans, which are backed by the United States government
and are less risky. But these loans, well suited to low-income or
first-time home buyers, do not generate the high fees that Countrywide
encouraged its sales force to pursue.
A few weeks ago, the former sales representative priced a $275,000
loan with a 30-year term and a fixed rate for a borrower putting down
10 percent, with fully documented income, and a credit score of 620.
While a F.H.A. loan on the same terms would have carried a 7 percent
rate and 0.125 percentage points, Countrywide's subprime loan for the
same borrower carried a rate of 9.875 percent and three additional
percentage points.
The monthly payment on the F.H.A. loan would have been $1,829, while
Countrywide's subprime loan generated a $2,387 monthly payment. That
amounts to a difference of $558 a month, or $6,696 a year - no small
sum for a low-income homeowner.
"F.H.A. loans are the best source of financing for low-income
borrowers," the former sales representative said. So Countrywide's
subprime lending program "is not living up to the promise of providing
the best loan programs to its clients," he said.
Mr. Simon of Countrywide said that Federal Housing Administration
loans were becoming a bigger part of the company's business.
"While they are very useful to some borrowers, F.H.A./V.A. mortgages
are extremely difficult to originate in markets with above-average
home prices, because the maximum loan amount is so low," he said.
"Countrywide believes F.H.A./V.A. loans are an increasingly important
part of its product menu, particularly for the homeownership hopes of
low- to moderate-income and minority borrowers we have concentrated on
reaching and serving."
WORKDAYS at Countrywide's mortgage lending units centered on an
intense telemarketing effort, former employees said. It involved
chasing down sales leads and hewing to carefully prepared scripts
during telephone calls with prospects.
One marketing manual used in Countrywide's subprime unit during 2005,
for example, walks sales representatives through the steps of a
successful call. "Step 3, Borrower Information, is where the Account
Executive gets on the Oasis of Rapport," the manual states. "The Oasis
of Rapport is the time spent with the client building rapport and
gathering information. At this point in the sales cycle, rates,
points, and fees are not discussed. The immediate objective is for the
Account Executive to get to know the client and look for points of
common interest. Use first names with clients as it facilitates a
friendly, helpful tone."
If clients proved to be uninterested, the script provided ways for
sales representatives to be more persuasive. Account executives
encountering prospective customers who said their mortgage had been
paid off, for instance, were advised to ask about a home equity loan.
"Don't you want the equity in your home to work for you?" the script
said. "You can use your equity for your advantage and pay bills or get
cash out. How does that sound?"
Other documents from the subprime unit also show that Countrywide was
willing to underwrite loans that left little disposable income for
borrowers' food, clothing and other living expenses. A different
manual states that loans could be written for borrowers even if, in a
family of four, they had just $1,000 in disposable income after paying
their mortgage bill. A loan to a single borrower could be made even if
the person had just $550 left each month to live on, the manual said.
Independent brokers who have worked with Countrywide also say the
company does not provide records of their compensation to the Internal
Revenue Service on a Form 1099, as the law requires. These brokers say
that all other home lenders they have worked with submitted 1099s
disclosing income earned from their associations.
One broker who worked with Countrywide for seven years said she never
got a 1099.
"When I got ready to do my first year's taxes I had received 1099s
from everybody but Countrywide," she said. "I called my rep and he
said, 'We're too big. There's too many. We don't do it.' "
A different broker supplied an e-mail message from a Countrywide
official stating that it was not company practice to submit 1099s. It
is unclear why Countrywide apparently chooses not to provide the
documents. Countrywide boasts that it is the No. 1 lender to
minorities, providing those borrowers with their piece of the American
homeownership dream. But it has run into problems with state
regulators in New York, who contended that the company overcharged
such borrowers for loans. Last December, Countrywide struck an
agreement with Eliot Spitzer, then the state attorney general, to
compensate black and Latino borrowers to whom it had improperly given
high-cost loans in 2004. Under the agreement, Countrywide, which
cooperated with the attorney general, agreed to improve its fair-
lending monitoring activities and set up a $3 million consumer
education program.
