COVER REPORT: TECHNOLOGY

Reprinted with permission from Mortgage Banking magazine (April 2001, pages 50-57), published by the Mortgage Bankers B Y Association of America. S TEVE B ERGSMAN BigMac IN JANUARY 1993, A SOMEWHAT INTIMIDATED MICHAEL PERRY stepped off the elevator onto the eighth floor of an office building in Pasadena, California, looking for his new station in life. He was 30 years old and had been recruited to become chief operating officer of Countrywide Mortgage Invest- ments, Inc., a struggling mortgage real estate investment trust (REIT) with total assets of $714 million. His staff consisted of three people. Eight years later, the hardened 38-year-old is now chief executive officer of IndyMac Bancorp, Pasadena, an FDIC-insured bank holding company and one of the real success stories in the online mortgage business. Assets of the company passed $5.7 billion as of December 31, 2000, and the payroll books count 1,746 employees, according to company documents. Perry is still in the same building in Pasadena, except now it is the corporate headquarters of IndyMac. Back when the company was called Countrywide Mortgage Investments, which was formed by Countrywide Credit Industries Inc., the IndyMac Bancorp has developed latter called the Pasadena building on North Lake Avenue its headquarters. Coun- into a powerhouse of Internet trywide Credit has since moved down the originations. Once a REIT, now road to Calabasas. an FDIC-insured savings and The transformation of Countrywide Mortgage Investments into IndyMac Ban- loan, IndyMac has plans to corp is really just the story of hard work become a very big mortgage and the ability of a group of youthful peo- ple to adapt very quickly to changing mar- origination company on top of ket conditions. The fact that it created a its status as a leading online killer technology and became a leading originator. Innovative risk- online mortgage banker is almost inciden- tal. As Gulshan Garg, IndyMac’s executive based pricing and automated vice president and chief technology offi- underwriting technology have cer, affectionately notes, “I see us as a tech- nology company that happens to be in been keys to its success. the financial services market.”

MORTGAGE BANKING . APRIL 2001 1 MORTGAGE BANKING 2 . APRIL 2001 mortgage business. stories intheonline of thereal success presides over one of IndyMacBancorp, CEO Michael Perry,

PHOTOGRAPHY BY MICHELE A. H. SMITH Perry would certainly disagree with that—but then again, Countrywide Credit’s founders, David Loeb and Angelo he’s not a tech guy, which is probably why IndyMac has Mozilo, created the publicly traded REIT, Countrywide done so well online. Not only is Perry’s company profitable Mortgage Investments, in 1985 to buy jumbo loans and ($92 million in earnings on revenue of $337 million in 2000, Fannie Mae and Freddie Mac securities from Countrywide according to company reports), but its Internet loan produc- Credit and to issue collateralized mortgage obligation tion has been consistent and growing. In the first quarter of (CMO) debt. Eventually the market changed, and the arbi- 1999, IndyMac notched $226 million of Internet loans—for trage went out of the Fannie Mae and Freddie Mac mort- business-to-consumer (B2C), that means loans started online; gage-backed securities (MBS) strategy. So from approxi- for business-to-business (B2B), it means loans submitted, mately 1988 to 1992, Countrywide Mortgage Investments underwritten, approved, priced and rate-locked online. Every still traded on the New York Stock Exchange, but was quarter since then, mortgage loan production has grown. At essentially dormant. That wasn’t good for a number of

Not only is Perry’s company profitable ($92 million in earnings on revenue of $337 million in 2000, according to company reports), but its Internet loan production has been consistent and growing.

