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

 3/01/07  Countrywide Financial Corp        10-K       12/31/06   14:9.1M                                   Merrill Corp-MD/FA

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K        Annual Report                                       HTML   5.04M 
 2: EX-4.39     Instrument Defining the Rights of Security Holders  HTML     35K 
 3: EX-4.40     Instrument Defining the Rights of Security Holders  HTML     23K 
 4: EX-4.41     Instrument Defining the Rights of Security Holders  HTML     76K 
 5: EX-4.42     Instrument Defining the Rights of Security Holders  HTML     71K 
 6: EX-4.46     Instrument Defining the Rights of Security Holders  HTML     28K 
 7: EX-4.47     Instrument Defining the Rights of Security Holders  HTML     23K 
 8: EX-12.1     Statement re: Computation of Ratios                 HTML     35K 
 9: EX-21       Subsidiaries of the Registrant                      HTML     88K 
10: EX-23       Consent of Experts or Counsel                       HTML     14K 
11: EX-31.1     Certification per Sarbanes-Oxley Act (Section 302)  HTML     14K 
12: EX-31.2     Certification per Sarbanes-Oxley Act (Section 302)  HTML     14K 
13: EX-32.1     Certification per Sarbanes-Oxley Act (Section 906)  HTML     11K 
14: EX-32.2     Certification per Sarbanes-Oxley Act (Section 906)  HTML     11K 

Countrywide Financial Corporation

2006 Annual Report on 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		10
		Capital Markets Segment		12
		Insurance Segment		13
		Global Operations Segment		15
		Financing of Operations		15
		Regulations		17
		Workforce		27
		Additional Information		27
		Loan Production Tables		28
	Item 1A.	Risk Factors		35
	Item 1B.	Unresolved Staff Comments		40
	Item 2.	Properties		40
	Item 3.	Legal Proceedings		40
	Item 4.	Submission of Matters to a Vote of Security Holders		40
PART II
	Item 5.	Market for the Company’s Common Stock, Related Stockholder Matters and Issuer Purchase of Equity Securities		41
	Item 6.	Selected Consolidated Financial Data		43
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		45
		Overview		45
		Critical Accounting Policies		47
		Results of Operations Comparison—Year Ended December 31, 2006 and Year Ended December 31, 2005		53
		Results of Operations Comparison—Year Ended December 31, 2005 and Year Ended December 31, 2004		75
		Quantitative and Qualitative Disclosures About Market Risk		94
		Credit Risk Management		100
		Loan Servicing		113
		Inflation		114
		Seasonality		114
		Liquidity and Capital Resources		114
		Off-Balance Sheet Arrangements and Aggregate Contractual Obligations		122
		Prospective Trends		123
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		128
	Item 8.	Financial Statements and Supplementary Data		128
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		129
	Item 9A.	Controls and Procedures		129
	Item 9B.	Other Information		132

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PART III
	Item 10.	Directors and Executive Officers of the Registrant		133
	Item 11.	Executive Compensation		133
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		133
	Item 13.	Certain Relationships and Related Transactions		133
	Item 14.	Principal Accountant Fees and Services		133
PART IV
	Item 15.	Exhibits, Financial Statement Schedules		134

 

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 real estate finance-related businesses, including mortgage banking, banking and mortgage warehouse lending, dealing in securities and insurance underwriting.

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, sell and service non-commercial mortgage loans nationwide.

·       Banking—We take deposits and invest in mortgage loans and home equity lines of credit, sourced primarily through our mortgage banking operation as well as through purchases from non-affiliates. We also provide short-term secured financing to mortgage lenders.

·       Capital Markets—We operate an institutional broker-dealer that primarily specializes in trading and underwriting mortgage-backed securities. We also trade derivative products and U.S. Treasury securities, provide asset management services and originate for sale loans secured by commercial real estate. Within this segment we also manage the acquisition and disposition of mortgage loans on behalf of the Mortgage Banking Segment.

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

·       Global Operations—We license proprietary technology to mortgage lenders in the UK. We also perform certain of the Company’s administrative and loan servicing functions through our India operations.

Mortgage banking continues to be our core business, generating 48% of our pre-tax earnings in 2006. Our other segments generated the following percentages of our pre-tax earnings in 2006: Banking—32%; Capital Markets—13%; Insurance—6%; and Global Operations—1%. We remain a real-estate lending-centered company and have built upon our mortgage banking operations in recent years to capitalize on meaningful related opportunities with the intent of stabilizing our consolidated earnings profile. 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 on which we 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, 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, the charters of the committees of our Board of Directors and all amendments and updates to these documents 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. Nearly all of the mortgage loans that we produce in the Mortgage Banking and Capital Markets Segments are sold into the secondary mortgage market, primarily in the form of securities and to a lesser extent in the form of loans. We generally perform the ongoing servicing functions related to the residential mortgage loans that we produce. Loans produced in our Banking Segment have generally been held for investment.

Types of Products

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, office buildings, 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 2007) 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.

