The Coming Battle Over BofA-Countrywide

A major battle is brewing over the proposed acquisition of Countrywide Financial (CFC) by Bank of America (BAC). To my mind, this battle is not just over the purchase price of CFC shares, but rather a conflict about when the mortgage market will return to normalcy.

Bank of America agreed on Januray 11 to buy CFC for about $4 billion, $500 million below the already-depressed trading price of CFC. If the transaction would close right now, BAC would pay around $4.45 billion, or a 10% premium off the current price for a share of CFC.

The battle over this merger is shaping up between Bank of America and at least two activist investment funds, Legg Mason Capital Management (LM) and SRM Fund Management (Cayman) Ltd. The debate: Are the capital markets dysfunctional enough that Countrywide essentially must sell, or will the mortgage market rebound soon because of the Federal Reserve’s monetary policy and the president’s budget-stimulus package?

Legg Mason and SRM have a more optimistic opinion of the mortgage market’s future. In his recent note to investors, Bill Miller, chairman and chief investment officer of Legg Mason Capital, wrote that:

We were quite surprised by the decision to sell the company at close to a seven-year low in the stock price … What makes the decision puzzling is that the company was seeing solid deposit growth, has no apparent capital problems, was not forced by the regulators to seek a merger partner, and is in sufficiently sound condition to have declared its regular quarterly dividend at the end of January.

Countrywide’s production is clearly in free-fall. In the fourth quarter 2007 CFC originated $61.2 billion of loans compared with $90.4 billion in the third quarter and $117.8 billion in 4Q06. But year-over-year Countrywide did fine, originating $385.1 billion vs. $421.1 billion in 2006 – a decline, but by no means an origination total to lament.

Countrywide sees a darker future. The fact that not a single securitization backed by mortgages has come to market since November suggests that a stand-alone lender just cannot survive in the modern financial world.

A central figure in this narrative is Goldman Sachs (GS). Countrywide paid Goldman $12.75 million to determine whether the deal was fair; the investment bank determined that it was. However, Goldman based a large part of its decision on the situation in the capital markets. And whose take on the capital markets did Goldman use? Countrywide’s!

“Countrywide advised Goldman Sachs that these [capital market] exposures had negatively affected recent financial results and that there was a material risk that they would impact Countrywide in the future,” Goldman wrote to Countrywide.

Then, Goldman made it clear that it:

... is not an expert in the evaluation of loan and lease portfolios for purposes of assessing the adequacy of the allowances for losses … and, accordingly, with the consent of Countrywide, Goldman Sachs assumed, with respect to Bank of America, that such allowances are in the aggregate adequate to cover such losses.

Goldman Sachs not an expert in the evaluation of loan and lease portfolios? This is hard to swallow.

I have issues with Goldman’s verdict on the deal. From Bank of America’s S4, it appears as though Goldman could have presented a more forceful opinion on the deal. Shareholders deserve a more declarative opinion. But clearly Countrywide on Jan. 10, the day before the merger was announced, was looking down the barrel of the capital markets’ gun, and saw a bullet entering its chamber. Today, does the merger still make sense? Will it still make sense after the bond issuers are set straight? I don’t know. As Miller says, CFC has a put option to Bank of America. That’s not a bad trade to have in hand.

Disclosure: none

Comments

[CrossProfit]

For some reason the obvious is being ignored. When GS unloads its puts and shorts on the financials then they will change their tune, not beforehand. Currently they are making too much money from the distressed sector and have no interest in the sector emerging from turmoil anytime soon.

Unequivocally, their is a conflict of interests, to say the least and any negative assessment emanating from GS today is suspect. An independent assessment should be made. We suspect that CFC's true market value to be much higher than what is being portrayed to the market.

This is what makes a market, bulls and bears. Beforehand the bulls got way ahead of themselves and created a CDO mess, most likely fed upon by pure greed. Now it looks like the bears are beginning to do the same in the opposite direction.

In time, the market will figure it out. Until then there will be a few corpses for the bears to feed upon. Likewise, a few scavenger vultures are circling the wounded as in Buffett going after ABK and others. Ironically the business model is sound, which is why Buffett wants into this business in the first place.

How this plays out is anyones guess though usually in these kinds of scenarios - cash is king.

Disclosure: This is the opinion of a CrossProfit analyst and mirrors the consensus at www.crossprofit.com.
Forward consensus for BAC, see
www.crossprofit.com/vi...
Forward consensus for CFC, see
www.crossprofit.com/vi...
Forward consensus for GS, see
www.crossprofit.com/vi...
Forward consensus for LM, see
www.crossprofit.com/vi...

[CrossProfit]

"Unequivocally, their is a conflict of interests"

correction: "there is"

[User 144791]

what happens to ccwe,pk accounts

[firboy4]

I'm just happy that GS made 12.75 million to give an opinion. Seems like a lot, but I hope it adds to "their" profits! By law, I think GS is supposed to do what is best for GS stockholders, and I suppose if Countrywide is dumb enough to ask a company's opinion that might have a conflict of interest, then maybe they do need to be bought, and have management burned at the stake, or at least fired.