Countrywide Layoffs Indicative of More Mortgage Market Pain

Implications: Countrywide projects a 25% decline in mortgage origination volume as the reason behind this dramatic employee layoff. Is Countrywide's new origination forecast in the ballpark? How far will the mortgage market fall? Will other institutions be affected too?

Analysis: Countrywide announced it will layoff 12,000 employees, or 20% of its work force, in the next three months to rebalance its origination capacity in a rapidly shrinking market. This announcement includes two recent layoff announcements of 500 and 900 employees respectively.

What does this significant layoff by the largest mortgage originator mean for the rest of the market? Will total mortgage originations fall more than 25%? Who will be the winners and losers in this shakeout?

1. The significance of the size of this layoff at Countrywide coupled with layoffs at other firms (e.g., Lehman Bros., National City, IndyMac) suggests that the mortgage origination market is still searching for a bottom.

2. Previous origination volume corrections involved an economic recession coupled with much higher interest rates than the current level.

  * However, the recent peak origination volumes were fueled in part by historically low mortgage rates, very aggressive loan underwriting (e.g., 100% LTV,  no doc and stated income from the borrowers), and unseasoned teaser loan products (e.g., pay option ARM, 2/28 and 3/27 ARMs).

  * These three factors contributed significantly to the big bump in mortgage volumes since 2002 as speculative investors, subprime borrowers, flippers, and chronic refinancers added to the conventional home purchase financing.

3. Through 2008, origination volume will consist primarily of new home and purchase financing and a much smaller diet of refinancing. If the  2006 volume of $2.5 trillion is reduced by 25% to $1.87 trillion as Countrywide's announcement suggested, then more industry layoffs are coming. The annualized market origination bottom is probably around $1.5 trillion as both new home sales and purchases volumes and unit prices are still declining.

4. The winners are likely to be the portfolio lenders that rely primarily on conventional fixed rate and ARM products. Also, the mortgage banking affiliates of large bank holding companies (e.g., Wells Fargo, JP Morgan Chase, Citigroup, Bank of America) with strong direct loan origination platforms will gain market share.

5. Obviously, some of the losers have already gone out of business. Others are faced with negative outlooks for the next 12 to 24 months. Mortgage brokers, independent mortgage bankers, mortgage REITs, and a wide range of mortgage servicing providers (e.g., Accredited Home Lenders, Ocwen Financial) must quickly revise their business models and operating plans or else.

6. Other mortgage-related service providers such as title companies, outside appraisers, escrow companies, and credit bureaus will all face declining volume and revenue levels too.