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The following table summarizes our mortgage loan production by segment and product, net of intersegment sales:

(1)          Acquisitions from third parties.

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. The mortgage loans we produce in this segment are generally sold into the secondary mortgage market, primarily in the form of securities, and to a lesser extent in the form of loans. We typically perform the ongoing servicing functions related to the mortgage loans that we produce. We also provide various loan closing services such as escrow, flood determinations and appraisal. We group the activities of our Mortgage Banking Segment into three business sectors—Loan Production, Loan Servicing and Loan Closing Services.

Loan Production

We produce mortgage loans through three production channels of Countrywide Home Loans (“CHL”)—Retail Channel (Consumer Markets and Full Spectrum Lending), Wholesale Lending Channel and Correspondent Lending Channel. These loans are funded either through one of these channels or through Countrywide Bank. Countrywide Bank funds loans for both our Mortgage Banking and Banking Segments.

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

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

(2)          $106.0 billion and $8.1 billion of these loans were funded by Countrywide Bank during the years ended December 31, 2006 and 2005, respectively.

Retail Channel

The retail channels consist of the Consumer Markets Division (“CMD”) and the Full Spectrum Lending Division (“FSLD”). CMD generally originates prime loans through existing relationships with customers and organizations that influence the placement of mortgage services, while the Full Spectrum Lending Division focuses on new customer acquisitions through mass media advertising. In addition, FSLD originates nonprime mortgage loans.

For 2006, Countrywide was ranked by Inside Mortgage Finance as the second largest retail lender, in terms of volume, among residential retail mortgage lenders nationwide. (Reprinted with the permission of Inside Mortgage Finance Inc. (“IMF”) Copyrighted. All rights reserved by IMF.)

Consumer Markets Division

CMD originates mortgage loans through three business groups: the Distributed Retail group, the Business-to-Consumer group and the Strategic Business Alliances group.

The Distributed Retail group is the branch network which originates loans through relationships with consumers, builders, Realtors® and through joint ventures. As of December 31, 2006, this group consisted of 773 branch offices in 48 states and the District of Columbia, including 62 dedicated joint venture branches. This group has a sales force of 6,602, which includes those dedicated to joint venture relationships. The Distributed Retail group (including the joint venture relationships) originated 74% of CMD total volume for the year ended December 31, 2006.

The Business-to-Consumer group primarily originates mortgage loans directly from existing customers through the Internet and through our call centers. The Business-to-Consumer group focuses on customer retention through marketing and by providing our existing customers with an efficient and convenient means to obtain financing for a new home or for refinancing their existing mortgage or a home equity loan. As of December 31, 2006, the Business-to-Consumer group consisted of five call centers with a sales staff of 985. This group accounted for 18% of CMD’s total volume for the year ended December 31, 2006.

The Strategic Business Alliance group facilitates and manages the development of new sources of loans through relationships with organizations that influence the placement of mortgage services. This

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group focuses primarily on developing revenue-sharing arrangements such as joint ventures, third party outsourcing, relocation lending, marketing service agreements and brokered-in agreements. This group accounted for 8% (excluding Distributed Retail volume from joint venture relationships) of CMD’s total volume for the year ended December 31, 2006.

Full Spectrum Lending Division

FSLD originates Nonprime and Prime Mortgage Loans with the primary focus on refinance and home equity products. FSLD operates through a network of 226 retail branch offices located in 39 states, as well as 11 call centers. The branches and call centers of FSLD are supported by four fulfillment centers for processing, underwriting and funding of these mortgage loans.

FSLD’s mortgage production is generated primarily through customer retention efforts directed to Countrywide’s nonprime servicing portfolio and new customer acquisition through direct mail, Internet, mass media and joint venture relationships. Of the 226 FSLD retail branch offices, 56 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.

Wholesale Lending Channel

Our Wholesale Lending Channel (“WLD”) underwrites and funds mortgage loans sourced by mortgage loan brokers and other financial intermediaries. WLD sources loans through approximately 30,000 mortgage loan brokers nationwide. WLD offers a wide variety of Prime and Nonprime Mortgage Loans and Prime Home Equity Loan products. Business is solicited through a sales force, the Internet and advertising.

As of December 31, 2006, WLD operated 52 branch offices and seven fulfillment centers in various parts of the United States.

For 2006, Countrywide was ranked by Inside Mortgage Finance as the largest wholesale originator, in terms of volume, among residential wholesale mortgage lenders nationwide. (Reprinted with the permission of IMF Copyrighted. All rights reserved by IMF.)

Correspondent Lending Channel

Our Correspondent Lending Channel (“CLD”) 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, 2006, this Channel had correspondent relationships with approximately 2,100 lenders, who are subject to initial and ongoing credit evaluation and monitoring. CLD operates in all 50 states.

For 2006, Countrywide was ranked by Inside Mortgage Finance as the largest correspondent lender, in terms of volume, among residential correspondent mortgage lenders nationwide. (Reprinted with the permission of IMF Copyrighted. All rights reserved by IMF.)

