As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 3/01/06  Countrywide Financial Corp        10-K       12/31/05   12:9.0M                                   Merrill Corp-MD/FA

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Annual Report Pursuant to Section 13 and 15(D)      HTML   4.75M 
 2: EX-4.2      Instruments Defining the Rights of Security         HTML     76K 
                          Holders, Including Indentures                          
 3: EX-10.125   Material Contracts                                  HTML    204K 
 4: EX-10.126   Material Contracts                                  HTML    183K 
 5: EX-12.1     Statements Regarding Computation of Ratios          HTML     38K 
 6: EX-21       Subsidiaries of the Registrant                      HTML    102K 
 7: EX-23       Consents of Experts and Counsel                     HTML     12K 
 8: EX-23.1     Consents of Experts and Counsel                     HTML     16K 
 9: EX-31.1     302 Certification                                   HTML     16K 
10: EX-31.2     302 Certification                                   HTML     16K 
11: EX-32.1     906 Certification                                   HTML     11K 
12: EX-32.2     906 Certification                                   HTML     11K 

Countrywide Financial Corporation

2005 Annual Report of Form 10-K

Table of Contents

					Page
PART I
	Item 1.	Business			1
		Overview			1
		Available Information			1
		Loan Production			2
		Mortgage Banking Segment			3
		Banking Segment			9
		Capital Markets Segment			11
		Insurance Segment			12
		Global Operations Segment			14
		Financing of Operations			14
		Regulations			16
		Workforce			23
		Additional Information			24
		Loan Production Tables			24
	Item 1A.	Risk Factors			32
	Item 1B.	Unresolved Staff Comments			36
	Item 2.	Properties			36
	Item 3.	Legal Proceedings			36
	Item 4.	Submission of Matters to a Vote of Security Holders			36
PART II
	Item 5.	Market for the Company’s Common Stock, Related Stockholder Matters and Issuer Purchase of Equity Securities			37
	Item 6.	Selected Consolidated Financial Data			39
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations			41
		Overview			41
		Critical Accounting Policies			43
		Results of Operations Comparison—Year Ended December 31, 2005 and Year Ended December 31, 2004			47
		Results of Operations Comparison—Year Ended December 31, 2004 and Year Ended December 31, 2003			68
		Quantitative and Qualitative Disclosures About Market Risk			86
		Credit Risk Management			92
		Loan Servicing			98
		Inflation			99
		Seasonality			99
		Liquidity and Capital Resources			99
		Off-Balance Sheet arrangements and Aggregate Contractual Obligations			103
		Prospective Trends			104
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk			108
	Item 8.	Financial Statements and Supplementary Data			108
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			108
	Item 9A.	Controls and Procedures			108
	Item 9B.	Other Information			112

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PART III
	Item 10.	Directors and Executive Officers of the Registrant		113
	Item 11.	Executive Compensation		113
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		113
	Item 13.	Certain Relationships and Related Transactions		113
	Item 14.	Principal Accountant Fees and Services		113
PART IV
	Item 15.	Exhibits, Financial Statement Schedules		114

 

PART I

Item 1.                        Business

Overview

Countrywide Financial Corporation (“Countrywide”) is a holding company which, through its subsidiaries (collectively, the “Company”), is engaged in mortgage lending and other finance-related businesses, including mortgage banking, retail banking and mortgage warehouse lending, securities dealing, insurance underwriting and international mortgage loan processing and subservicing.

We manage our business through five business segments—Mortgage Banking, Banking, Capital Markets, Insurance and Global Operations. We primarily conduct the following operations in these segments:

·       Mortgage Banking—We originate, purchase, securitize and service mortgage loans nationwide.

·       Banking—We operate a federally-chartered bank that primarily invests in mortgage loans and home equity lines of credit primarily sourced through our mortgage banking operation. We also provide short-term secured financing to mortgage lenders through a non-depository lending company.

·       Capital Markets—We operate an institutional broker-dealer that primarily specializes in trading and underwriting mortgage-backed securities. During 2004, this segment began originating for sale loans secured by commercial real estate. We also manage within this segment the acquisition and disposition of mortgage loans on behalf of Countrywide Home Loans (“CHL”), our primary mortgage banking subsidiary.

·       Insurance—We offer property, casualty, life and credit insurance as an underwriter and as an independent agent. We also provide reinsurance coverage to primary mortgage insurers.

·       Global Operations—We provided mortgage loan application processing and mortgage loan servicing on behalf of a financial institution in the United Kingdom through a joint venture with that institution. This joint venture was terminated on December 23, 2005. We will continue to offer these services in addition to licensing the proprietary technology supporting these services. Certain of the Company’s administrative functions are performed through an Indian subsidiary.

Mortgage banking continues to be our core business, generating 59% of our pre-tax earnings in 2005. Our other segments generated the following percentages of our pre-tax earnings in 2005: Banking—25%; Capital Markets—11%; Insurance—4%; and Global Operations—1%. We have leveraged our mortgage lending operations in recent years to capitalize on meaningful related opportunities to provide sources of earnings that are less cyclical than the mortgage banking business. For financial information about our segments, see the “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Operating Segment Results” section and “Note 26—Segments and Related Information” in the financial statement section of this Report.

Available Information

We have a Web site located at www.countrywide.com and make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all exhibits and amendments to these reports available, free of charge, on that Web site, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. Our Corporate Governance Guidelines, our Code of Business Ethics, and the charters of the committees of our Board of Directors are also available on our Web site and printed copies are available upon request.

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Loan Production

We produce residential and commercial mortgage loans within the Mortgage Banking, Banking and Capital Markets Segments. Most of the mortgage loans we produce in the Mortgage Banking and Capital Markets Segments are sold into the secondary mortgage market, primarily in the form of mortgage-backed securities. We generally perform the ongoing servicing functions related to the mortgage loans that we produce. Loans produced in our Banking Segment are generally held for investment.

Types of Loans

We originate and purchase mortgage loans that generally fall into one of the following four categories:

·       Prime Mortgage Loans—These are prime credit quality first-lien mortgage loans secured by single-family residences. References to loans secured by single-family residences in this document include loans secured by one-to-four dwelling unit residential real estate.

·       Prime Home Equity Loans—These are prime credit quality second-lien mortgage loans, including home equity lines of credit, secured by single-family residences.

·       Nonprime Mortgage Loans—These are first- and second-lien mortgage loans secured by single-family residences, made to individuals with credit profiles that do not qualify them for a prime loan.

·       Commercial Real Estate Loans—These are prime credit quality first-lien mortgage loans secured by commercial properties, such as apartment buildings, retail properties, offices, industrial sites, hotels and other commercial properties.

