A Mortgage Industry Walk-around FNCE 332 – Prof. Harding

1. A Mortgage Industry Walk-aroundFNCE 332 – Prof. Harding Jeff Lebowitz (301) 585-6640 www.mortech-llc.com MORTECH, LLC

2. “The mortgage business is a dog!” –John Reed, Chairman Citicorp MORTECH, LLC

3. The Mortgage Industry is a Management Nightmare The mortgage industry is: • Rippin’ large • Unpredictable • Consolidating, but not enough • Not particularly profitable • Operationally fragmented MORTECH, LLC

4. Mortgage Market is Very Large – Flow is Highly Variable and Unpredictable Source: Fannie Mae MORTECH, LLC

5. Over Two Quarters, Volume Estimates for 2002 Increased 38% Source: Fannie Mae MORTECH, LLC

6. Rapid Concentration of Origination Volume Share of Large Lenders Up 43% Since 1996 MORTECH, LLC

7. Growing Share of Large Mortgage Companies is the Talk of the Town • Relative share of top 25 originators increased an average 11% per year over decade • Top 25 firms account for ~ 70% of loans produced in 2001 MORTECH, LLC

8. Top 10 Lenders Take Increased ShareAre Share Gains Meaningful? Concentration of Market Share U.S. Mortgage Originations 45% Top 5 Top 6-10 40% 10% 9% 35% 8% 30% 7% 6% 25% % origination volume 7% 20% 31% 31% 15% 30% 25% 24% 10% 18% 5% 0% 1995 1996 1997 1998 1999 2000 Source: Mortgage Bankers Association MORTECH, LLC

9. “It is easier to stay out than get out.” --Mark Twain MORTECH, LLC

10. Mortgage Banking Industry Profitability Is Erratic • Industry suffers uncertain profitability • Essentially all lenders have basic functional automation • Automation has not be a strong determinant of average industry profit • Calls for resolution of structural inefficiencies and new strategies/business models MORTECH, LLC

11. Margins Are Also Unpredictable Peer Group Margins (bps): All Production Channels Lender segment - 2001 Average-all Peer Group/ A C E M 2001 2000 Revenues 188 199 192 163 167 148 Direct Expense 99 113 102 66 71 104 Production Support Expense 16 20 21 14 15 18 Corporate Admin Expense 21 17 24 10 12 20 Total Expenses 136 149 147 91 97 141 Pretax Margin 51 50 45 73 70 6 Segment key: M = Mega ($48B); A = Large ($5B) C = Small ($1.4B); E = Thrift ($1.9B) 42% vs 4% Source: MBAA, Stratmor Group MORTECH, LLC

12. Industry Structure Changed as Value has Migrated • Industry has tended to “modularize” into specialized businesses. • Evolving technology and need to capture value will cause financial and process integration. Mortgage Industry Business Model Changes 1960 - 1980 1980 - 1990 1990 - Present Investor aggregation Investment Bankers GSE’s, Depositories Pensions, REIT’S Investment fulfillment Thrifts GSE’s Risk transformation Thrifts, Bank Holding Companies, Mega - wholesalers Product creation Thrifts Mortgage Banks Fulfillment Mortgage Brokers Consumer aggregation Data infrastructure Appraisers, credit repositories, title co’s, tax services Information conglomerates Technology infrastructure MORTECH, LLC Alltel, Lomas Alltel, Fiserv, Interlinq, GSE’s

13. Wholesaler's Fees Servicing Value Large Lenders Focus on Two Nominally Profitable Parts of the Value Chain • Fragmented value chain • leaves little for aggregators • Services vendors (e.g. MI), • independent originators, • GSE’s take 60% of revenue 5.88% -- total fees Third Party • Lack of substantial, predictable • profits will force industry • to restructure again • and blur lines of business Originator • Lenders will be forced to take on additional interest rate and default risk. Profit Contribution Wholesaler • Lenders will also begin to resemble financial holding companies (ala Countrywide) Lender's less than .05% Revenue Servicing Sources less than .10% Credit Risk Premium MORTECH, LLC