Countrywide Bank Mortgage Banking Activities

As well as funding loans for its investment portfolio, Countrywide Bank funds loans that are originated for sale by our Mortgage Banking Segment. Because this activity is a Mortgage Banking activity, the mortgage loan production, the related balance sheet and the income relating to the holding and sale of these loans is included in our Mortgage Banking Segment. The funding of loans by Countrywide Bank for our Mortgage Banking operations provides an efficient means of financing loans during the period the loans are held for sale.

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Affordable and Multicultural Home Loan Programs

Since 1992, we have adopted 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 (“HUD”).

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 Internet-based resources to educate prospective first-time minority and low-to moderate-income homebuyers about the home loan process. We House America® also provides Spanish-speaking 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 930 mortgage loan programs that assist borrowers 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 borrower populations by the end of 2010. As of December 31, 2006, we made loans to 4.2 million borrowers and funded $668 billion (including Prime and Nonprime Mortgage Loans) toward this goal.

Loan Servicing

When we sell or securitize mortgage loans, we generally retain the rights to service these loans. These are referred to as mortgage servicing rights (“MSRs”). We may also retain financial interests when we securitize mortgage loans. We include the value of these retained interests on our balance sheet. The results of the Loan Servicing Sector income statement includes the changes in value related to our MSRs and retained interests, as well as the revenues and expenses arising from servicing the 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 and supervise foreclosures and property dispositions. We receive servicing fees and other remuneration in return for performing these functions.

Mortgage Servicing Rights, 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 sale or securitization of mortgage loans that we originate, we also occasionally purchase MSRs from others. For a more complete description of MSRs, see Note 3—Loan Sales in the financial statement section of this Report.

MSRs and retained interests are generally subject to a loss in value when mortgage rates decline. To moderate the effect on earnings caused by a rate-driven decline in value of MSRs and retained interests, we maintain a portfolio of financial instruments, primarily derivative contracts, which generally increase in value when interest rates decline. This portfolio of financial instruments is referred to as the “Servicing

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Hedge.” See Note 4—Derivative Financial Instruments—Risk Management Activities Related to Mortgage Servicing Rights (MSRs) and 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 eight primary locations using the same systems and processes: two in California, three in Texas, one in Arizona and two in India.

Customer Service

Our Customer Service Call Centers managed nearly 58 million contacts with customers in 2006. These contacts were primarily handled through our customer service representatives, automated phone system and Website (www.customers.countrywide.com). This division also prints monthly statements and oversees outbound customer correspondence.

Remittance Processing

Our Remittance Processing division processes all payments, loan payoffs and payoff demand statements.

Collections and Loss Mitigation

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

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, Freddie Mac and the Government National Mortgage Association (“Ginnie Mae”), as well as private investors.

Foreclosure and Bankruptcy

Foreclosure and bankruptcy are complex processes that are subject to federal and state laws and regulations, as well as mortgage investor and insurer requirements. Our workflow-based systems facilitate consistent and compliant processing of defaulted mortgage loans, as well as an efficient flow of data between internal and external business partners. We use our own companies in support of many of our foreclosure and bankruptcy activities to minimize related costs and to increase efficiency.

Related Services

We perform several loan servicing functions internally that other loan servicers commonly outsource to third parties. Our integrated services include performing property tax payment processing, property inspections, and insurance tracking and premium payment processing. 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.

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The following table sets forth certain information regarding the Company’s loan servicing portfolio of single-family mortgage loans, including loans and securities held for sale, loans held for investment and loans subserviced under subservicing agreements, for the periods indicated:

(1)          Excludes purchases from third parties in which the servicing rights were not acquired.

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(1)          This excludes subserviced loans and loans purchased at a discount due to their collection status. Expressed as a percentage of the number of loans serviced.

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 the total unpaid principal balance at December 31, 2006:

State				Unpaid Principal Balance					% Total Balance
				(in millions)
California
Southern					$	237,013				18	%
Northern					130,409					10	%
					367,422					28	%
Florida					97,442					8	%
Texas					57,724					4	%
All other states					775,806					60	%
Total					$	1,298,394				100	%

 

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Loan Closing Services Sector

We provide loan closing products and services such as credit reports, appraisals, 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 channels, but also to third parties.

Competition and Consolidation

The mortgage lending industry is dominated by large, sophisticated financial institutions. To continue to compete effectively, we will be required to maintain a high level of operational, technological, and managerial expertise, as well as an ability to attract capital at a competitive cost. Recently, well-capitalized Wall Street investment banking firms have increased their participation in the mortgage banking business. We expect the entrance of these firms to the marketplace to increase competition in the near-term, especially in the nonconforming and nonprime loan products.

The industry continues to undergo consolidation. We expect this trend to continue. We believe that we will benefit from industry consolidation through increased market share and enhanced ability to recruit talented personnel.

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

Banking Operations

Our Banking Operations primarily fund and purchase mortgage loans and home equity loans for investment purposes. The majority of these loans are sourced through our Mortgage Banking production channels. For liquidity and asset-liability management purposes, we also invest in securities such as collateralized mortgage obligations and agency Mortgage-Backed Securities (“MBS”). The Bank activities provide the Company with an expanded product menu, lower cost funding sources and opportunities for a stable source of revenue in the form of net interest income.