The majority of our loan production consists of Prime Mortgage Loans. Prime Mortgage Loans include conventional mortgage loans, loans insured by the Federal Housing Administration (“FHA”) and loans guaranteed by the Veterans Administration (“VA”). A significant portion of the conventional loans qualify for inclusion in guaranteed mortgage securities backed by Fannie Mae or Freddie Mac (“conforming loans”). Some of the conventional loans we produce either have an original loan amount in excess of the Fannie Mae and Freddie Mac loan limit for single-family loans ($417,000 for 2006) or otherwise do not meet Fannie Mae or Freddie Mac guidelines. Loans that do not meet Fannie Mae or Freddie Mac guidelines are referred to as “nonconforming loans.” In certain tables and elsewhere in this Report, FHA and VA loans may be referred to as Government Loans.

The following table summarizes our mortgage loan production by business segment and by loan type:

(1)   Acquisitions from third parties

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For additional loan production statistics, see the section in this Report entitled “Business—Loan Production Tables.”

Mortgage Banking Segment

Our Mortgage Banking Segment produces mortgage loans through a variety of channels on a national scale. Most of the mortgage loans we produce in this segment are sold into the secondary mortgage market, primarily in the form of mortgage-backed securities. We generally perform the ongoing servicing functions related to the mortgage loans that we produce. We also provide various loan closing services such as title, escrow and appraisal. We group the activities of our Mortgage Banking Segment into three business sectors—Loan Production, Loan Servicing and Loan Closing Services. See the section in this Report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Seasonality” for a discussion of the effect of seasonality on our business.

Loan Production

We produce mortgage loans through four production divisions of Countrywide Home Loans (“CHL”)—Consumer Markets, Wholesale Lending, Correspondent Lending and Full Spectrum Lending and, beginning in the third quarter of 2005, through Countrywide Bank. Countrywide Bank funds loans for both investment purposes and for sale. Bank production in the Mortgage Banking Segment includes loans originated for sale at the Bank together with bulk sales of loans from the Bank to the Mortgage Banking Segment.

The following table summarizes our Mortgage Banking loan production by division:

(1)          For additional production statistics, see the section in this Report entitled “Business—Loan Production Tables.”

Correspondent Lending Division

Our Correspondent Lending Division purchases mortgage loans from other lenders, which include mortgage bankers, commercial banks, savings and loan associations, home builders and credit unions. As of December 31, 2005, this Division served approximately 2,100 lenders, who are subject to initial and ongoing credit evaluation and monitoring, operating in all 50 states and the District of Columbia.

For 2005, Countrywide was ranked by Inside Mortgage Finance as the largest correspondent lender, in terms of volume, among residential correspondent mortgage lenders nationwide.

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Consumer Markets Division

Our Consumer Markets Division (“CMD”) originates mortgage loans through three business channels: the Distributed Retail channel, the Business-to-Consumer channel and the Strategic Business Alliances channel.

The Distributed Retail channel is the branch network which originates loans through relationships with consumers, builders, realtors and through joint ventures. As of December 31, 2005, this channel consisted of 662 branch offices in 48 states and the District of Columbia, including 70 dedicated joint venture branches. This channel has a sales force of 6,373 primary originators, which includes those dedicated to joint venture relationships. The sales staff for the Distributed Retail channel is primarily focused on consumer lending through relationships established with previous customers, realtors, builders and joint venture partners. The Distributed Retail channel (including the joint venture relationships) originated 83% of Consumer Markets Division total volume for the year ended December 31, 2005.

The Business-to-Consumer channel primarily originates mortgage loans directly from portfolio customers through the Internet and through our call centers. The Business-to-Consumer channel focuses on customer retention and marketing by providing our existing customers with an efficient and convenient means to obtain financing for a new home, refinance their existing mortgage or to obtain a Home Equity loan. As of December 31, 2005, the Business-to-Consumer channel consisted of four call centers with a sales staff of 749. This channel accounted for 15% of CMD’s total volume for the year ended December 31, 2005.

The Strategic Business Alliance channel facilitates and manages the development of new sources of loans by developing and deploying relationships with organizations that influence the placement of mortgage services and by supporting acquisition-related activities. This channel focuses primarily on developing revenue-sharing arrangements such as joint ventures, third party outsourcing, relocation lending, marketing service agreements and brokered-in agreements. This channel accounted for 2% (excluding Distributed Retail volume from joint venture relationships) of CMD’s total volume for the year ended December 31, 2005.

For 2005, Countrywide was ranked by Inside Mortgage Finance as the second largest retail lender, in terms of volume, among residential retail mortgage lenders nationwide.

Wholesale Lending Division

Our Wholesale Lending Division underwrites and funds mortgage loans sourced by mortgage loan brokers and other financial intermediaries. The Division offers a wide variety of Prime and Nonprime Mortgage Loan and Prime Home Equity Loan products. Business is solicited through a sales force, the Internet (www.CWBC.com), advertising and participation of branch management and sales personnel in trade associations.

As of December 31, 2005, our Wholesale Lending Division operated 52 branch offices and seven fulfillment centers in various parts of the United States. Through this Division we source loans through approximately 30,000 mortgage loan brokers nationwide.

For 2005, Countrywide was ranked by Inside Mortgage Finance as the largest wholesale originator, in terms of volume, among residential wholesale mortgage lenders nationwide.

Full Spectrum Lending Division

The Full Spectrum Lending Division originates Nonprime and Prime Mortgage Loans with the primary focus on refinance and home equity products. This Division operates through a network of

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195 retail branch offices located in 38 states, as well as 7 call centers. The branches and call centers of this Division are supported by 3 fulfillment centers for underwriting and funding of these mortgage loans.

The Division’s mortgage production is generated primarily through customer retention efforts directed to Countrywide’s nonprime servicing portfolio, but also through direct mail, internet, mass media and joint venture relationships. Of the 195 Full Spectrum retail branch offices, 45 operate with a large network of sales associates who are dedicated to the fulfillment of referrals of Nonprime Mortgage Loan customers from Countrywide’s Consumer Markets Division.

Countrywide Bank Mortgage Banking Activities

Countrywide Bank produces loans for sale by our Mortgage Banking Segment. As this activity is a Mortgage Banking activity, the mortgage loan production and the income relating to the sale of these loans is included in the Mortgage Banking Segment. The production of loans by Countrywide Bank for our Mortgage Banking operations is an efficient means to manage growth of the Bank’s portfolio of loans held for investment while complying with regulatory requirements.

Affordable and Multicultural Home Loan Programs

For more than a decade, we have pursued a variety of affordable home loan initiatives designed to increase homeownership opportunities for low-to moderate-income borrowers and those with diverse backgrounds. Our long-time initiative, known as We House America®, supports affordable housing programs undertaken by Fannie Mae and promoted by various government agencies, including the U.S. Department of Housing and Urban Development.

We have specifically designed We House America loan programs to meet the needs of low-to moderate-income borrowers and others with financial, employment or personal situations which might prevent them from qualifying for traditional mortgages. These loan programs enable such borrowers to qualify for a home loan by allowing, for example, lower down payments, lower cash reserves, alternative income sources and more flexible underwriting criteria than on a typical loan. The mortgage loans we produce through We House America are sold and serviced on a non-recourse basis, generally through guarantee programs sponsored by Fannie Mae.

