BofA's Countrywide Purchase is a Huge Mistake

This might be one of the biggest mistakes I have seen in a long while. Bank of America (BAC) should not have bought Countrywide Financial (CFC).

Let me start by saying that we have been short BAC since $54.5 in our longer term portfolio. We were considering a cover, but this makes us second guess that move. The reason we shorted BAC was that the company had reached a cap in terms of the percentage of assets that they could hold in the United States. In effect, they had reached a limit and could not grow, save some non-core business acquisition. The decision to buy CFC could be analogous to that. They were searching for something...

Imagine a rookie investor sitting on a wad of cash, and itching to invest it. He makes a decision to invest in a stock and it goes down. Yeah, bad move, but the stock will go up, I just know it will, he thinks. So he throws the rest of his money at the stock, in effect catching that falling knife with both hands. Next thing, he's nearly wiped out. How many times have you heard this story? Better, how many times have you seen a major firm make this mistake? The answer to #2 is, not many.

BAC has just made the worst decision on 2008, so far. They can review CFC's book all they want, but there's no way they can determine what the impact of the subprime 1.8 million resets are going to have on CFC going forward. The risk is extremely high, and the conservative nature of BAC has been compromised. BAC, with CFC, is a much more volatile company, a much riskier play, and unnecessarily so. BAC was a good, conservative company, and management had no business bruising the foundation that BAC was built on with this ridiculous move. Every dime that BAC has invested in CFC will be lost to the continued deterioration of the CFC assets in the next two years.

Coupled with the finding of the Investment Rate, this was the worst mistake I have seen in a long time.

Disclosure: Author is short BAC

Comments

[TA:]

As to your first comment about the size, clearly this was a way of skirting the 10% limitations that can only be done in a crisis. Also remember that's 10% of US deposits, not international(China Construction Bank anyone).

As for the falling knife concept, that makes sense as investor but how does this apply to the whole sale when it's made at bankruptcy prices? Granted the original 2 bill purchase was a clear mistake but what about the 84% for 4 bill?

What kind of premium is that for the lucrative servicing business?
Do you not think they can tear apart the company and wring 4 bill worth of equity out of it? Does 4 bill really mean much to a cash balance of nearly 400 bill?

I guess you are a not a follower of Buffett/Graham where you should always buy assets for pennies on the dollar if you can. No idea if you were around then but I'm sure you would have written this same short article on American Express when Buffett put 30% of his money into it.

Of course if you believe in amageddon, then your argument makes perfect sense.

As for your short, well the easy money has been made which is clear from friday's broad based financial short covering. I don't doubt that it could easily go lower but your risk has now gone up, hopefully the reward is worth it.

2008 Jan 13 12:34 PM

[seriously ?:]

I agree with the above commenter, many of the articles' critiques of BoFa were very short sited.

Bofa is aggressive internationally, ( again, China anyone!)
I highly doubt that it was the case that " They were searching for something..."

Also, I find even the logic a bit muddled and therefore must fear the author may be suffering a bit from hubris...

After admitting that, "The reason we shorted BAC was that the company had reached a cap in terms of the percentage of assets that they could hold in the United States" ;

The author goes on to "politley" insinuate that Bofa may be somewhat naive.
"Imagine a rookie investor sitting on a wad of cash, and itching to invest it."

Hmmm... so we have a bank that has literally grown itself as large as it legally can and is then compared to being a "rookie investor" ...interesting... but not asinine.

What is asinine is saying that you shorted the stock because it had met a limit on its growth and then you go on to talk about how many investing mistakes Bofa is making and will continue to make.

So, then why did you really short the stock ? For both of these reasons or simply due to the aforementioned "limit" ( which only matters domestically and in terms of assets held, and NOT EVEN all aspects of their domestic business/ATMs/Credit Cards/Free online investing etc. ).

A much more cogent reason for shorting the stock at 54.5 would be that it was nearly at a ( 3 year !?) high and the housing market crash was painfully obvious.