Our Banking Operations continue to leverage the relationship with our Mortgage Banking Segment, sourcing high-quality mortgage assets for our investment portfolio through the Mortgage Banking Segment’s existing production distribution channels, as well as through purchases of loans from non-affiliated lenders. Asset growth is funded by the Bank’s liability base. The Bank obtains retail deposits, primarily certificates of deposit, through 99 financial centers, 78 of which are located in CHL’s retail branch offices as of December 31, 2006, call centers and the Internet. Countrywide Bank also offers deposit accounts through deposit brokers (generally, well-recognized financial intermediaries).

A significant portion of Countrywide Bank’s deposit liabilities are comprised of custodial funds that relate to the loan servicing portfolio of CHL. Countrywide Bank also borrows funds from other sources to supplement its deposit liabilities, including mortgage loan-secured borrowings from the Federal Home Loan Bank (“FHLB”) of Atlanta, repurchase agreements secured by purchased federal funds. Countrywide Bank also offers commercial deposit accounts to title and mortgage insurance companies through a developing commercial business unit.

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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, collateral review/certification, collateral releases and customer reporting.

Properties securing the mortgage loans in our Banking Operations’ 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 portfolio for the states with more than five percent of the total unpaid principal balance at December 31, 2006:

State				Unpaid Principal Balance					% Total Balance
				(in thousands)
California
Southern					$	19,638,756				27	%
Northern					13,272,718					19	%
					32,911,474					46	%
Florida					4,292,588					6	%
Virginia					3,777,253					5	%
All other states					30,816,948					43	%
Total					$	71,798,263				100	%

 

Mortgage Banking Activities

Countrywide Bank produces loans for sale which we have defined as a Mortgage Banking activity. The mortgage loan production, the related balance sheet and the income relating to the holding and sale of these loans is therefore included in our Mortgage Banking Segment. We fund loans through Countrywide Bank for sale by our Mortgage Banking Segment as an efficient means of financing loans during the period the loans are held for sale.

Countrywide Warehouse Lending

We provide committed and uncommitted lines of credit to mortgage bankers to finance their mortgage loan inventories, which we refer to as warehouse lending, through both a non-depository lending company and Countrywide Bank. Most of these mortgage bankers sell loans to our Mortgage Banking Segment’s Correspondent Lending Channel. All of these advances are secured by mortgage loans that have a market value in excess of the balance of our advances.

Competition

We operate in a highly competitive environment. Competition for retail deposits comes primarily from other insured depository institutions, which include more than 7,400 commercial banks and approximately 1,300 savings institutions. We attract and retain deposits through a combination of competitive rates, physical presence, experienced banking professionals and easy access to our products through call centers and the Internet at www.countrywidebank.com. Because of our low-cost structure relative to other financial institutions, we are able to offer deposit rates that are among the most competitive in the industry.

Countrywide Bank invests primarily in adjustable-rate and short duration residential mortgage loans. Competition in making real estate loans comes 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 Segment. Countrywide Bank also competes with commercial banks and investment banks in the purchase of loans from third parties.

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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 CHL. As discussed above, Countrywide Bank obtains retail deposit products through financial centers placed within certain of CHL’s retail branch offices. This economical use of space reduces the Bank’s deposit acquisition costs.

Capital Markets Segment

Our Capital Markets Segment primarily operates as a registered securities broker-dealer, which is also a primary dealer of U.S. Treasury securities, a residential mortgage loan manager and a commercial mortgage loan originator. We also operate broker-dealers in Japan, Hong Kong and the United Kingdom; an introducing broker of futures contracts; an asset manager; a broker of MSRs and a derivatives dealer. With the exception of our commercial mortgage activities, we transact primarily 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 CHL. In our conduits, we manage both Nonprime Mortgage Loans and Prime Mortgage Loans which are either acquired from third parties or originated by CHL. We accumulate these loans for sale either through securitizations or loan sales. 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 CHL, 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.

Underwriting

Capital Markets participates in both competitive bid and negotiated underwritings and underwrites for both CHL and third parties. Underwriting activities may encompass the assumption of the market 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. 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 and the level of market risk assumed may vary based upon the nature of the market and the terms of the underwriting agreement.

Securities Trading

Securities trading activities include the trading of debt securities in the secondary market after the original issuance of the security and, to a much lesser extent, trading of derivative financial instruments. We generally trade mortgage-related fixed-income securities, including MBS, collateralized mortgage obligations and asset-backed securities (“ABS”) issued by Fannie Mae, Freddie Mac, Ginnie Mae and other financial institutions, including CHL. We also trade securities issued by the U.S. Department of Treasury and other governmental agencies.

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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, office buildings, industrial sites and hotels.