the end of the fourth quarter 2000, IndyMac Bank totaled reasons—most importantly that, because of prepayment $2.561 billion of Internet production. Fully 88 percent of the risk, the spread between assets and liabilities was quickly company’s permanent home loans are generated via the Web, compressing. according to IndyMac. To help solve its financial situation, in 1988 the company Not bad work for a Sacramento, California, boy who grad- raised $35 million in new equity to establish an adjustable-rate uated from the local college and then went to work for the mortgage (ARM) MBS portfolio. For a few years that was a local savings and loan, Commerce Savings Bank, which pretty good hedge against prepayment risk, but that strategy, became Commerce Security Bank. too, collapsed, and the company had to sell its entire ARM mortgage-backed securities portfolio to avoid reporting a loss. Creating something out of nothing That’s when Perry was hired. Today IndyMac Bancorp, parent company of IndyMac Bank, “What I inherited in January 1993 was a very sick compa- finds itself ranked as the No. 1 savings and loan in Los Ange- ny,” says Perry. Assets had dropped to below $800 million. Of les County, according to IndyMac documents; one of the top that, $120 million was in equity capital and the rest CMO FDIC-insured bank holding companies in California (extrapo- debt. Of the $120 million, half was tied up in assets that were lated from Bloomberg numbers, according to IndyMac docu- going to lose $10 million. The other half was to be used to ments); selected by Gomez Advisors, Waltham, Massachusetts, start the company’s newest business venture, a jumbo mort- as the No. 1 online mortgage lender in the country, according gage conduit. to Gomez’s last three quarterly mortgage scorecards; and the “We started out with a balance sheet and a company that 19th-largest mortgage lender in the nation, according to a was worse than a startup, because half of our equity capital National Mortgage News fourth-quarter 2000 survey. was going to lose money,” says Perry. “We had a strategic It rose to these lofty positions by always being one step plan and no customers.” ahead of disaster. Nevertheless, Perry managed to pull it off. The conduit

MORTGAGE BANKING . APRIL 2001 3 made a profit of $13 million in its new business. As expect- 1998, the fourth quarter of the year registered some serious ed, the old business lost $10 million, so it, in fact, made an losses—the only quarter in which the Perry-directed compa- overall profit of $3 million in 1993. ny has ever lost money so far. For the next four years—really the heyday of the conduit “In retrospect, that was the best thing that could have industry—the company did phenomenal business, even happened to us as a company,” says Perry. As chief execu- changing its name to CWM Mortgage Holdings so as not to tive officer, Perry knew the company was limited by its confuse it with Countrywide Credit. REIT structure—it couldn’t retain earnings. So he per- Then in 1998 came the great credit crunch, and once suaded the board and shareholders to “de-REIT” the com- again the company was in peril. The former high-flyer sub- pany, which it did at the end of 1999. With the alteration mitted itself to a period of forced shrinkage and asset sale. of the company’s structure, shareholders also approved a Although CWM Mortgage still earned $33.790 million in new corporate moniker, IndyMac Bancorp Inc., which was