But few borrowers of any sort, even the most creditworthy, appear to
escape Countrywide's fee machine. When borrowers close on their loans,
they pay fees for flood and tax certifications, appraisals, document
preparation, even charges associated with e-mailing documents or using
FedEx to send or receive paperwork, according to Countrywide
documents. It's a big business: During the last 12 months, Countrywide
did 3.5 million flood certifications, conducted 10.8 million credit
checks and 1.3 million appraisals, its filings show. Many of the fees
go to its loan closing services subsidiary, LandSafe Inc.
According to dozens of loan documents, LandSafe routinely charges tax
service fees of $60, far above what other lenders charge, for
information about any outstanding tax obligations of the borrowers.
Credit checks can cost $36 at LandSafe, double what others levy. Some
Countrywide loans even included fees of $100 to e-mail documents or
$45 to ship them overnight. LandSafe also charges borrowers $26 for
flood certifications, for which other companies typically charge $12
to $14, according to sales representatives and brokers familiar with
the fees.
LAST April, Countrywide customers in Los Angeles filed suit against
the company in California state court, contending that it overcharged
borrowers by collecting unearned fees in relation to tax service fees
and flood certification charges. These markups were not disclosed to
borrowers, the lawsuit said.
Appraisals are another profit center for Countrywide, brokers said,
because it often requires more than one appraisal on properties,
especially if borrowers initially choose not to use the company's own
internal firm. Appraisal fees at Countrywide totaled $137 million in
2006, up from $110 million in the previous year. Credit report fees
were $74 million last year, down slightly from 2005.
All of those fees may soon be part of what Countrywide comes to
consider the good old days. The mortgage market has cooled, and so
have the company's fortunes. Mr. Mozilo remains undaunted, however.
In an interview with CNBC on Thursday, he conceded that Countrywide's
balance sheet had to be strengthened. "But at the end of the day we
could be doing very substantial volumes for high-quality loans," he
said, "because there is nobody else in town."
Countrywide Financial Corporation encouraged its sales force to court
customers over the telephone with a seductive pitch that seldom
varied. "I want to be sure you are getting the best loan possible,"
the sales representatives would say.
Skip to next paragraph
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Graphic
A Loan Giant Hits a Wall
Podcast
Weekend Business
This week: The subprime crisis goes global, Robert Shiller on
irrational exuberance, the plight of American industrial workers, and
hedge fund contagion.
How to Subscribe
This Week's Podcast (mp3)
Kevork Djansezian/Associated Press
A Countrywide branch in Los Angeles.
Lucas Jackson/Reuters
Angelo R. Mozilo, chief executive of the Countrywide Financial
Corporation, remains undaunted as the mortgage market has cooled.
But providing "the best loan possible" to customers wasn't always the
bank's main goal, say some former employees. Instead, potential
borrowers were often led to high-cost and sometimes unfavorable loans
that resulted in richer commissions for Countrywide's smooth-talking
sales force, outsize fees to company affiliates providing services on
the loans, and a roaring stock price that made Countrywide executives
among the highest paid in America.
Countrywide's entire operation, from its computer system to its
incentive pay structure and financing arrangements, is intended to
wring maximum profits out of the mortgage lending boom no matter what
it costs borrowers, according to interviews with former employees and
brokers who worked in different units of the company and internal
documents they provided. One document, for instance, shows that until
last September the computer system in the company's subprime unit
excluded borrowers' cash reserves, which had the effect of steering
them away from lower-cost loans to those that were more expensive to
homeowners and more profitable to Countrywide.
Now, with the entire mortgage business on tenterhooks and industry
practices under scrutiny by securities regulators and banking industry
overseers, Countrywide's money machine is sputtering. So far this
year, fearful investors have cut its stock in half. About two weeks
ago, the company was forced to draw down its entire $11.5 billion
credit line from a consortium of banks because it could no longer sell
or borrow against home loans it has made. And last week, Bank of
America invested $2 billion for a 16 percent stake in Countrywide, a
move that came amid speculation that Countrywide's survival was in
question and that it had become a takeover target - notions that
Countrywide publicly disputed.