Brokering

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

Asset Management

Asset management activities are conducted for the benefit of investors. This includes managing a private equity fund, as well as management of 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 CHL 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, we believe that our competitive position is strengthened by our offerings of more non-residential mortgage related products and services to the global institutional investor markets.

For 2006, according to Inside MBS & ABS, we ranked second among Non-Agency MBS Underwriters.

Insurance Segment

Our Insurance Segment’s primary activities are:

·       Offering property, casualty, life and disability insurance as an underwriter and as an insurance agent, offering warranty products and services, insurance tracking services affiliated with our lender-placed insurance programs and an array of commercial insurance products through our agency (“Insurance Operations”).

·       Providing reinsurance coverage to primary mortgage insurers (“Reinsurance Operations”).

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

Insurance Operations

Our insurance operations include our insurance underwriters/carriers and their affiliated businesses, and our agency operations.

We underwrite property, casualty, life and disability insurance in 50 states and the District of Columbia through the insurers that make up Balboa Insurance Group. Our retail insurance products are offered by select general insurance agents serving the consumer market, including our insurance agency.

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Our insurance operations offer the following insurance product lines:

·       Lender-Placed Property and Automobile—We offer lender-placed real-property hazard insurance and lender-placed automobile insurance. Such insurance is provided on behalf of mortgage and automobile 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 18.5 million loans, including nearly 8.2 million loans serviced within our Mortgage Banking Segment.

·       Voluntary Homeowners and Automobile—We underwrite retail homeowners and automobile insurance for consumers under the brand name Countrywide Insurance Group. We also offer home warranties to consumers.

·       Life, Disability and Credit—We underwrite term life, credit disability and credit life insurance products. Our retail insurance products are offered by select general insurance agents servicing the consumer market, including our affiliated agency.

During 2005, we filed a notice with the Florida Office of Insurance Regulation to discontinue underwriting voluntary homeowners and renters insurance in Florida. In March 2006, the Florida office of Insurance Regulation approved our plan to discontinue underwriting voluntary homeowners and renters insurance in Florida, with non-renewal of residential policies beginning July 1, 2006.

Our Insurance Operations’ property and casualty division has received an “A (Excellent)” rating from A.M. Best Company, an insurance company rating and information service. Our life insurance operations maintain an “A- (Excellent)” rating from A.M. Best Company. The “Excellent” rating is defined by the A.M. Best Company as having “an excellent ability to meet ongoing obligations to policy holders.”

Our insurance agencies provide consumers, in particular our mortgage customers, with homeowners, life, disability, automobile and various other insurance products. Our insurance agencies also operate a full-service commercial insurance program that offers a comprehensive menu of products and services to meet the insurance needs of small, mid-size and large businesses. The commercial insurance group 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.

Reinsurance Operations

We provide mortgage reinsurance to the insurance companies that provide primary mortgage insurance (“PMI”) on loans in our servicing portfolio. This reinsurance covers losses in excess of a specified percentage of the principal balance of a given pool of mortgage loans, subject to a contractual limit, in exchange for a portion of the pools’ mortgage insurance premium. 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 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 price.

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The homeowners, automobile, term life, credit-life and credit-disability marketplaces are dominated by large, well-known providers. Consumers select such insurance based on price, service 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 provided mortgage loan application processing and mortgage loan subservicing in the UK until July 31, 2006, when we discontinued such businesses. However, we continue to license certain of the related technology to mortgage lenders in the UK.

·       Offshore Services—We perform business process and technology services for various units of the Company at three locations in India.

Competition

Our competitors in this segment include 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 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.

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

·       Investments in mortgage loans

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

·       Financial instruments acquired to manage the interest rate risk associated with those investments.

Sources of Financing

We meet our financing needs primarily through the following means:

·       Unsecured commercial paper and medium-term notes

·       Asset-backed commercial paper

·       Revolving lines of credit

·       Short-term repurchase agreements

·  Deposit-gathering

·       FHLB advances

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·       Unsecured subordinated debt and junior subordinated debt, which includes high equity content debt securities

·       Retained earnings.

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

Our ongoing access to the public debt markets is dependent on a high credit rating. For the last 14 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 standby lines of credit. We also must maintain a conservative debt-to-equity ratio. Current credit ratings are as follows:

Countrywide Financial Corporation

Countrywide Home Loans

Countrywide Bank

Rating Agency

Short-Term

Long-Term

Short-Term

Long-Term

Short-Term

Long-Term

Standard & Poors

A-1

A

A-1

A

A-1

A

Moody’s Investors Service

P-2

A3

P-2

A3

P-2

A3

Fitch

F1

A

F1

A

F1

A

 

We use short-term secured financing such as asset-backed commercial paper conduits and repurchase agreements 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 FHLB 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 and Capital Markets Segment are sold in the secondary mortgage market, primarily in the form of MBS and ABS.

Our strategy is to 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. 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 subordinated and junior subordinated debt that receives varying degrees of “equity treatment” from rating agencies, bank lenders and regulators. From time to time, we may issue common stock or other debt securities that receive high equity treatment as a means of supplementing our capital base and supporting our growth. We may also repurchase common stock pursuant to the repurchase program approved by our Board of Directors.