Another Loeb-Mozilo Venture

S ANGELO MOZILO RECALLS, HE WAS closing services—and which is one of the trage it continued to do in the repo market. 21 years old and working for a nation’s leading mortgage lenders—boasts “Countrywide Mortgage, which had, at that A company in New York called 500 offices in 47 states and Washington, time, about 30 employees, saw its work rolls United Mortgagee when it merged with D.C. Last year’s revenues for Countrywide drop to single digits,” says Loeb. “I operated Lomas Realty Securities out of Virginia Credit totaled $2.02 billion. it with two other employees, one of which Beach,Virginia, and a man named David Loeb To get to that point, however, Country- was a bookkeeper.” came over as vice president of United. wide Credit had to evolve. In the early 1990s, Loeb and Mozilo The year was 1960, and it was the first Back in the mid-1980s, Countrywide decided once again to make Countrywide time Mozilo had ever met the man he would Credit needed to make an important Mortgage an active operation. In 1993, they partner with for almost 40 years and would change. It was being constricted on loan lim- hired Michael Perry to run what was now a found two public companies with—Coun- its by the Federal Housing Administration mortgage conduit, and that was the begin- trywide Credit Industries Inc. and IndyMac (FHA), Fannie Mae and ning of the transformation of Country- Bancorp Inc. Freddie Mac, but it was wide Mortgage into IndyMac Bancorp. “I had been working at United Mort- based in Southern Cali- The success The success of IndyMac, oddly gagee since I was 14, through high school fornia—where there enough, resulted in the culmination of of IndyMac, and college, but I stood out as ‘the young was a big need for the Loeb-Mozilo partnership. “I was person’ because most of the people there high-ticket mortgages. oddly enough, always the chairman of both compa- were getting on in age,” says Mozilo. The solution was the resulted in the nies,” says Loeb, “but when IndyMac “Loeb, who had been with Lomas, had that creation of Country- culmination of acquired the First Federal Savings & young guy he saw running around sent wide Mortgage Invest- the Loeb-Mozilo Loan of San Gabriel Valley [California] down to Virginia Beach to help merge the ments, which has since partnership. and converted itself to a depository, two companies.” become IndyMac Ban- we couldn’t have interlocking Loeb was 36 years old at the time. He corp. boards—so either Angelo or I had to liked Mozilo and began sending him out to Countrywide Mort- resign [from] Countrywide Credit. I different corporate ventures in Florida, Cali- gage was a real estate investment trust resigned and went to IndyMac.” fornia and then back to Virginia Beach. In (REIT), and originally its sole responsibility Loeb had been chairman and Mozilo vice 1968, when United Mortgagee was acquired was to buy the jumbo loans of Countrywide chairman and chief executive officer at by a bigger company, Loeb and Mozilo Credit. Eventually, the loans were floated as Countrywide Credit. “He was at a different decided to leave together and, in March collateralized mortgage obligations with ser- phase of his career, and he deemed it best 1969, they formed the California company vicing held by Countrywide Credit. “What for himself personally and financially to that would grow into Countrywide Credit. we wanted to do was establish a controlled become chairman of IndyMac,” says Mozilo. “We wanted to form the first national market for Countrywide production,” “I moved up to chairman of Countrywide mortgage company, and we wanted to beat explains Loeb. Credit, but in fact very little changed.” the hell out of our old company.There was The concept worked so well that the Says Loeb, “It was a natural progression. a little bit of vengeance in our motive,” jumbo mortgage market opened up and a It was time for Angelo to take over.” laughs Mozilo. host of other companies entered the field. “We had been partners for a long time— The irony of it all was that the newer mort- 40 years,” says Mozilo. “David and I built Whatever works! gage REITs were willing to pay Countrywide great things together and we are proud of Indeed, Countrywide Credit Industries has better prices than it was willing to pay itself our accomplishments. But I’m 62 years old been an extremely successful enterprise. through Countrywide Mortgage. and David is 77, and you come to a point Today, the diversified financial services firm Countrywide Mortgage became a passive where you realize the runway does run out with interests in insurance, investments and operation, except for some successful arbi- and things do not go on forever.”

MORTGAGE BANKING . APRIL 2001 4 put into use following the acquisition of SGV Bancorp. cent to 80 percent of the company’s loan volume. Another 10 Along the way, Perry also formally cut the ties to Country- percent to 15 percent comes through a consumer channel, wide Credit. In 1997, CWM paid $80 million in stock to buy IndyMacMortgage.com; and remaining volume arrives via a itself out of onerous management fees to Countrywide, smaller consumer construction business and a relatively new according to Perry. Three years later, the interlocking direc- business-to-Realtor channel called LoanWorks.com. torships of the two companies also ended. CWM—now Indy- The success of the company’s B2B channel can be attrib- Mac—was on its own. It even got some experienced help as uted to technology the company developed in-house called e- Loeb, the founding chairman of Countrywide Credit, resigned MITS® (electronic mortgage information and transaction his old position to become chairman of IndyMac Bancorp. system). E-MITS was introduced in January 1998 and was an IndyMac had to make one further change to form the basis immediate success. Just a year and half after its introduction, of the company it is today. In July 2000, IndyMac Bancorp the number of brokers using e-MITS already climbed to more completed the purchase of SGV Bancorp, the parent of First than 2,000, according to IndyMac. Federal Savings and Loan of San Gabriel Valley, California, Part of the appeal has been e-MITS’ relative ease of use. which was based in nearby West Covina. “We give the broker a disk, and once they are set up, they can “We did not have a choice,” explains Perry. “As a REIT, you can have low leverage and get decent returns because you don’t pay taxes. Once you de-REIT to retain earnings, the leverage doesn’t increase but your returns are cut to pay “ ight now, taxes. And we couldn’t increase our leverage, because we R were a low-rated entity with the rating companies. By merg- ing into SGV and becoming a depository institution with our philosophy in new, diversified financing sources, we got the leverage of a regulated financial institution—which created for us a ton of the mortgage bank is excess capital because of the greater leverage combined with the ability to retain earnings.” all products, all channels,