This article sounds nothing more than a pump or should I say dump piece. Bofa is the new kid on the block in Manhattan and I have been just laughing when I turn on CNBC as Goldman, Morgan Stanley etc repeatedly and nearly unabashedly bad mouth the company. ( Market cap envy ? ) This just smacks of the typical wall street rhetoric surrounding this company. They don't know how to invest...blah blah blah...

I wish the people politicking like this would just be a little bit more frank. Or at least make sense.

If you think that Bofa if full of rookie investors, just come out and say, "I am shorting the stock because Bofa is very bad at investing."

If somone said this and had any sort of data/numbers to back this up ( I've looked BTW and I hate to tell you but they have a "bit" of cash and assets ) I would actually listen.

The rhetoric in this article quickly lead me to read it with the same "inquisitiveness" that I lend to politicians and talking heads.

I feel dumber now; ergo, a bit upset.

But no worries, I encourage you and whomever to continue to publish pieces like this because I enjoy reinvesting a 7% dividend in a stock with a P/E of 8.

Especially, if that stock just happens to be the biggest bank in the USA.

O and BTW how have those non-rookie savvy investors been doing lately, like say...Morgan Stanley ? I haven't been paying attention.

2008 Jan 13 04:13 PM

[Assunta:]

Hillary Clinton Promised to pump 30 billion in tax dollars to bail out the mortgage industry. This was on “meet the press” this morning. When asked if she will support companies that made bad business decisions, she did not back down on her commitment. If she wins the elections, Bank of America would have made the deal of the century.
Did Bank of America directly or indirectly make any election campaign contributions?

2008 Jan 13 10:30 PM

[West_S:]

The reason BAC bought CFC is primarily due to the legal limitation that prohibits any one financial institution from controlling/holding more than 10% of deposits in the USA. BAC is priming itself for additional deposit growth through CFC's Countrywide Bank, which holds a thrift charter, and is not subject to the 10% deposit share max imposed on commercial banks. BAC is buying a well-established, high-profile (high brand recognition among consumers) mortgage origination network that allows them to leapfrog to the front of the retail lending arena in the USA, and is positioning itself well for the next economic upturn. BAC is getting this mortgage origination network for SIGNIFICANTLY less than it could have built it from the ground up itself. There might still be pain in the short run in this acquisition, but apparently BAC analysts and their investment banking advisors see long-term value in the acquisition.

2008 Jan 14 08:30 AM

[Wow.:]

Man, I bet Ken Lewis is kicking himself right now, wishing the meathead that wrote this article had been involved in the due diligence that went into greenlighting the deal. It's amazing that the 60 folks Lewis sent to Calabasas didn't have the requisite info that this genius posted on a group blog.

By the way, this is the same guy who said on CNBC that the DOW would be at 9975 by December of 2007. How'd that turn out?

2008 Jan 14 10:38 PM

[No Moss:]

I think West_S got it. Everybody is pointing to this thing like BAC bought a loan portfolio. They bought a franchise. Now there's no question that the franchise is damaged. It's best money-maker, the subprime loan business (Full Spectrum unit at CFC) is history. There are suits against CFC, and the ability to place loans with Freddie Mac and Fannie Mae is seized up right now. However, the business of writing mortgages gets you points, placement fees, and loan servicing fees. It makes money, and it makes pretty good money in a normal market, which the mortgage will be in a year or two.

The loan portfolio at CFC, including the stuff held for resale, is not great stuff, but you've got a lot of negative goodwill (that's what happens when you buy for less than book value) to write it off against. S&P estimated a writeoff of 1% of the loan portfolio in 2008.

Ken Lewis wanted this company. He got it for what one writer on this web site characterized as a rounding error on BAC's books.

He wanted to reduce his dependence on investment banking, which he doesn't understand, and increase his footprint in retail banking, which he understands far better than you and I. BAC is a little clumsy, but so is your average 500 pound gorilla.

2008 Jan 15 01:50 AM

[Lobogal:]

Based on the rhetoric in this blog, I think I will just keep reinvesting my BAC dividends and sit back and watch the future action. Long on BAC.

2008 Jan 21 05:18 PM