Through We House America, we provide telephone-based counseling services and web channel resources to educate prospective first-time minority and low- to moderate-income homebuyers about the home loan process. We House America also provides bilingual counselors and instructors, and educational materials printed in other languages.

We have made other significant commitments to affordable lending and multicultural markets initiatives designed to increase homeownership opportunities among minority and immigrant communities. For example, we are approved to participate in more than 950 mortgage loan programs that assist with down payments and closing costs, which are offered by state, county and city agencies, municipalities and not-for-profit organizations. In early 2005, we extended our five-year We House America Campaign, with a goal of originating $1.0 trillion in loans to targeted homebuyers by the end of 2010. As of December 31, 2005, we made loans to 3.4 million borrowers and funded $512 billion (including Prime and Nonprime Mortgage Loans) toward this goal.

Loan Servicing

When we sell mortgage loans, we generally retain the rights to service these loans. The value we assign to these rights are referred to as mortgage servicing rights (“MSRs”). We may also retain other financial interests when we securitize mortgage loans. We include the value of these retained interests on our

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balance sheet. The results of the Loan Servicing Sector include the performance of these interests, as well as the operational and other financial activities related to servicing mortgage loans.

In servicing mortgage loans, we collect and remit loan payments, respond to customer inquiries, account for principal and interest, hold custodial (impound) funds for payment of property taxes and insurance premiums, counsel delinquent mortgagors, supervise foreclosures and property dispositions. We receive servicing fees and other remuneration in return for performing these functions.

Mortgage Servicing Rights, Other Retained Interests and the Servicing Hedge

Our MSRs arise from contractual agreements between us and investors (or their agents) in mortgage-backed securities and mortgage loans. Although MSRs generally arise from the securitization of mortgage loans that we originate, we also occasionally purchase MSRs from other servicers. For a more complete description of MSRs, see “Note 3—Loan Sales” in the financial statement section of this Report.

MSRs and other retained interests are generally subject to a loss in value when mortgage rates decline. To moderate the effect on earnings of declines in value of MSRs and other retained interests, we maintain a portfolio of financial instruments, primarily derivative contracts, which generally increases in value when interest rates decline. This portfolio of financial instruments is referred to as the “Servicing Hedge.” See “Note 4—Derivative Financial Instruments—Risk Management Activities Related to Mortgage Servicing Rights (MSRs) and Other Retained Interests” in the financial statement section of this Report for a further discussion of our Servicing Hedge.

Loan Servicing Operations

The various functions within our loan servicing operations are briefly described in the following paragraphs. These operations are performed in six primary locations: two in California, three in Texas and one in Mumbai, India.

Customer Service

Our Customer Service Call Centers managed more than 51 million contacts with customers in 2005. These contacts were primarily handled through our Customer Service Representatives, Automated Phone System and Web site (www.customers.countrywide.com). This division also prints monthly statements and oversees outbound customer correspondence. Approximately 23% of our customers have chosen to receive electronic statements, which reduces the cost and improves the timeliness of providing loan information to them.

Remittance Processing

Our Remittance Processing division processes all payments, loan payoffs and payoff demand statements. Approximately 39% of our customers make their monthly payments electronically using various automated payment methods.

Collections and Loss Mitigation

Our Collections and Loss Mitigation units work with delinquent borrowers to bring their mortgages back to current status and to avoid foreclosure if possible. Workout efforts are tailored to the specific borrower circumstances and comply with the requirements of the mortgage investor.

Foreclosure and Bankruptcy

Foreclosure and bankruptcy are complex processes that are subject to federal and state laws and regulations, as well as various guidelines imposed by mortgage investors and insurers. Our workflow-based

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systems facilitate consistent processing of defaulted mortgage loans, as well as an efficient flow of data between internal and external business partners. To minimize related costs and to increase efficiency, we utilize our own companies in support of our foreclosure and bankruptcy activities.

Investor Accounting

Our Investor Accounting department reconciles custodial accounts, processes investor remittances and maintains accounting records on behalf of our mortgage investors, including Fannie Mae, the Government National Mortgage Association (“Ginnie Mae”) and Freddie Mac, as well as more than 2,000 private investors.

Related Services

We perform several loan servicing functions internally that other loan servicers commonly outsource to third parties. We believe the integration of these functions gives us a competitive advantage by lowering overall servicing costs and enabling us to provide a high level of service to our mortgage customers and mortgage investors. In addition to providing foreclosure and bankruptcy activities, our integrated services include property tax payment processing, performing property inspections, and insurance tracking and premium payment processing.

The following table sets forth certain information regarding the Company’s loan servicing portfolio, including mortgage loans and securities held for sale and residential mortgage loans subserviced for others, for the periods indicated:

 

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(1)          Runoff refers to principal repayments on loans.

(2)          Expressed as a percentage of the total number of loans serviced, excluding subserviced loans and loans purchased at a discount due to their non-performing status.

Properties securing the mortgage loans in the Company’s servicing portfolio are geographically dispersed. The following is a summary of the geographical distribution of loans included in the Company’s servicing portfolio for the top three states (as measured by unpaid principal balance) at December 31, 2005:

 

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Loan Closing Services Sector

We provide loan closing products and services such as credit reports, appraisals, title reports, property valuation services and flood determinations through our LandSafe, Inc. group of companies. We provide these services primarily to customers referred by our loan production divisions but to third parties as well.

Competition

The mortgage lending business is inherently complex due to several factors:

·       The continuing evolution of the secondary mortgage market

·       The proliferation of mortgage products

·       Greater regulation imposed on the industry by more levels of government has resulted in increased costs and the need for higher levels of specialization.

·       Increasing interest rate volatility, compounded by homeowners’ increasing tendency to refinance their mortgages as the refinance process has become more efficient and cost effective, has resulted in significant fluctuations in the volume of mortgage loans originated from year to year. These swings in mortgage origination volume have placed significant operational and financial pressures on mortgage lenders.

To compete effectively in this environment, mortgage lenders must have a very high level of operational, technological and managerial expertise. In addition, the residential mortgage business has become more capital-intensive and therefore access to capital at a competitive cost is critical. Primarily as a result of these factors, the industry has consolidated significantly.

Today, large, sophisticated financial institutions dominate the residential mortgage industry. These industry leaders are primarily commercial banks operating through their mortgage banking subsidiaries. Today, the top 30 mortgage lenders have a combined 88% share of the mortgage origination market, up from 63% five years ago.

This consolidation trend also is reflected in loan servicing. Today, the top 30 mortgage servicers combined have a 71% share of the total mortgages outstanding, up from 64% five years ago.

Generally, we compete as a mortgage banker by consistently offering a wide selection of mortgage loans through all marketing channels on a national scale, by providing high-quality service, and by pricing our mortgage loans at competitive rates.

Banking Segment

Our Banking Segment consists of the following operations:

·       The investment and fee-based activities of Countrywide Bank, N.A., an FDIC-insured, federally-chartered bank (“Banking Operations”)

·       Countrywide Warehouse Lending, a non-depository lending company that provides short-term secured financing to mortgage lenders.

