BofA's Countrywide Acquisition: Dumb And Dumber

In the run-up to Bank of America's (BAC) acquisition of Countrywide Financial (CFC), the media was abuzz with speculation that the U.S's largest mortgage lender would close shop. Just about when everyone was expecting Countrywide to roll over and die, in comes Bank of America's $4.1 billion all-stock offer for the beleaguered mortgage lender.

Relieved that the nation largest mortgage lender had been rescued from bankruptcy, the market jumped on this news. Now that the dust has settled, it is a good time to scrutinize the marriage between Bank of America and Countrywide.

The biggest question investors are asking is, was this the right move? My answer is a resounding NO. This merger is doomed to fail even before the ink has dried.

Why so?

1. Like the merger of corporate titans, America Online and Time Warner, this merger can be likened to a marriage between a teenage bride and a retired banker. Countrywide's business model is reflected by it's aggressive growth model that saw it venture deep into the sub-prime mortgage mess. All while its suitor, Bank of America, pursued a relatively moderate lending strategy and exited sub-prime lending in 2001.

   The clash between two opposing and conflicting corporate cultures is bound to affect the operations of Bank of America. Never mind that they will be shutting down many of Countrywide's offices and laying off thousands of their employers. The fact that Countrywide has a larger mortgage portfolio means that many of Countrywide's executives will be left untouched.

2. Even though the media is not highlighting it, there was no way that the U.S Treasury would have watched Countrywide fold into bankruptcy. Not in an election year and not the largest mortgage lender and servicer in the U.S. The repercussions of Countrywide rolling over would have been too much to bear for the current administration. The backlash from voters borrowers had to be contained before it spilled into electioneering campaigns.

   By and large, someone from Wall Street had to rescue Countrywide and Bank of America happened to be the one. Bank of America investors might not like it but who cares about what the 270,000 plus stock holders have to say. After all, not all of them will vote in the up coming elections. Had they all the stock holders been residents of say Iowa or Florida, a different financial institution would have been arm-twisted called-in to rescue Countrywide.



3. Last August's $2 billion investment for a stake in Countrywide at the start of the credit crunch turned out to be a bad bet for Bank America. With Countrywide's shares trading above $20 when the announcement was made, the deal looked like a steal for Bank of America at that time. The preferred stock that is convertible to common stock at $18 a share pays a dividend of 7.25% and gives Bank of America the first chance to buy Countrywide in the event that it was sold.

   Less than 6 months later, Bank of America's 16% stake in Countrywide is underwater and they are adding more money to a loosing position. Like they say, never throw good money after bad. Especially at a time when U.S housing market woes are far from over and more home owners are expected to turn in their keys.

Should the merger fall through, Bank of America will be forced to cough a $160 million termination fee. Interestingly, the termination fee is just about the $150 million that Bank of America will earn this year from their 16% stake. That said, I don't expect this transaction to close because the housing situation is expected to worsen between now and the time this transaction is due to close.

Disclosure: none

Comments

[gina gardner:]

God, if this is going to have any credibility at least learn how to spell "lose" and I believe that CW employEES will be laid off, not employERS. For what it's worth, CW employees have been told that B of A will leave Countrywide pretty much alone, the layoffs will be mostly support staff in duplicate or unprofitable branches, and there will be severence packages for them. Most do not have to fear for their jobs if they are producers or in areas with no existing B of A lending offices (too bad about Mozilo's severence, unwarranted and should rightly have gone to mitigating the mess CW had created in hard-hit neighborhoods or to shoring up the company). CW will keep most of its loan products and be the mortgage arm of B of A while "old" B of A will focus primarily on the banking side of things. Countrywide even keeps its name, with the addition os "A Bank of America Company." Many analysts feel that B of A got a screaming deal; the servicing and chance to increase its presence in new markets is worth more than what they pais; even with significant writedowns of the CW portfolio B of A will realize about a 10% return on its investment.

2008 Jan 22 11:16 AM

[Frank Brandy:]

Speaking of "credibility gaps" in your article, I think you are better off sticking with subject that you have a little more knowledge about. It is Countrywide that would have to pay a $160mm termination fee, not the other way around, as you have written.

2008 Jan 22 12:26 PM

[ANDREW PAPA...:]

We are deeply depressed about the news concerning Countrywide.We do not know whether to keep the bond or sell it.It matures in 2011 and it is priced in pound sterling.I bought the bond in Athens,Greece.It was a A- rated bond.We follow the news and we feel helpless especially when we are located in a country like Greece.

2008 Jan 22 01:26 PM

[helplessobs...:]

Since banks usually earn 15 to 20 percent on their investments, why is 10 percent a gold mine? BAC clearly had their arm twisted; most merger partners spend a lot of time going over the books, not the milisec that BAC used. Buffet has said it took 4 years for him to unravel just $400M of credit default swaps General Re had on its books. I wonder how you make money when your staff is on the phone all day trying to contact the owners and settle the swaps?

2008 Jan 22 01:29 PM

[Mister C:]

I missed that one on the termination fee. Countrywide pays Bank of America? That's a new one for me.

2008 Jan 22 08:27 PM

[TA:]

I suppose it's much better when companies buy other companies when things are rosy and expensive - they will easily get their investment back and then some - the servicing business was alone worth just under 2B a year in 2004(much higher in the bubble years of 2005/2006). Even if it goes back to 1B in a worst case scenario, that's a return of your money in 6 years

Your article is a serious pile of crap

2008 Jan 24 12:03 AM

[Richard Weed:]

I think the media slant on sub-prime lending is pathetic. Companies like Countrywide are tongue-lashed for being sub-prime lenders, but sub-prime lending helped a lot of people get into homes where they would not have had the opportunity previously. The majority of these sub-prime customers make their monthly payments on time and are now receiving the benfits of home ownership. Why does nobody talk about that side of the coin?

2008 Jan 24 01:33 PM

[Wow.:]

Chris - perhaps before you shit out an article, it would be advisable to read even a sliver of the SEC filing on the merger, or maybe just 1 of the countless articles that mentioned the term fee going from CW to BOA. Or perhaps you could do us all a favor and not write about stocks, since you're clearly out of your element.

2008 Jan 24 10:42 PM