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 Resources.

Interest Rate Risk

We typically bear interest rate risk from the time we commit to make a loan at a specified interest rate through the sale or repayment of the loan. We also bear interest rate risk related to the interests we retain in the loans we sell, which are typically in the form of MSRs and retained securities, and to the extent that our loan and securities investment portfolios’ yields change on a different basis or at different times than

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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

Credit risk is the risk that a borrower will not repay the loan’s balance as agreed and the risk that the proceeds from liquidation of the collateral securing the loan will not be adequate to repay the loan’s balance. Historically, our primary source of credit risk has been the continuing investments and/or obligations we retain either in the form of credit-enhancing subordinated interests, corporate guarantees or representations and warranties issued when we sell or securitize loans. As our portfolio of investment loans has grown, our portfolio credit risk has also grown. 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 Financial Institutions and their Holding Companies

General

On December 6, 2006, we applied to the Office of Thrift Supervision (the “OTS”) to convert Countrywide Bank to a federally chartered savings bank and thereby Countrywide will become a savings and loan holding company subject to regulation by the OTS. We expect the conversion application to be acted upon, and the conversion implemented in the first quarter of 2007, although there can be no assurances when or if regulatory approval will be obtained. However, as of February 28, 2007, we were a bank holding company that had elected to become a financial holding company under the Bank Holding Company Act, as amended (the “BHC Act”).

The references in the following 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.

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Regulations Applicable to our Current Status

Regulations Applicable to Bank Holding Companies

General:   As a financial holding company, 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 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 Deposit Insurance Fund of the Federal Deposit Insurance Corporation, not our shareholders or creditors.

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 at least “satisfactory” Community Reinvestment Act (“CRA”) ratings, may elect to become a “financial holding company” and engage in a broader range of powers that are financial in nature or incidental to a financial activity (such as insurance, securities underwriting and dealing, and merchant banking). 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 CRA rating 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, 2006, the Company was in compliance with all of the FRB’s capital adequacy guidelines to be classified as “well capitalized” with a Leverage ratio of 6.9%, Tier 1 Risked-Based Capital ratio of 11.6% and a Total Risk-Based Capital ratio of 12.8%.

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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 (“Basel 1A”), with the expressed intention to align those standards more closely with those that would be applicable to Basel II institutions. These standards would 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 and Basel 1A Capital Standards.”

Source of Strength:   FRB policy expects 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 as a National Bank

General:   Countrywide Bank, N.A. (the “Bank”), a national banking association, is subject to regulation and examination by the Office of the Comptroller of the Currency (the “OCC”). The Bank’s deposits are insured by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”) to the maximum extent permitted by law. 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 Deposit 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. The Bank must be well capitalized and well managed for the Company to remain a financial holding company. On December 31, 2006, the Bank was in compliance with the OCC’s minimum capital requirements to be classified as well capitalized, with a leverage ratio of 7.3%, a Tier 1 Risked-Based Capital ratio of 12.4% and a Total-Risk Based Capital ratio of 12.8%.

Deposit Insurance and Assessments:   As a result of the Federal Deposit Insurance Reform Act of 2005, the FDIC adopted a revised risk-based assessment system to determine assessment rates to be paid by member institutions such as the Bank, including institutions that are well managed and well capitalized. Under this revised assessment system, risk is defined and measured using an institution’s supervisory ratings with certain other risk measures, including certain financial ratios and, for large institutions, such as the Bank, long-term debt issuer ratings. The annual rates for 2007 for institutions in risk category I, the lowest risk category, range from 5 to 7 basis points. These rates may be offset by a one time assessment credit held by an institutions, based on the assessment base of that institution as of December 31, 1996, and in the future by dividends that may be declared by the FDIC if the deposit reserve ratio increases above a certain amount.

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

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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 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 (“CRA”):   The Bank is subject to the 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. The Bank’s CRA rating is “satisfactory.”

Limitations on Transactions with Affiliates:   Countrywide Financial Corporation and its non-bank subsidiaries are affiliates of the Bank within the definition 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.

Regulation of Other Activities of National Banks

The investments and activities of the Bank as a national 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.

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In addition, Countrywide Bank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations including the USA Patriot Act of 2001. These laws and regulations require Countrywide Bank to have an effective anti-money laundering program that would prevent the use of Countrywide Bank for facilitating the flow of illegal funds by for example, reporting large currency transactions, filing suspicious activity reports, implementing appropriate know your customer programs, and maintaining appropriate compliance programs. Violation of these provisions can result in substantial civil and criminal penalties. In addition, the federal bank regulatory agencies, including the FRB, OCC and OTS, are required to consider the effectiveness of an institution’s anti-money laundering program when reviewing bank mergers and acquisitions.