An online mortgage powerhouse all the time,” In the fourth quarter of 2000, IndyMac’s Mortgage Banking Group produced $3 billion of mortgage loans, up 91 percent says Wohl. over the fourth quarter of 1999 and 20 percent over the third quarter of 2000, according to IndyMac reports. Even though access us directly through the Web,” explains Wohl. industrywide production volume, as reported by the Mort- “www.indymacb2b.com is our proprietary Web site just for gage Banker’s Association of America (MBA), declined by 8 brokers.” percent in the fourth quarter, IndyMac was going great Basically with e-MITS, the broker can sit in the customer’s guns—and almost all of it was production from the Internet. house and, using a laptop, get a firm loan price in a matter of “Within the Mortgage Banking Group, every channel exe- minutes. “Brokers used to have to work with their lenders in cuted our strategy for growth through channel expansion, a manual search process, to search and find appropriate loan product expansion and effectively leveraging our technology,” matches for [their] customers,” says Wohl. “With e-MITS, the says Richard Wohl, IndyMac’s president and the chief oper- broker can give a customer a committed rate lock within ating officer of IndyMac’s Mortgage Banking Group. minutes.” IndyMac Bancorp consists of five operating units: con- He adds that, with e-MITS, the broker can look at Indy- sumer banking, which includes IndyMacBank.com and a Mac’s price for a loan and even compare it with other prices limited Southern California Branch network; the Mortgage from other lenders. “We are confident enough in our price Banking Group; the Commercial Lending Group that we make a point of showing the prices of others. We are (www.clcaloan.com); the Asset Management Group, including competitive across the board in almost every product.” loan servicing and credit-risk, single-family assets; and the The average cost of a B2B wholesale loan, as published by Investment Portfolio Group. the MBA in a 1998 mortgage survey, is 120 basis points, says By far the largest unit of the company is the Mortgage Wohl. “Our average cost is about 79 basis points, which Banking Group, which last year was responsible for 55 per- allows us to be very competitive.” cent to 60 percent of the overall revenues and 52 percent of In the past, the company’s main products were prime the profits. (conforming and nonconforming) and subprime loans; but “Right now, our philosophy in the mortgage bank is all in the third quarter of last year, IndyMac acquired Orange products, all channels, all the time,” says Wohl. “And when County, California–based PNB Mortgage, which was a gov- we talk about channels, we are talking about the Mortgage ernment lender—so now IndyMac offers FHA/VA loans as Banking Group’s different business operations—the biggest well. By the fourth quarter of 2000, product break-out of which is our B2B business or our broker channel. We ser- showed $323 million of conforming loans, $2.058 billion of vice 3,000 mortgage broker customers all over the country nonconforming loans, $32 million of government (FHA/VA) who deliver to us either closed loans or table-funded loans.” loans, $391 million of subprime loans and $187 million of The broker channel, IndyMacB2B.com, delivers 75 per- consumer construction loans.