Homeowners, meanwhile, drawn in by Countrywide sales scripts assuring
"the best loan possible," are behind on their mortgages in record
numbers. As of June 30, almost one in four subprime loans that
Countrywide services was delinquent, up from 15 percent in the same
period last year, according to company filings. Almost 10 percent were
delinquent by 90 days or more, compared with last year's rate of 5.35
percent.
Many of these loans had interest rates that recently reset from low
teaser levels to double digits; others carry prohibitive prepayment
penalties that have made refinancing impossibly expensive, even before
this month's upheaval in the mortgage markets.
To be sure, Countrywide was not the only lender that sold questionable
loans with enormous fees during the housing bubble. And as real estate
prices soared, borrowers themselves proved all too eager to
participate, even if it meant paying high costs or signing up for a
loan with an interest rate that would jump in coming years.
But few companies benefited more from the mortgage mania than
Countrywide, among the most aggressive home lenders in the nation. As
such, the company is Exhibit A for the lax and, until recently, highly
lucrative lending that has turned a once-hot business ice cold and has
touched off a housing crisis of historic proportions.
"In terms of being unresponsive to what was happening, to sticking it
out the longest, and continuing to justify the garbage they were
selling, Countrywide was the worst lender," said Ira Rheingold,
executive director of the National Association of Consumer Advocates.
"And anytime states tried to pass responsible lending laws,
Countrywide was fighting it tooth and nail."
Started as Countrywide Credit Industries in New York 38 years ago by
Angelo R. Mozilo, a butcher's son from the Bronx, and David Loeb, a
founder of a mortgage banking firm in New York, who died in 2003, the
company has become a $500 billion home loan machine with 62,000
employees, 900 offices and assets of $200 billion. Countrywide's stock
price was up 561 percent over the 10 years ended last December.
Mr. Mozilo has ridden this remarkable wave to immense riches, thanks
to generous annual stock option grants. Rarely a buyer of Countrywide
shares - he has not bought a share since 1987, according to Securities
and Exchange Commission filings - he has been a huge seller in recent
years. Since the company listed its shares on the New York Stock
Exchange in 1984, he has reaped $406 million selling Countrywide
stock.
As the subprime mortgage debacle began to unfold this year, Mr.
Mozilo's selling accelerated. Filings show that he made $129 million
from stock sales during the last 12 months, or almost one-third of the
entire amount he has reaped over the last 23 years. He still holds 1.4
million shares in Countrywide, a 0.24 percent stake that is worth
$29.4 million.
"Mr. Mozilo has stated publicly that his current plan recognizes his
personal need to diversify some of his assets as he approaches
retirement," said Rick Simon, a Countrywide spokesman. "His personal
wealth remains heavily weighted in Countrywide shares, and he is, by
far, the leading individual shareholder in the company."
Mr. Simon said that Mr. Mozilo and other top Countrywide executives
were not available for interviews. The spokesman declined to answer a
list of questions, saying that he and his staff were too busy.
A former sales representative and several brokers interviewed for this
article were granted anonymity because they feared retribution from
Countrywide.
AMONG Countrywide's operations are a bank, overseen by the Office of
Thrift Supervision; a broker-dealer that trades United States
government securities and sells mortgage-backed securities; a mortgage
servicing arm; a real estate closing services company; an insurance
company; and three special-purpose vehicles that issue short-term
commercial paper backed by Countrywide mortgages.
Last year, Countrywide had revenue of $11.4 billion and pretax income
of $4.3 billion. Mortgage banking contributed mightily in 2006,
generating $2.06 billion before taxes. In the last 12 months,
Countrywide financed almost $500 billion in loans, or around $41
billion a month. It financed 177,000 to 240,000 loans a month during
the last 12 months.