Regulations Applicable After Conversion of Countrywide Bank to a Federal Chartered Savings Bank

Regulations Applicable to Savings and Loan Holding Companies

Limitation on Activities:   As a unitary savings and loan holding company, Countrywide will be limited to business activities that are permitted under applicable provisions of the Home Owners’ Loan Act and regulations promulgated thereunder. These activities include those permitted to bank or financial holding companies under the BHC Act, any activities in which a multiple savings and loan holding company was authorized to engage in directly on March 5, 1987 (which include certain real estate related activities) and certain other activities outlined in applicable law and regulation. Management believes that the restrictions on our activities as a savings and loan holding company will not substantially differ from those applicable to a bank holding company.

Regulatory Capital Requirements: As a savings and loan holding company, Countrywide will not be subject to the consolidated regulatory capital requirements applicable to a bank holding company. However, the OTS expects savings and loan holding companies to maintain capital that is sufficient to support the holding company’s business activities, and the risks inherent in those activities. Countrywide Bank will remain subject to capital requirements that are substantially similar to those applicable to national banks.

Enforcement:   The OTS has the power to take enforcement action against savings and loan holding companies and their affiliates to the extent that any action or business taken or conducted by the holding company or affiliate threatens the safety, soundness or stability of the subsidiary insured institution.

Qualified Thrift Lender Test: Federal savings banks must comply with the Qualified Thrift Lender (“QTL”) Test. The QTL Test requires that a savings association, including a federal savings bank, have assets designated as “qualified thrift investments” constituting no less than 65% of its portfolio assets. Qualified thrift investments are defined to include mortgage loans, home improvement loans, home equity loans, mortgage-backed securities, shares of stock issued by any federal home loan bank, small business loans, credit card loans, certain qualifying CRA investments and certain consumer loans. If an institution does not meet the QTL Test, it may be precluded from interstate branching and engaging in any new activities, and certain other restrictions. The Company believes that upon the conversion of the Bank to a federally chartered savings bank, it will be in compliance with the QTL Test. The QTL Test does not apply to national banks or their holding companies.

Regulations Applicable to Countrywide Bank as a Federally Chartered Savings Bank

General:   As a federal savings bank, the Bank will be subject to regulation and examination by the OTS. The Bank’s deposits will continue to be insured by the Deposit Insurance Fund of the FDIC. The OTS is empowered to issue cease and desist orders against a federal savings bank if it determines that activities of the institution represent unsafe and unsound banking practices or violations of law. The OTS has the power to impose upon federal savings banks and certain affiliated parties civil money penalties for violations of banking statutes and regulations. Regulation by this agency is primarily intended to protect

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the depositors of the federal savings bank and the Deposit Insurance Fund of the FDIC, not shareholders or other creditors of the federal savings bank or its holding companies.

Bank Regulatory Capital Requirements:   A federal savings bank is generally subject to regulatory capital requirements similar to those applicable to national banks. In addition, federal savings banks are required to maintain tangible equity capital, as defined in OTS regulations, of no less than 1.5% of adjusted total assets. While intangible assets are deducted from the assets to make this calculation, a substantial portion of MSRs are not considered intangible assets for this purpose. The Company believes that the Bank will be in compliance with the tangible equity capital requirement upon its conversion to a federal savings bank.

Deposit Insurance and Assessments:   As a federal savings bank, the Bank will be subject to the same deposit insurance assessment level as is applicable to it as a national bank.

Limitations on Interest Rate and Loans to One Borrower:   The rate of interest a federal savings bank may charge on certain classes of loans is limited by the same laws as are applicable to national banks. The maximum amount that a federal savings 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:   As a federal savings bank, the Bank will continue to be subject to the provisions of the FDIA relating to dividends and will not be permitted to pay dividends while it is undercapitalized or if payment would cause it to become undercapitalized. The OTS requires federal savings banks that are subsidiaries of savings and loan holding companies to provide notice to the OTS of the declaration of a dividend. In certain instances, such as where the dividend, when aggregated with all other capital distributions in the applicable year, would exceed net income for that year plus retained net income for the preceding two years, or where the federal savings bank would not be at least adequately capitalized, OTS approval of a dividend is required.

Community Reinvestment Act:   As a federal savings bank, the Bank will continue to be subject to the CRA and implementing regulations. CRA ratings will be taken into account by the OTS in reviewing certain applications made by the Company and the Bank.

Limitations on Transactions with Affiliates:   The federal banking laws and regulations applicable to transactions between the Bank and its affiliates will continue to be applicable to the Bank after its conversion to a federal savings bank. In addition, as a federal savings bank, the Bank will not be permitted to extend credit to affiliates that are engaged in certain business activities that were not permitted to bank holding companies prior to the enactment of the GLB Act, nor will it be permitted to invest in securities of an affiliate other than a subsidiary of the Bank.

Regulation of Other Activities of Federally Chartered Savings Bank

The investments and activities of the Bank following its conversion to a federally chartered savings bank are subject to regulation by federal Banking agencies as described in the Regulations Applicable to Our Current Status—Regulation of Other Activities of National Banks section of this Report. In addition, Countrywide Bank will continue to be subject to the Bank Secrecy Act and other anti-money laundering laws and regulations including the USA Patriot Act of 2001.