MORTGAGE BANKING . APRIL 2001 5 “We are one of the most profitable mortgage lenders in the operation as opposed to a B2C application, because the con- country,” says Wohl, “and that’s due to a couple of reasons. We sumer does not get a mortgage more than once every four or have a very profitable product mix and every product lever- five years and is not going to use the Web site consistently.” ages our technology. We place a huge premium on keeping IndyMac was able to be successful as a B2B mortgage costs as low as possible in every channel.” operator because it was able to develop a very efficient and While IndyMac has traditionally been a B2B Internet oper- easy-to-use technology—e-MITS. And, as even chief technol- ation, the company also has a successful consumer banking ogy officer Garg would probably agree, there was a little bit of group and a consumer mortgage operation, indymacmort- luck in that development. gage.com. Development of e-MITS began back in 1996, at the same The company boasts 10 branches in Southern California. time the government-sponsored enterprises (GSEs) were “Eighty percent of our lending business is done online,” says beginning to roll out their automated underwriting systems. Perry, “but the regulators love the ‘brick,’ so from regulatory IndyMac collaborated with them on a project to explore perceptions it is important. We probably won’t expand con- expanding the automated underwriting process of conform- sumer banking with branches outside of Southern California. ing products to the alternative-A niche products that IndyMac It is more than likely this part of our business will grow was a specialist in, according to Garg. “E-MITS came into through telemarketing and the Web as it relates to deposits.” being from the work we started with the GSEs and was built out of our vision to incorporate automated risk-based pricing A focus on B2C lending and rate-lock capability in addition to the automated under- Much more a part of the company’s focus is B2C mortgage writing process,” Garg says. lending, which has now grown to about $140 million in orig- The problems that needed to be solved by e-MITS, Garg inations per month. “If you look at our ranking in terms of says, “is that we had to convert the mortgage application total mortgage origination, we are about 19th,” says Perry. process into something that was objective, cost-efficient and “However, what a lot of companies do is refinance their could run through the loan process quickly. From a borrower’s existing loan-servicing customers. I don’t think anybody in perspective, there was always a two- to three-week response the business does more Web-based B2C business that is not time before he or she knew if a loan was approved or not.” refinance than we do.” Although the Internet was fast becoming a popular mode Just as important to IndyMac is the fact that its B2C oper- of communication, IndyMac in its initial development work ations are now profitable. For a time, the company spent big in 1997 was on an older technology path. “We used to provide bucks using advertising to drive traffic to its Web site, but it disks and broker-installed software. Information would come eventually gave that strategy up. “We focused on expanding to us via a modem,” says Garg. “But there were always some our B2B, Web-based lending and growing our B2C more slow- conflict issues with different software programs. When we ly,” says Perry. found that brokers were adapting to the Internet more rapid- Using what Perry calls the “mall” approach, IndyMac links ly, we moved from a client-server application to a Web-based its B2C site to other Web sites (i.e., LendingTree.com, application.” bankrate.com, GetSmart.com) that are doing the advertis- Santa Monica, California–based First Capital Corporation, ing—in effect letting indymacmortgage.com be one of sever- a mortgage brokerage and mortgage banking firm, hooked up al choices, or one store out of many in a mall. “They spend the with IndyMac when the e-MITS system was launched—and big advertising dollars to attract customers, and we pay them because its loan volume expanded so rapidly, IndyMac placed on a cost-per-lead, pull-through and a cost-per-funded-loan an underwriter in First Capital’s office. [basis],” says Perry. “If those metrics do not work, we move “We are the only company in the country that has our on to the next Web site—the next ‘mall.’ That is our strategy, own e-MITS underwriter on-site,” says Jay Robertson, presi- and it has turned out well.” dent of First Capital, a mortgage company that did more than $1 billion in loans in 1999 and 2000. The secret of its success “The e-MITS system is a computer-generated loan approval The reason IndyMac has been able to do so well while others system that, within 10 to 15 minutes of getting information, in the online mortgage industry have faltered has something can spit out a loan approval for somebody,” says Robertson. to do with luck, but mostly it has to do with technological “So, as far as service, it is a tremendous tool for working with development and a more radical approach to assessing loan real estate agents who have short time frames—and the applications. majority of our business is done with real estate agents. We According to Perry, the fundamental difference between are not a big refi house. We do mostly purchases, which is, IndyMac and other online mortgage companies is that Indy- on average, about 70 percent of our business.” Mac began life as a B2B company and was not in the expen- Robertson knows there’s some good competition out sive business of bringing mortgages to consumers via the there for e-MITS—especially, as he says, from Freddie Mac Internet. This was not so much by design as it was in the and Fannie Mae, “but they have mostly conforming-loan com- development of the company, which was an existing business. puterized systems that do up to $275,000.” Obviously, with a growing online mortgage origination First Capital’s market area stretches from Malibu and business, Perry is not opposed to the concept. “E-LOAN and Hancock Park in Los Angeles north to Santa Barbara— some of the others in the field were a little ahead of their through some of the priciest real estate in the country. “You time,” he says. “It just made more sense to first build a B2B cannot buy a shed at Sears for under $275,000 here,” says