14. Major Lenders Have Another Challenge – Disappearing Assets • Large lenders have grown – their ability to manage growth has not kept pace. • The four largest servicers have grown in excess of 30% per year in the 1990’s • WAMU grew at a compound rate of over 60%, mostly through acquisitions • But, the run-off of their servicing portfolios outpaced their abilities to replace lost assets internally • The major lenders have become heavily dependent on third party originations (brokers and correspondents) MORTECH, LLC

15. Where is Value Created – at the GSE’s(Government Sponsored Enterprises) MORTECH, LLC

16. Fannie Mae and Freddie Mac Expand Their Influence in the Mortgage Business • GSE’s share of mortgage debt outstanding has accelerated over the past five years – to over 40% in 2001 • GSE importance to housing finance industry grows commensurately. MORTECH, LLC

17. Reliance on Fannie Mae and Freddie Mac Continues to Grow • Fannie Mae and Freddie Mac bought 40%+ of mortgages made • Industry’s increasingly relies on funding source MORTECH, LLC

18. Fannie Mae Grown at Multiples of the Industry and Maintained Super Profitability • Fannie Mae has grown its assets almost 3x as fast as the industry in total • While maintaining a very steady and strong 25% return on equity MORTECH, LLC

19. The Industry is as Operationally Complex as it is Structurally Fragmented MORTECH, LLC

20. RE Agent(Buyer) Buyer Tax Assessor Tax Collector County Recorder RE Agent(Seller) Lender(Buyer) Document Custodian Servicer(Seller) Process Relationships are Complex and Still Manual Title Agent Title Insurer Title & RE Info Providers Investor MortgageBroker • Closing • - Agent or Attorney * • Seller(s) • Borrower(s) • - Notary Public Seller Lender Services Providers Total Process Time: Up to 45 Days WarehouseLender MORTECH, LLC * In escrow states, funding and closing functions are handled separately.

21. Online Ordering The Mortgage Lending Process Today Is a Hybrid Paper and Electronic World Application Fulfillment Closing/Post-closing/Recording/Delivery Consumer Loan Officer/Mortgage Broker Lender Appraiser Title Flood MI Others Lender Closing Agent/Attorney County Recorder Investor Servicer MORTECH, LLC

22. Technology Providers Compete to Reorder Value Chain with Electronic Services Custodial Interface Mortgage Services Vendors Third Party Service Settlement AUS Servicers Electronic Integrator Originators /Sellers Transaction Security Document Mgt. Document Tracking Investors Product/ Price Engine Loan Approval Engine Commitment Mgt. Conditions Mgt. MORTECH, LLC

23. Lender Adopt New Technology Slowly and Over a Long Period of Time MORTECH, LLC

24. Number of Transactional Web Sites Indicates A Growing Maturity in Web Use Note: Transactional web site = at least able to prequalify MORTECH, LLC

25. “By trying we can easily learn to endure adversity. Another man’s, I mean.” – Mark Twain The Imperative to Change MORTECH, LLC

26. The Mortgage Industry Faces Fundamental Change -- MORTECH Identifies and Tracks these Changes Mortgage Industry Driving Forces Processes Convergence Early Adoption of Electronification Fragmentation Vertical vendors small, no architecture standards Technology Supply Industry Structure Large Servicers Drive for Scale Concentration Value Migrates to GSE’s Revenue Stream Diverted Lender Returns Become Variable and Uncertain Business Model Failing MORTECH, LLC

27. As Business Conditions Change Lenders’ Strategic Positioning Must Change to Capture Value Positioning Keys Traditional Customer View Indicated Grow Production Competitive Effectiveness Driving Force Strategy Focus Expanded Scale Asset/Customer Management Enhanced Service Operational Objective Cost Control MORTECH, LLC