Countrywide lends to both prime borrowers - those with sterling credit
- and so-called subprime, or riskier, borrowers. Among the $470
billion in loans that Countrywide made last year, 45 percent were
conventional nonconforming loans, those that are too big to be sold to
government-sponsored enterprises like Fannie Mae or Freddie Mac. Home
equity lines of credit given to prime borrowers accounted for 10.2
percent of the total, while subprime loans were 8.7 percent.
Regulatory filings show that, as of last year, 45 percent of
Countrywide's loans carried adjustable rates - the kind of loans that
are set to reprice this fall and later, and which are causing so much
anxiety among borrowers and investors alike. Countrywide has a huge
presence in California: 46 percent of the loans it holds on its books
were made there, and 28 percent of the loans it services are there.
Countrywide packages most of its loans into securities pools that it
sells to investors.
Another big business for Countrywide is loan servicing, the collection
of monthly principal and interest payments from borrowers and the
disbursement of them to investors. Countrywide serviced 8.2 million
loans as of the end of the year; in June the portfolio totaled $1.4
trillion. In addition to the enormous profits this business generates
- $660 million in 2006, or 25 percent of its overall earnings -
customers of the Countrywide servicing unit are a huge source of leads
for its mortgage sales staff, say former employees.
In a mid-March interview on CNBC, Mr. Mozilo said Countrywide was
poised to benefit from the spreading crisis in the mortgage lending
industry. "This will be great for Countrywide," he said, "because at
the end of the day, all of the irrational competitors will be gone."
But Countrywide documents show that it, too, was a lax lender. For
example, it wasn't until March 16 that Countrywide eliminated so-
called piggyback loans from its product list, loans that permitted
borrowers to buy a house without putting down any of their own money.
And Countrywide waited until Feb. 23 to stop peddling another risky
product, loans that were worth more than 95 percent of a home's
appraised value and required no documentation of a borrower's income.
As recently as July 27, Countrywide's product list showed that it
would lend $500,000 to a borrower rated C-minus, the second-riskiest
grade. As long as the loan represented no more than 70 percent of the
underlying property's value, Countrywide would lend to a borrower even
if the person had a credit score as low as 500. (The top score is
850.)
The company would lend even if the borrower had been 90 days late on a
current mortgage payment twice in the last 12 months, if the borrower
had filed for personal bankruptcy protection, or if the borrower had
faced foreclosure or default notices on his or her property.
Such loans were made, former employees say, because they were so
lucrative - to Countrywide. The company harvested a steady stream of
fees or payments on such loans and busily repackaged them as
securities to sell to investors. As long as housing prices kept
rising, everyone - borrowers, lenders and investors - appeared to be
winners.
One former employee provided documents indicating Countrywide's
minimum profit margins on subprime loans of different sizes. These
ranged from 5 percent on small loans of $100,000 to $200,000 to 3
percent on loans of $350,000 to $500,000. But on subprime loans that
imposed heavy burdens on borrowers, like high prepayment penalties
that persisted for three years, Countrywide's margins could reach 15
percent of the loan, the former employee said.
Regulatory filings show how much more profitable subprime loans are
for Countrywide than higher-quality prime loans. Last year, for
example, the profit margins Countrywide generated on subprime loans
that it sold to investors were 1.84 percent, versus 1.07 percent on
prime loans. A year earlier, when the subprime machine was really
cranking, sales of these mortgages produced profits of 2 percent,
versus 0.82 percent from prime mortgages. And in 2004, subprime loans
produced gains of 3.64 percent, versus 0.93 percent for prime loans.
One reason these loans were so lucrative for Countrywide is that
investors who bought securities backed by the mortgages were willing
to pay more for loans with prepayment penalties and those whose
interest rates were going to reset at higher levels. Investors ponied
up because pools of subprime loans were likely to generate a larger
cash flow than prime loans that carried lower fixed rates.
As a result, former employees said, the company's commission structure
rewarded sales representatives for making risky, high-cost loans. For
example, according to another mortgage sales representative affiliated
with Countrywide, adding a three-year prepayment penalty to a loan
would generate an extra 1 percent of the loan's value in a commission.
While mortgage brokers' commissions would vary on loans that reset
after a short period with a low teaser rate, the higher the rate at
reset, the greater the commission earned, these people said.