Countrywide Bank

Mortgage Banking Activities

Countrywide Bank produces loans for sale that are part of our Mortgage Banking Segment. As this activity is a Mortgage Banking activity, the mortgage loan production and the income relating to the sale of these loans is included in the Mortgage Banking Segment. The production of loans by Countrywide Bank

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for our Mortgage Banking operations is an efficient means to manage growth of the Bank’s portfolio of loans held for investment while minimizing the operational impact of complying with regulatory requirements.

Banking Operations

Our Banking Operation primarily originates and purchases mortgage loans and home equity lines of credit for investment purposes. The majority of these loans are sourced through our mortgage banking subsidiary, Countrywide Home Loans. For liquidity and asset-liability management purposes, we also invest in collateralized mortgage obligations and other securities that supplement the loan portfolio of our Banking Operations.

Our banking operations continue to leverage the relationship with the Mortgage Banking Segment by sourcing high-quality mortgage assets through existing production distribution channels and then funding the loans for retention in the Bank’s investment portfolio. Asset growth is funded by the Bank’s overall low-cost liability base, where growth is driven by the continued expansion of its core retail deposit franchise. The Bank obtains retail deposits, primarily certificates of deposit, through the Internet, call centers and 86 financial centers, 73 of which are located in Countrywide Home Loans’ retail branch offices as of December 31, 2005. The Bank activities provide the Company with an expanded product menu, lower cost funding sources and opportunities for a diversified revenue stream through net interest income.

Through Countrywide Bank we offer deposit accounts. We also sell these deposit products online, from call centers and through deposit brokers (generally well-recognized financial intermediaries). Countrywide Bank also offers commercial deposit accounts to title and mortgage insurance companies through a developing commercial business unit. A significant portion of Countrywide Bank’s deposit liabilities are comprised of custodial funds that relate to the loan servicing portfolio of Countrywide Home Loans. Countrywide Bank also borrows funds on a secured basis from the Federal Home Loan Bank of Atlanta, executes repurchase agreements and purchases federal funds to supplement its deposit liabilities.

Countrywide Bank acts as a mortgage document custodian, primarily for our mortgage banking operations. As a document custodian, we verify, maintain and release collateral for issuers, servicers, sellers and purchasers of debt securitizations. We also provide other services including safekeeping, review/certification, release requests and customer reporting.

Properties securing the mortgage loans in our portfolio of loans held for investment are concentrated in the State of California. The following is a summary of the geographical distribution of loans included in the Bank’s loan inventory portfolio for the top three states (as measured by unpaid principal balance) at December 31, 2005:

 

Countrywide Warehouse Lending

We provide committed and uncommitted lines of credit to mortgage bankers to finance their mortgage loan inventories (“warehouse”). Most of these mortgage bankers sell loans to our Correspondent Lending Division. All of these advances are secured by mortgage loans that have a market value in excess of the balance of our advances.

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Competition

We operate in a highly competitive environment. Competition for retail deposits comes primarily from other insured depository institutions, which include approximately 7,500 commercial banks and approximately 1,300 savings institutions. We attract and retain deposits through a combination of competitive rates, physical presence, and experienced banking professionals, as well as easy access to our products through call centers and the Internet at www.countrywidebank.com. Because of our low-cost structure, we are able to offer deposit rates that are among the most competitive in the industry.

Countrywide Bank invests primarily in short duration residential mortgage loans. Competition in making real estate loans come principally from other savings institutions, mortgage banking companies, and commercial banks. The majority of loans that the Banking Segment invests in are sourced by the Mortgage Banking Operation. Countrywide Bank also competes with commercial banks and investment banks in the purchase of loans from third parties.

Our Banking Segment’s competitive position is enhanced by its relationship with our Mortgage Banking Segment. For example, a significant portion of Countrywide Bank’s deposit liabilities consists of custodial funds controlled by Countrywide Home Loans. As discussed above, Countrywide Bank obtains retail deposit products through financial centers placed within certain of Countrywide Home Loans’ retail branch offices. This economical use of space reduces the Bank’s deposit acquisition costs. Countrywide Bank also provides mortgage document custodial, reconveyance and foreclosure trustee services for our Mortgage Banking Segment.

Capital Markets Segment

Our Capital Markets Segment primarily operates as a registered securities broker dealer, a residential mortgage loan manager and a commercial mortgage loan originator. We also operate broker dealers in Japan and the United Kingdom, an introducing broker dealer of futures contracts, an asset manager and a broker of mortgage servicing rights. With the exception of our commercial mortgage activities, we transact only with institutional customers, such as banks, other depository institutions, insurance companies, asset managers, mutual funds, pension plans, other broker dealers and governmental agencies. Customers of our commercial real estate finance business are the owners or sponsors of commercial properties, who can be individuals or institutions.

Our activities consist of the following:

Conduit

Conduit activities include the purchase, warehousing and ultimate disposition of residential mortgage loans on behalf of Countrywide Home Loans. In our conduits, we manage both Nonprime Mortgage Loans and Prime Mortgage Loans which are either acquired from third parties or originated by Countrywide Home Loans. We dispose of the loans through sale to third parties or through securitization. We also manage the acquisition and disposition of delinquent or otherwise illiquid residential mortgage loans, some of which have been originated under FHA and VA programs. We attempt to cure the loans, using the servicing operations of Countrywide Home Loans, with the intent to securitize those loans that become eligible for securitization. The remaining loans are serviced through foreclosure and liquidation, which includes the collection of government insurance and guarantee proceeds relating to defaulted FHA and VA program loans.

Securities Trading

Securities trading activities include the trading of debt securities in the secondary market after the original issuance of the security. We generally trade mortgage-related fixed-income securities, including Mortgage-Backed Securities (“MBS”), collateralized mortgage obligations and asset-backed securities

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issued by Fannie Mae, Freddie Mac, Ginnie Mae and other financial institutions, including Countrywide Home Loans. We also trade securities issued by the U.S. Department of Treasury and other governmental agencies.

Underwriting

Underwriting activities encompass the assumption of the risk of buying a new issue of securities from the issuer and reselling the securities to investors, either directly or through dealers. Capital Markets primarily underwrites mortgage-related debt securities. In return for assuming this risk, Capital Markets earns an underwriting spread that is the difference between the amount paid to the issuer of securities and the offering price to investors, net of expenses. The spread earned on each transaction may vary based upon the nature of the market and the terms of the underwriting agreement. Capital Markets participates in both competitive bid and negotiated underwritings. We underwrite for CHL and for third parties.

Brokering

Brokering activities include brokerage of residential mortgage loan transactions, brokerage of mortgage servicing rights, advisory services and brokering of exchange traded futures contracts and commodity options in an agent capacity. The brokerage of residential mortgage loans, mortgage servicing rights and futures contracts can be between third parties or between CHL and third parties.