MORTGAGE BANKING . APRIL 2001 6 Robertson. “Those Freddie Mac and Fannie Mae programs Co., Los Angeles. “It did about 24 percent of all the Internet- are terrific for people in Des Moines, but here [they are] not related originated mortgages last year, with $30 billion total. as useful.” The largest online originator was Countrywide, but IndyMac Since the e-MITS system can go up to $1.5 million on loan is a very credible presence.” amounts, it’s more compatible with First Capital’s needs. IndyMac, says Chamberlain, uses the B2B model, which “We do mostly jumbo loans,” says Robertson. “Our loan size “has worked better and is more profitable than B2C because, average is $400,000. E-MITS is truly about the best comput- with B2B, you can capture the purchase market as well as refi.” er-generated system for the jumbo market grid. IndyMac is Chamberlain remains optimistic that IndyMac will be really the leader in moving the jumbo market forward in com- showing 20 percent to 30 percent earnings-per-share growth puter-generated approvals.” for the next couple of years, but there is a caution: “IndyMac It isn’t just the technology that gives e-MITS the capabili- consistently had above-average nonperformance [nonper- ty to confirm a loan in a matter of minutes. IndyMac moved forming loans]—around 2 percent—compared to other early to an evaluation methodology called risk-based pricing. thrifts,” which, in the fourth quarter, had 0.51 percent Most companies use a rate sheet in evaluating loan pricing, which has various price adjustments based on loan-level characteristics. “The rate sheet is incremental, like a stair step,” says Richard Lieber, senior vice president of IndyMac’s Capital Markets Group. “Traditional rate sheets also don’t show any loan-to-value under 80 percent.” While many of the startup Each one of the loans priced through the e-MITS channel is run through a computer algorithm “that evaluates individ- Internet mortgage companies ual credit and payment risk for that loan, and values those risks based on market indices,” says Lieber. “E-MITS comes found themselves starved for back with a price for the loan—which means what it will pay the broker—and what the interest rate is.” capital last year, IndyMac Again, says Lieber, “the traditional method of the loan process meant getting a rate lock. Basically, someone looks at was in the enviable position the rate sheet and in about five to 10 minutes might be able to give an answer. However, no known rate sheet can address of having excess capital. all the complications that a computer model can.” The advantage IndyMac has with the e-MITS system is all the loan information is submitted electronically, so it can automatically run the data through a computer program and nonperforming loans as a percentage of all assets, says Cham- come back with a more accurate and precise price. berlain. “For example, Washington Mutual or First Federal “Five years ago, a lot of loans weren’t being done because Santa Monica had about 1 percent nonperformers, and some people couldn’t evaluate certain kinds of risk,” says Lieber. of the best have 0.2 percent nonperformers. IndyMac non- “Today, IndyMac is able to price those riskier loans accurately.” performers are well above average.” With the deal for SGV Bancorp, the nature of IndyMac Staying focused changed. “We are a Web-based mortgage bank in a bank struc- While many of the startup Internet mortgage companies ture,” says Perry. “To get proper leverage, proper financing found themselves starved for capital last year, IndyMac was and maintain safety and soundness, we are quickly growing in the enviable position of having excess capital. This turn of consumer deposits—which are now at $900 million, up from events came about because of dropping its REIT structure about $350 million at acquisition. But, unlike many consumer and the purchase of SGV Bancorp. “As a REIT, we had to banks, our emphasis will be on raising certificates of deposits maintain a lot of excess liquidity because we didn’t have a sta- as opposed to checking accounts. We will do some checking, ble source of financing,” says Wohl. “Once we became a but we can more cost-effectively raise funds through certifi- depository, we could leverage ourselves better because we had cates of deposits and other money-market instruments.” that stable source of capital.” Even noting all that, Perry doesn’t want anyone to confuse Last year, IndyMac used its excess capital to repurchase the mission of IndyMac. “Our strategy,” he affirms, “is to grow 18.5 million shares of its stock, or 23 percent of its shares out- our mortgage business. That is our core, and what we are best standing. With less of a float, the company’s share price rose, at. We have gone through a radical change in the last two closing the year at $29.50. years, and we are still in the mortgage banking business. The repurchase program has been put into temporary Two years from now we will continue to be in the mortgage abeyance, if for no other reason than the fact that, with a higher banking business—but ranked as the 15th-largest mortgage share price, the projected return on investment for the repurchase originator industrywide or higher—and you will see us as program diminished. Now, says Wohl, “we can look at strategic one of the most profitable mortgage banking companies in acquisition opportunities to fill in gaps in our product.” the industry.” MB IndyMac is a play on Internet-originated mortgages, according to Charlotte Chamberlain, an analyst at Jeffries & Steve Bergsman is a freelance writer based in Mesa, Arizona.

MORTGAGE BANKING . APRIL 2001 7