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

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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

·       The OCC or OTS as applicable

·       The Federal Home Loan Bank (“FHLB”)

·       The Federal Trade Commission

·       State regulatory authorities and Attorneys General

·       Regulation AB of the Securities and Exchange Commission

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 annual percentage rate 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

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prepayment penalties; may require borrower counseling; and increase penalties for non-compliance. The impact of these regulations and guidance on the industry and us is uncertain at this time.

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, Securities and Futures Commission of Hong Kong, Financial Services Authority of the United Kingdom, the National Futures Association and the Commodities and Futures Trading Commission. State, federal and foreign securities laws govern many aspects of the broker-dealer’s business, including the maintenance of required levels of capital requirements, 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 “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 forms; 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 MSRs created upon the sale of mortgage loans. According to the Internal Revenue Code and related

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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 2006 and 2005. 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 currently under examination for tax years 2003 and 2004 by the California Franchise Tax Board, which has previously 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.

Interagency Guidance on Residential Mortgage Products

On October 4, 2006, the FRB, OCC, OTS and the federal financial regulatory agencies issued final interagency guidance on residential mortgage products that allow borrowers to defer repayment of principal and/or interest, including “interest-only” mortgage loans and “payment option” adjustable-rate mortgages, which provide a borrower with flexible payment options, including payments that have the potential for negative amortization. While acknowledging that innovations in mortgage lending can benefit some consumers, in issuing this guidance, the federal banking agencies stated their concern that these and other practices described in the guidance can present risks that institutions must appropriately manage.

The guidance requires that management assess a borrower’s ability to repay the loan, including any additional principal balances resulting from negative amortization, which results when deferred interest payments are added to the principal balance. In particular, the guidance requires that for all nontraditional mortgage loan products, an institution’s analysis of a borrower’s repayment capacity should include an evaluation of their ability to repay the debt at final maturity at the fully indexed rate, assuming a fully amortizing repayment schedule. In addition, for products that permit negative amortization, the repayment analysis should be based upon the initial loan amount plus any balance increase that may accrue from the negative amortization features. The guidance contains further steps which must be taken with respect to loans that have additional risk-layering features, such as reduced documentation programs and simultaneous second liens. The guidance also articulated portfolio management measures that should be taken by institutions that originate or invest in nontraditional mortgage products. Finally, the guidance also requires that financial institutions provide customers sufficient information to clearly understand the loan terms and associated risks prior to a customer’s choosing a nontraditional mortgage product. The impact of this guidance on the industry and the Company is uncertain at this time.

Future Legislation

Various legislation, including proposals to change substantially the financial institution regulatory system, is from time to time proposed for adoption. Any new legislation may change banking or other 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

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effect that it, or 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, as proposed to be implemented in the United States. 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. 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. As a bank holding company, the threshold for mandatory adoption is determined by reference to the consolidated company; following conversion to a federal savings bank, the threshold for mandatory adoption is determined by reference to the federal savings bank subsidiary. We have not yet determined whether to adopt the Basel II Accord prior to the time when the Company is required to adopt it.

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 regulator that our measurement approaches meet relevant supervisory standards. Opting into Basel II may require us to meet more onerous computational requirements. U.S. regulators have proposed an effective date of January 1, 2009 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, or, if adopted earlier, the Basel 1A standards described below, but not the leverage capital requirements imposed under U.S. law and regulation.

In December 2006, the bank regulatory agencies issued a revised notice of proposed rulemaking with respect to a new regulatory capital framework (“Basel 1A”) which will be available to banking organizations that are not required to adopt, and have not elected to adopt, the Basel II Framework. Countrywide Bank may implement the Basel IA framework once it has been finalized and an implementation date is established, unless it has adopted the Basel II Accord. The comment period for the Basel 1A proposed rulemaking expires on March 26, 2007, after which the bank regulatory agencies will evaluate the proposed rule in light of the comments that are submitted. Among the key issues under consideration in connection with Basel 1A are the use of loan-to-value ratios to determine risk weights for most residential mortgages, an increase in the number of risk weight categories to which credit exposures may be assigned; expansion of the use of external credit ratings for certain externally rated exposures, expansion of the range of collateral and guarantors that may qualify an exposure for lower risk weights, and assessment of a risk-based capital charge to reflect the risk in securitizations with early amortization provisions.

At this time, Countrywide cannot predict the final form the Basel IA capital framework will take, when it will be implemented, the effect that it might have on Countrywide Bank’s financial condition or results of its operations, or how these effects might impact Countrywide Financial Corporation. We are monitoring the evolution of the Basel IA capital framework, its potential impact on the Bank, Countrywide Financial Corporation and the industry at large.

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Workforce

At December 31, 2006, we had a workforce of 54,655, including regular employees and temporary staff, engaged in the following activities:

 

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.

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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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The following table presents our Mortgage Banking Segment loan production by loan type:

(1)           $106.0 billion and $8.1 billion of these loans were funded by Countrywide Bank during the years ended December 31, 2006 and 2005, respectively.

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