Origination and Sale of Commercial Mortgage Loans

Capital Markets originates and sells commercial mortgage loans. Commercial mortgages are mortgages secured by commercial properties, such as apartment buildings, retail properties, offices, industrial sites, hotels and other. These loans are significantly larger than residential mortgage loans. The average loan balance of the commercial loans originated in 2005 was $15.2 million.

Asset Management

Asset management activities derive from the management of assets for the benefit of investors. This may include managing a private equity fund, as well as collateralized debt and bond obligations. We receive fees, including performance fees, for providing these services. We may also share in the results of the funds when we hold an investment interest in the fund.

Competition

The securities industry is both highly competitive and fragmented. In the mortgage securities market, we compete with global investment banks as well as regional broker-dealers. We believe by leveraging the strengths of Countrywide Home Loans and by specializing in the mortgage securities market, we can offer information, products and services tailored to the unique needs of institutional customers, giving us an advantage in the market. In contrast, many of our competitors offer a broader range of products and services, which may place us at a competitive disadvantage. However, by offering more non-residential mortgage related products and services to the global institutional investor markets we believe this helps us compete.

For 2005, according to Inside MBS & ABS, we ranked fourth among Non-Agency MBS Underwriters.

Insurance Segment

Our Insurance Segment’s primary activities are:

·       Offering property, casualty, life and credit insurance as an underwriter and as an insurance agency

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·       Providing reinsurance coverage to primary mortgage insurers

We manage these activities through two business units—Balboa Life and Casualty Group and Balboa Reinsurance Company.

Life and Casualty Operations

Life and Casualty operations include the operations of Balboa Life and Casualty Group, an insurance underwriter/carrier, and Countrywide Insurance Services Group, an insurance agency.

Balboa Life and Casualty Group

We underwrite property, casualty, life and credit insurance in all 50 states and the District of Columbia through our Balboa Life and Casualty Group. However, during October 2005, we filed a notice with the Florida Office of Insurance Regulation to discontinue underwriting voluntary homeowners and renters insurance in Florida.

Balboa Life and Casualty Group offers the following insurance product lines:

·       Lender-Placed Property and Auto—We offer lender-placed real-property hazard insurance and lender-placed auto insurance. Such insurance is provided on behalf of auto and mortgage lenders when borrowers fail to have agreed-upon insurance coverage in place to protect the lender’s security interest. We also provide insurance tracking services, which alert a lender when there is a lapse in a borrower’s insurance, for more than 17.2 million loans, including nearly 7.4 million loans serviced within our Mortgage Banking Segment.

·       Voluntary Homeowners and Auto—We underwrite retail homeowners and auto insurance and home warranty plans for consumers.

·       Life and Credit—We underwrite term life, credit life and credit disability insurance products.

Our retail insurance products are offered by select general insurance agents serving the consumer market, including our Countrywide Insurance Services Group.

The Balboa Life and Casualty Group has received an “Excellent” rating from A.M. Best Company, an insurance company rating and information service. The “Excellent” rating is defined by the A.M. Best Company as having “an excellent ability to meet ongoing obligations to policyholders.”

Countrywide Insurance Services Group

Our Countrywide Insurance Services (“CIS”) Group operates an insurance agency that provides consumers, in particular our mortgage customers, with homeowners insurance, life insurance, disability insurance, automobile insurance and various other insurance products. CIS also operates a full-service commercial insurance brokerage that offers a comprehensive menu of products and services to meet the insurance needs of small, mid-size and large commercial businesses. The commercial insurance brokerage distributes a wide array of competitively priced property & casualty and employee benefits programs in specialty niche markets, including home builders, mortgage brokers and bankers, real estate brokers and commercial property owners.

Balboa Reinsurance Company

We provide a mezzanine layer of reinsurance coverage for losses between minimum and maximum specified amounts to the insurance companies that provide primary mortgage insurance (“PMI”) on loans in our servicing portfolio. We provide this coverage with respect to substantially all of the loans in our portfolio that are covered by PMI, which generally includes all conventional loans with an original loan

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amount in excess of 80% of the property’s appraised value. In return for providing this coverage, we earn a portion of the PMI premiums.

Competition

The lender-placed insurance market is dominated by a small number of providers, competing on policy terms and conditions, service, technological innovation, compliance capability, loan tracking ability and commissions.

The homeowners, auto, term life, credit-life and credit-disability marketplaces are dominated by large, well-known providers. Consumers select such insurance based on price, service, commissions and the efficiency and effectiveness of marketing and underwriting operations.

We compete generally by providing high-quality service and pricing our products at competitive rates, as well as by leveraging our residential mortgage loan customer base.

Global Operations Segment

The primary activities we conduct in our Global Operations Segment include:

·       Loan Processing and Subservicing—We provide mortgage loan application processing and mortgage loan subservicing in the UK. Before December 23, 2005, this business was a joint venture between Barclays, PLC (“Barclays”) and us. We held a majority interest in that venture. On December 23, 2005, we reached an agreement with Barclays to terminate the joint venture. The termination agreement provides for the transfer of the Barclays mortgage business back to Barclays effective February 1, 2006, for us to acquire Barclays’ interest in the venture, and for a three-year software licensing agreement, which allows Barclays to use our global originations, servicing and arrears management systems. We acquired Barclay’s interest in the joint venture on December 23, 2005.

    In 2005, we processed more than 11.3 billion pounds sterling ($20.3 billion) in loans, all of which are subserviced for Barclays Bank, PLC, our joint venture partner until December 2005. At December 31, 2005, Global’s subservicing portfolio was 59 billion pounds sterling ($102 billion).

·       Offshore Services—We perform business process and technology services for various units of the Company both in the U.S. and UK through our Mumbai, India service center.

·       Valuation Services—We provide electronic residential property valuation services to third parties in the UK through a majority-owned joint venture.

Competition

Our competitors in this segment include direct lenders, business process outsourcers and technology companies operating in Europe and India. We compete by leveraging Countrywide’s mortgage expertise and our proprietary technology.

Financing of Operations

Uses of Financing

We have significant short-term and long-term financing needs. Our short-term financing needs arise primarily from the following:

·       Warehousing of mortgage loans pending sale

·       Trading activities of our broker-dealer

·       Providing mortgage warehouse credit to others

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Our long-term financing needs arise primarily from the following:

·       Investments in mortgage loans

·       Investments in MSRs and other interests that we retain when we securitize mortgage loans.

Sources of Financing

We meet our short- and long-term financing needs primarily through the following means:

·       Unsecured commercial paper and medium-term notes

·       Short-term repurchase agreements

·       Asset-backed financings

·       Deposit-gathering

·       Federal Home Loan Bank advances

·       Retained earnings

·       Revolving lines of credit.

We typically access the unsecured public corporate debt market by issuing commercial paper and medium-term notes. At times, we may also issue subordinated debt, convertible debt and securities that rating agencies credit with high equity-equivalency.