Persuading someone to add a home equity line of credit to a loan
carried extra commissions of 0.25 percent, according to a former sales
representative.
"The whole commission structure in both prime and subprime was
designed to reward salespeople for pushing whatever programs
Countrywide made the most money on in the secondary market," the
former sales representative said.
CONSIDER an example provided by a former mortgage broker. Say that a
borrower was persuaded to take on a $1 million adjustable-rate loan
that required the person to pay only a tiny fraction of the real
interest rate and no principal during the first year - a loan known in
the trade as a pay option adjustable-rate mortgage. If the loan
carried a three-year prepayment penalty requiring the borrower to pay
six months' worth of interest at the much higher reset rate of 3
percentage points over the prevailing market rate, Countrywide would
pay the broker a $30,000 commission.
When borrowers tried to reduce their mortgage debt, Countrywide cashed
in: prepayment penalties generated significant revenue for the company
- $268 million last year, up from $212 million in 2005. When borrowers
had difficulty making payments, Countrywide cashed in again: late
charges produced even more in 2006 - some $285 million.
The company's incentive system also encouraged brokers and sales
representatives to move borrowers into the subprime category, even if
their financial position meant that they belonged higher up the loan
spectrum. Brokers who peddled subprime loans received commissions of
0.50 percent of the loan's value, versus 0.20 percent on loans one
step up the quality ladder, known as Alternate-A, former brokers said.
For years, a software system in Countrywide's subprime unit that sales
representatives used to calculate the loan type that a borrower
qualified for did not allow the input of a borrower's cash reserves, a
former employee said.
A borrower who has more assets poses less risk to a lender, and will
typically get a better rate on a loan as a result. But, this sales
representative said, Countrywide's software prevented the input of
cash reserves so borrowers would have to be pitched on pricier loans.
It was not until last September that the company changed this
practice, as part of what was called in an internal memo the "Do the
Right Thing" campaign.
According to the former sales representative, Countrywide's big
subprime unit also avoided offering borrowers Federal Housing
Administration loans, which are backed by the United States government
and are less risky. But these loans, well suited to low-income or
first-time home buyers, do not generate the high fees that Countrywide
encouraged its sales force to pursue.
A few weeks ago, the former sales representative priced a $275,000
loan with a 30-year term and a fixed rate for a borrower putting down
10 percent, with fully documented income, and a credit score of 620.
While a F.H.A. loan on the same terms would have carried a 7 percent
rate and 0.125 percentage points, Countrywide's subprime loan for the
same borrower carried a rate of 9.875 percent and three additional
percentage points.
The monthly payment on the F.H.A. loan would have been $1,829, while
Countrywide's subprime loan generated a $2,387 monthly payment. That
amounts to a difference of $558 a month, or $6,696 a year - no small
sum for a low-income homeowner.
"F.H.A. loans are the best source of financing for low-income
borrowers," the former sales representative said. So Countrywide's
subprime lending program "is not living up to the promise of providing
the best loan programs to its clients," he said.
Mr. Simon of Countrywide said that Federal Housing Administration
loans were becoming a bigger part of the company's business.
"While they are very useful to some borrowers, F.H.A./V.A. mortgages
are extremely difficult to originate in markets with above-average
home prices, because the maximum loan amount is so low," he said.
"Countrywide believes F.H.A./V.A. loans are an increasingly important
part of its product menu, particularly for the homeownership hopes of
low- to moderate-income and minority borrowers we have concentrated on
reaching and serving."
WORKDAYS at Countrywide's mortgage lending units centered on an
intense telemarketing effort, former employees said. It involved
chasing down sales leads and hewing to carefully prepared scripts
during telephone calls with prospects.
One marketing manual used in Countrywide's subprime unit during 2005,
for example, walks sales representatives through the steps of a
successful call. "Step 3, Borrower Information, is where the Account
Executive gets on the Oasis of Rapport," the manual states. "The Oasis
of Rapport is the time spent with the client building rapport and
gathering information. At this point in the sales cycle, rates,
points, and fees are not discussed. The immediate objective is for the
Account Executive to get to know the client and look for points of
common interest. Use first names with clients as it facilitates a
friendly, helpful tone."