Our ongoing access to the public debt markets is dependent on a high credit rating. For the last 12 years, we have consistently maintained solid investment-grade ratings. To maintain investment-grade ratings we must, among other considerations, maintain a high level of liquidity, including access to alternative sources of funding such as committed bank stand-by lines of credit. We also must maintain a conservative debt-to-equity ratio. Current credit ratings are as follows:

 

We use short-term secured financing such as repurchase agreements and asset-backed commercial paper conduits to finance a substantial portion of our mortgage loan inventory and securities trading portfolio. Countrywide Bank finances its investments in mortgage loans primarily with a combination of deposit liabilities and secured Federal Home Loan Bank advances.

We rely substantially on the secondary mortgage market as a source of long-term capital to support our mortgage banking operations. Most of the mortgage loans that we produce in our Mortgage Banking Segment are sold in the secondary mortgage market, primarily in the form of MBS and asset-backed securities.

We ensure our ongoing access to the secondary mortgage market by consistently producing quality mortgages and servicing those mortgages at levels that meet or exceed secondary mortgage market standards. As described elsewhere in this document, we make significant investments in personnel and technology to ensure the quality of our mortgage loan production.

Our primary source of equity capital is retained earnings. We supplement our equity capital with $1.0 billion in trust-preferred securities that receive varying degrees of “equity treatment” from rating agencies, bank lenders and regulators. From time to time, we may issue common stock or other securities

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that receive high equity-equivalent treatment as a means of supplementing our capital base and supporting our growth.

For a further discussion of our liquidity and capital management see the section in this Report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Management.”

Interest Rate Risk

We typically bear interest rate risk from the time a loan application is taken through the sale of the loan. Thereafter, we continue to bear interest rate risk related to the interests we retain in the loans sold, which are typically in the form of mortgage servicing rights and residual securities. We also bear interest-rate risk to the extent that our loan and securities investment portfolios’ yields change on a different basis or at different times than the rates we pay on our borrowings. For a further discussion of our interest rate risk and how this risk is managed, see the section in this Report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Quantitative and Qualitative Disclosures About Market Risk.”

Credit Risk

When we securitize our mortgage loans we retain varying levels of credit risk. This credit risk arises through representations and warranties that we make as part of our securitization activities, as well as through retention of limited recourse for credit losses in the case of certain securitizations. For a further discussion of our exposure to credit risk and how we manage this risk, see the section in this Report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Credit Risk Management.”

Operational Risk

Countrywide, like all large corporations, is exposed to many types of operational risk, including the risk of fraud by employees or outsiders, unauthorized transactions by employees, or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.

For a further discussion of our operational risk and how we manage this risk see the section in this Report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Operational Risk.”

Regulations

Regulations Applicable to Bank Holding Companies and Financial Holding Companies

General

We are a registered bank holding company under the Bank Holding Company Act, as amended (the “BHC Act”). As such, we are subject to supervision and examination by the Board of Governors of the Federal Reserve System (the “FRB”). The FRB has authority to issue cease and desist orders against bank holding companies if it determines that their actions represent unsafe and unsound practices or violations of law. The FRB is empowered to impose civil money penalties for violations of banking statutes and regulations. Regulation by the FRB is primarily intended to protect depositors of the Bank and the Bank Insurance Fund of the Federal Deposit Insurance Corporation, not our shareholders or creditors.

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Limitation on Activities

The activities of bank holding companies and their subsidiaries are generally limited to the business of banking, managing or controlling banks or furnishing or performing services for their subsidiaries, and other activities that the FRB has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under provisions of the BHC Act enacted as part of the Gramm-Leach Bliley Act (the “GLB Act”), a bank holding company, all of whose controlled depository institutions are “well capitalized” and “well managed” (as defined in federal banking regulations) and which obtains “satisfactory” Community Reinvestment Act ratings, may elect to become a “financial holding company” and engage in a broader range of activities. The Company is a financial holding company.

A financial holding company that desires to engage in activities that are financial in nature or incidental to a financial activity but not previously authorized by the FRB must obtain approval from the FRB before engaging in such activities. The BHC Act requires a bank holding company to obtain prior approval of the FRB before making certain acquisitions.

If any subsidiary bank of a financial holding company ceases to be “well capitalized” or “well managed,” the financial holding company will not be in compliance with the requirements of the BHC Act regarding financial holding companies. If a financial holding company is notified by the FRB of such a change in the ratings of any of its subsidiary banks, it must take certain corrective actions within specified timeframes.

If any subsidiary bank of a financial holding company receives a rating under the Community Reinvestment Act of less than “satisfactory,” then the financial holding company is prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations until the rating is raised to “satisfactory” or better.

Regulatory Capital Requirements

The FRB has promulgated capital adequacy guidelines for use in its examination and supervision of bank holding companies. If a bank holding company’s capital falls below minimum required levels, then the bank holding company must implement a plan to increase its capital, and its ability to pay dividends and make acquisitions of new bank subsidiaries may be restricted or prohibited.

To be classified as “adequately capitalized,” the FRB’s capital adequacy guidelines require that a bank holding company maintain a Tier 1 Leverage ratio equal to at least 4.0% of its average total consolidated assets, a Tier 1 Risk-Based Capital ratio equal to 4.0% of its risk-weighted assets and a Total Risk-Based Capital ratio equal to 8.0% of its risk-weighted assets. To be classified as “well capitalized,” a bank holding company is required to maintain a Tier 1 Leverage ratio of 5.0% or greater, a Tier 1 Risk-Based Capital ratio of 6.0% or greater, and a Total Risk-Based Capital ratio of 10.0% or greater. On December 31, 2005, the Company was in compliance with all of the FRB’s capital adequacy guidelines.

On December 31, 2005, the Company’s Leverage ratio was 6.3%, the Tier 1 Risked-Based Capital ratio was 10.7% and Total Risk-Based Capital ratio was 11.7%.

The federal banking regulatory agencies are in the process of proposing revised capital standards that would apply to all financial institutions that are not subject to the Basel II Accord, with the expressed intention to align those standards more closely with those that would be applicable to Basel II institutions. These standards would only apply to Countrywide if it is neither required to adopt, nor voluntarily elects to adopt, the Basel II Accord. For a discussion of the Basel II Accord, see the section of this Report entitled “Business-Regulation-Basel II Capital Standards.”

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Interstate Banking and Branching

Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”), a bank holding company is permitted to acquire the stock or substantially all of the assets of banks located in any state regardless of whether such transaction is prohibited under the laws of any state. The FRB will not approve an interstate acquisition if, as a result of the acquisition, the bank holding company would control more than 10% of the total amount of insured deposits in the United States or would control more than 30% of the insured deposits in the home state of the acquired bank. The 30% of insured deposits state limit does not apply if the acquisition is the initial entry into a state by a bank holding company or if the home state waives such limit. The Riegle-Neal Act also authorizes banks to merge across state lines, thereby creating interstate branches. Banks are also permitted to acquire and to establish new branches in other states where authorized under the laws of those states.

Under the Riegle-Neal Act, individual states may restrict interstate acquisitions in two ways. A state may prohibit an out-of-state bank holding company from acquiring a bank located in the state unless the target bank has been in existence for a specified minimum period of time (not to exceed five years). A state may also establish limits on the total amount of insured deposits within the state which are controlled by a single bank holding company, provided that such deposit limit does not discriminate against out-of-state bank holding companies.

Source of Strength

FRB regulations require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. Under this “source of strength doctrine,” a bank holding company is expected to stand ready to use its available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity, and to maintain resources and the capacity to raise capital that it can commit to its subsidiary banks. Furthermore, the FRB has the right to order a bank holding company to terminate any activity that the FRB believes is a serious risk to the financial safety, soundness or stability of any subsidiary bank.

Regulations Applicable to Countrywide Bank

General

Countrywide Bank, N.A. (the “Bank”), a federally chartered bank, is subject to regulation and examination by the Office of the Comptroller of the Currency (the “OCC”). The Bank is also regulated by the Federal Deposit Insurance Corporation (the “FDIC”). The OCC is empowered to issue cease and desist orders against the Bank if it determines that activities of the Bank represent unsafe and unsound banking practices or violations of law. The OCC has the power to impose civil money penalties for violations of banking statutes and regulations. Regulation by this agency is primarily intended to protect the depositors of the Bank and the Bank Insurance Fund of the FDIC, not shareholders or other creditors of the Company or the Bank.

Bank Regulatory Capital Requirements

The OCC has adopted minimum capital requirements applicable to national banks, which are similar to the capital adequacy guidelines established by the FRB for bank holding companies. Federal banking laws classify an insured financial institution in one of the following five categories, depending upon the amount of its regulatory capital: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. On December 31, 2005, the Bank was in compliance with the OCC’s minimum capital requirements and satisfied the requirements to be classified as well capitalized.

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The Bank must be well capitalized and well managed for the Company to remain a financial holding company. On December 31, 2005, the Bank’s Leverage ratio was 7.3%, the Tier 1 Risked-Based Capital ratio was 12.2% and Total-Risk Based Capital ratio was 12.5%.

Deposit Insurance and Assessments

As a result of the Federal Deposit Insurance Reform Act of 2005, the FDIC will use a risk-based assessment system to determine assessment rates to be paid by member institutions such as the Bank. Until new regulations are issued with respect to that system, FDIC assessments will continue to range from zero cents to 27 cents per $100 of insured deposits based upon the level of an institution’s capital as well the degree of supervisory concern over the institution.

Limitations on Interest Rates and Loans to One Borrower

The rate of interest a bank may charge on certain classes of loans is limited by state and federal law. At certain times in the past, these limitations have resulted in reductions of net interest margins on certain classes of loans. Federal and state laws impose additional restrictions on the lending activities of banks. The maximum amount that a national bank may loan to one borrower generally is limited to 15% of the bank’s capital, plus an additional 10% for loans fully secured by readily marketable collateral, as such term is defined in applicable regulation.

Payment of Dividends

The Bank is subject to federal and state laws limiting the payment of dividends. Under the Federal Deposit Insurance Act (“FDIA”), an FDIC-insured institution may not pay dividends while it is undercapitalized or if payment would cause it to become undercapitalized. The OCC also generally prohibits the declaration of a dividend out of the capital and surplus of a bank.

Community Reinvestment Act

The Bank is subject to the Community Reinvestment Act (“CRA”) and implementing regulations. CRA regulations establish the framework and criteria by which the bank regulatory agencies assess an institution’s record of helping to meet the credit needs of its community, including low- and moderate- income neighborhoods. CRA ratings are taken into account by regulators in reviewing certain applications made by the Company and its banking subsidiaries.

Limitations on Transactions with Affiliates

Countrywide Financial Corporation and its non-bank subsidiaries are affiliates of the Bank within the meaning of Sections 23A and 23B of the Federal Reserve Act and regulations promulgated thereunder. Transactions between a bank and an affiliate are generally subject to the requirement that they be on terms and conditions, including credit standards, substantially the same as, or at least as favorable to the bank as, those prevailing at the time for comparable transactions with non-affiliates or, in the absence of comparable transactions, on terms and conditions that would be offered to nonaffiliates. In addition, certain transactions between a bank and an affiliate, such as asset purchases by a bank from an affiliate, and bank extensions of credit to or for the benefit of an affiliate, are defined as “covered transactions,” and are subject to quantitative limitations and more stringent qualitative restrictions, including but not limited to collateralization and safety and soundness requirements.

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Other Banking Activities

The investments and activities of the Bank are also subject to regulation by federal banking agencies, with respect to:

·       Investments in subsidiaries

·       Investments for the Bank’s account (including limitations on investments)

·       Unsecured commercial paper and medium-term notes

·       Loans to officers, Directors and their affiliates

·       Security requirements

·       Anti-tying limitations, anti-money laundering

·       Financial privacy and customer identity verification requirements

·       Truth-in-lending

·       The types of interest-bearing deposit accounts which it can offer

·       Trust department operations

·       Brokered deposits

·       Audit requirements

·       Issuance of securities

·       Branching

·       Mergers and acquisitions.

Regulations Applicable to Non-Bank Subsidiaries

General

As discussed below, the non-bank subsidiaries of the Company are subject to supervision and examination by the FRB and may be subject to the supervision of, and regulation and licensure by, other state and federal regulatory agencies. There are also a number of proposed and enacted federal, state and local laws aimed at protecting a consumer’s privacy. Generally, privacy laws cover a wide range of issues including limiting a company’s ability to share information with third parties or affiliates, providing stronger identity theft protection, victim’s assistance programs and security breach notification, providing the ability to avoid telemarketing solicitations through “do-not-call” lists, and limiting e-mail and fax advertising. These laws also impose penalties for non-compliance.

Mortgage Banking Segment

Our mortgage banking business is subject to the rules, regulations or guidelines of, and/or examination or investigation by, the following entities with respect to the processing, originating, selling and servicing of mortgage loans:

·       The Federal Reserve Board

·       The Department of Housing and Urban Development (“HUD”)

·       The Federal Housing Administration

·       The Department of Veteran Affairs

·       Fannie Mae, Freddie Mac and Ginnie Mae

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·       Office of the Comptroller of Currency

·       The Federal Home Loan Bank (“FHLB”)

·       The Federal Trade Commission

·       State regulatory authorities and Attorneys General.

The rules, regulations and requirements of these entities, among other things, impose licensing obligations on the Company or its subsidiaries; establish standards for advertising as well as processing; underwriting and servicing mortgage loans and appraisal practices; prohibit discrimination; restrict certain loan features in some cases; and fix maximum interest rates and fees in some states.

As an FHA lender, we are required to submit to the FHA Commissioner, on an annual basis, audited financial statements. Ginnie Mae, HUD, Fannie Mae and Freddie Mac require the maintenance of specified net worth levels (which vary among the entities). Our affairs are also subject to examination by the Federal Housing Commissioner to assure compliance with FHA regulations, policies and procedures.