If clients proved to be uninterested, the script provided ways for
sales representatives to be more persuasive. Account executives
encountering prospective customers who said their mortgage had been
paid off, for instance, were advised to ask about a home equity loan.
"Don't you want the equity in your home to work for you?" the script
said. "You can use your equity for your advantage and pay bills or get
cash out. How does that sound?"
Other documents from the subprime unit also show that Countrywide was
willing to underwrite loans that left little disposable income for
borrowers' food, clothing and other living expenses. A different
manual states that loans could be written for borrowers even if, in a
family of four, they had just $1,000 in disposable income after paying
their mortgage bill. A loan to a single borrower could be made even if
the person had just $550 left each month to live on, the manual said.
Independent brokers who have worked with Countrywide also say the
company does not provide records of their compensation to the Internal
Revenue Service on a Form 1099, as the law requires. These brokers say
that all other home lenders they have worked with submitted 1099s
disclosing income earned from their associations.
One broker who worked with Countrywide for seven years said she never
got a 1099.
"When I got ready to do my first year's taxes I had received 1099s
from everybody but Countrywide," she said. "I called my rep and he
said, 'We're too big. There's too many. We don't do it.' "
A different broker supplied an e-mail message from a Countrywide
official stating that it was not company practice to submit 1099s. It
is unclear why Countrywide apparently chooses not to provide the
documents. Countrywide boasts that it is the No. 1 lender to
minorities, providing those borrowers with their piece of the American
homeownership dream. But it has run into problems with state
regulators in New York, who contended that the company overcharged
such borrowers for loans. Last December, Countrywide struck an
agreement with Eliot Spitzer, then the state attorney general, to
compensate black and Latino borrowers to whom it had improperly given
high-cost loans in 2004. Under the agreement, Countrywide, which
cooperated with the attorney general, agreed to improve its fair-
lending monitoring activities and set up a $3 million consumer
education program.
But few borrowers of any sort, even the most creditworthy, appear to
escape Countrywide's fee machine. When borrowers close on their loans,
they pay fees for flood and tax certifications, appraisals, document
preparation, even charges associated with e-mailing documents or using
FedEx to send or receive paperwork, according to Countrywide
documents. It's a big business: During the last 12 months, Countrywide
did 3.5 million flood certifications, conducted 10.8 million credit
checks and 1.3 million appraisals, its filings show. Many of the fees
go to its loan closing services subsidiary, LandSafe Inc.
According to dozens of loan documents, LandSafe routinely charges tax
service fees of $60, far above what other lenders charge, for
information about any outstanding tax obligations of the borrowers.
Credit checks can cost $36 at LandSafe, double what others levy. Some
Countrywide loans even included fees of $100 to e-mail documents or
$45 to ship them overnight. LandSafe also charges borrowers $26 for
flood certifications, for which other companies typically charge $12
to $14, according to sales representatives and brokers familiar with
the fees.
LAST April, Countrywide customers in Los Angeles filed suit against
the company in California state court, contending that it overcharged
borrowers by collecting unearned fees in relation to tax service fees
and flood certification charges. These markups were not disclosed to
borrowers, the lawsuit said.
Appraisals are another profit center for Countrywide, brokers said,
because it often requires more than one appraisal on properties,
especially if borrowers initially choose not to use the company's own
internal firm. Appraisal fees at Countrywide totaled $137 million in
2006, up from $110 million in the previous year. Credit report fees
were $74 million last year, down slightly from 2005.
All of those fees may soon be part of what Countrywide comes to
consider the good old days. The mortgage market has cooled, and so
have the company's fortunes. Mr. Mozilo remains undaunted, however.
In an interview with CNBC on Thursday, he conceded that Countrywide's
balance sheet had to be strengthened. "But at the end of the day we
could be doing very substantial volumes for high-quality loans," he
said, "because there is nobody else in town."