Mortgage origination activities are subject to the Fair Housing Act, Equal Credit Opportunity Act, Truth-in-Lending Act, Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act and the Home Ownership Equity Protection Act and the regulations promulgated under those statutes, as well as other federal laws and other regulations. These laws prohibit discrimination, require the disclosure of certain basic information to mortgagors concerning credit terms and settlement costs, prohibit referral fees and require the maintenance and disclosure of information regarding the disposition of mortgage applications based on race, gender, geographical distribution, income level and APR over certain thresholds. We expect the publication of such information to lead to heightened scrutiny of all mortgage lenders’ loan pricing and underwriting practices.

Currently, there are a number of proposed and recently enacted federal, state and local laws and regulations and guidance addressing responsible lending practices with respect to borrowers with blemished credit or nontraditional mortgage products. In general, these laws and regulations would or will impose new loan disclosure requirements; restrict or prohibit certain loan terms, fees and charges such as prepayment penalties; may require borrower counseling; and increase penalties for non-compliance. Due to our lending practices, we do not believe that the existence of, or compliance with, these laws and regulations would have a material adverse impact on our business.

However, there can be no assurance that more restrictive laws, rules and regulations will not be adopted in the future or that the existing laws, rules and regulations will not be applied in a manner that may adversely impact our business or make compliance more difficult or expensive.

Capital Markets Segment

Securities broker-dealer operations are subject to federal and state securities laws, as well as the rules of the United States Securities and Exchange Commission, the National Association of Securities Dealers, Inc., Financial Services Agency of Japan, Financial Services Authority of the United Kingdom, the National Futures Association and the Commodities and Futures Trading Commission. State and federal securities laws govern many aspects of the broker-dealer’s business, including the maintenance of required levels of net capital, the establishment of segregated cash accounts for the benefit of customers, the monthly and annual reporting of operating and financial data to regulators, the approval and documentation of trading activity, the retention of records and the governance of the manner in which business may be conducted with customers.

Insurance Segment

The Company, by virtue of its ownership of insurance companies, is a member of an insurance holding company group pursuant to the provisions of the insurance holding company acts (collectively the

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“Holding Company Acts”). The insurance company entities are subject to the various state insurance departments’ broad regulatory, supervisory and administrative powers. These powers relate primarily to: the standards of capital and solvency which must be met and maintained; the licensing of insurers and their agents; the nature and limitation of insurers’ investments; the approval of rates, rules and form; the issuance of securities by insurers; periodic examinations of the affairs of insurers; and the establishment of reserves required to be maintained for unearned premiums, losses and other purposes.

Pursuant to the Holding Company Acts, the Company must provide state insurance departments with certain financial information. In addition, certain transactions specified by the Holding Company Acts may not be effected without the prior notice and/or approval of the applicable insurance department. Examples of transactions that may require prior approval include, but are not limited to, sales, purchases, exchanges, loans and extensions of credit, and dividends and investments between the insurance company entity and other entities within the holding company group.

Global Operations

The mortgage loan application processing and servicing business of our Global Operations Segment is regulated by the Financial Services Authority in the United Kingdom.

Taxation

Countrywide files a consolidated federal income tax return and a combined income tax return in California and certain other states. Additional income tax returns are filed on a separate entity basis in various other states and localities.

Deferred taxes are provided for the future tax effects of temporary differences between the book and tax basis of assets and liabilities. The Company’s primary temporary difference relates to its investment in mortgage servicing rights retained upon the sale of mortgage loans. According to the Internal Revenue Code and related administrative guidance, substantially all of the Company’s gain on sale of loans is recognized in future periods as servicing fee income is earned.

Countrywide is generally subject to California’s higher income tax rate for financial corporations in lieu of having to pay certain state and local personal property and other taxes that are paid by non-financial corporations. The statutory financial corporation tax rate was 10.84% for both 2005 and 2004. The Company apportions taxable income to the various states in which it does business based on its level of business activity in those states, which is determined primarily by reference to payroll costs, revenues and property (including loans outstanding). Among the many factors that the Company considers in determining where to conduct its business activities are prevailing state income tax rates.

As a matter of course, the Company is regularly audited by federal, state and other tax authorities. The Internal Revenue Service has examined Countrywide’s tax returns for tax years through 2002, and is currently examining 2003 and 2004. The Company is not currently under examination by the California Franchise Tax Board, which has audited tax years through 2001. Management believes it has adequately provided for probable tax liabilities that may be assessed for years in which the statute of limitations remain open.

Future Legislation

Various legislation, including proposals to change substantially the financial institution regulatory system, is from time to time introduced in Congress. This legislation may change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, this legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. We cannot predict whether any of this potential legislation will be enacted and, if enacted, the effect that it, or

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any implementing regulations, could have on the Company’s business, results of operations or financial condition.

Basel II Capital Standards

We may be required to comply with, or decide to adopt, certain new capital and other regulatory requirements proposed by the Basel Committee on Banking Supervision. These proposed requirements, which are often referred to as the Basel II Accord, would, among other things, modify the capital charge applicable to credit risk and incorporate a capital charge for operational risk. The Basel II Accord also places greater reliance on market discipline than current standards. We have not yet determined whether to adopt to the Basel II Accord. The  Basel II standards will be mandatory with respect to banking organizations with total banking assets of $250 billion or more or total on-balance-sheet foreign exposure of $10 billion or more.

If we choose to opt in, Countrywide Financial Corporation will be required to implement advanced measurement techniques employing internal estimates of certain key risk drivers to derive capital requirements. Prior to our implementation of the new capital regime, we will be required to demonstrate to our primary federal regulators that our measurement approaches meet relevant supervisory standards. Although opting into Basel II may require us to meet more onerous computational requirements, we believe it may provide a more favorable capital treatment with respect to home loans. U.S. regulators have proposed an effective date of January 1, 2008 with a gradual phase-in schedule. If Countrywide Financial Corporation adopts Basel II, voluntarily or mandatorily, the Basel II Accord requirements would replace existing risk-based capital requirements, but not the leverage capital requirements imposed under U.S. law and regulation.

The references in the foregoing discussion to various aspects of statutes and regulations are summaries which do not purport to be complete and which are qualified in their entirety by reference to the actual statutes and regulations.

Workforce

At December 31, 2005, we had a workforce of 54,456, including regular employees and temporary staff, engaged in the following activities:

 

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Other than certain Global Home Loans employees who are represented by an independent trade union in the United Kingdom, none of our employees are represented by a collective bargaining agent.

Additional Information

Countrywide Financial Corporation was incorporated in New York on March 14, 1969, and on February 6, 1987, was reincorporated in Delaware. The Company was originally named OLM Credit Industries, Inc., and has also been known as Countrywide Credit Industries, Inc.

Loan Production Tables

The following table presents our consolidated loan production by loan type for the periods indicated:

(1)          Excludes commercial real estate loans.

(2)          Percentage of total loan production based on dollar volume.

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