Will BofA Really Buy Countrywide?

Marketwatch reports that Bank of America's (BAC) acquisition of Countrywide Financial (CFC) is proceeding as planned, according to a statement issued by Bank of America yesterday. Apparently this deal will proceed despite extreme and accelerating problems with Countrywide’s mortgage portfolio.

According to the 10-K filed on February 29th, and as reported by Marketwatch, Countrywide’s 90-day delinquency rates in its $28.42 billion adjustable rate mortgage portfolio climbed more than 900% from a year earlier, up to 5.4% from 0.6% during the same period last year. Also, 71% of its ARM borrowers are making only the minimum payment allowed, and 80% of those loans had not required borrowers to verify their income prior to receiving funding.

Analysis

Over 20 years of operating a business, I have made some bad decisions. The process with respect to bad decisions usually went as follows:

Stage 1: Investigative Stage: Investigate subject matter of the decision

Stage 2: Decision-Making Stage: Decide that the decision is a good decision

Stage 3: Implementation Stage: Move forward with the plan

Stage 4: Reevaluation Stage: See the plan is working and if the underlying premise holds.Stage 5: Stubbornness Stage: Ignore negative information and stubbornly forge ahead refusing to accept my mistake

Stage 6: Worrying Stage: Begin losing sleep and face continued stress and worry that I am getting in too deep

Stage 7: Epiphany Stage: Finally decide, “Screw it, I messed up, I don’t need this headache”

Stage 8: Unwinding Stage: Get rid of the problem as fast and efficiently as possible. Take the losses.

Stage 9: Moving On Stage: “Whew, I am glad I made that decision, what a relief!”

Conclusion

Mr. Lewis, or may I call you Ken? You are at the top of your game here. You are the leader of arguably the nation’s most successful banking institution. Unless you haven’t been completely forthright, you and your fellow managers have largely steered clear of most of the major destructive problems facing many of your competitors. You won! Why are you taking this risk? You have seen what this mortgage debacle has done to your competitors. Did you see what just happened to Thornburg (TMA)? Why are you saving Countrywide? Why take this risk? You can build your own national mortgage network! In fact, you already have one! Why do you need this? What are you thinking?

Actually, I know what you are thinking. You are probably somewhere between Stage 5 and Stage 6 right now, or maybe you are in full blown Stage 6? I feel your pain! Let me tell you, I think you are going to get to Stage 9. I have so much faith in you to get there that I bought your stock today. The sooner you do it, the less sleep you will lose and the sooner you can move on.

Best of luck.

Disclosure: Author has a long position in BAC

Comments

[Donp]

Dear Mr. Lewis

You do not need to save the world - just BoA.

[MrBillbr]

1 thru 3 makes sense..That's why the CEO makes the big bucks.
4 thru 9 appears to be your own opinion of the deal as it stands.
Have a nice day.

[BrettEllis]

I think Bank of America understands that Countrywide can orginate laons better than anyone, and also the fact that by generating loans, Countrywide can significantly assist BOA in bringing more asset deposits, as well as serving ancillary related core business strategies from within BOA. BOA has ha their eye on Countrywide for 10 years, and they finally got their chance to buy at bargain basement prices, even if they do suffer some losses. It is less expensive than paying the old share price.

[Kaos]

"You can build your own national mortgage network! In fact, you already have one! Why do you need this? What are you thinking?"

Uh, gee dude. I guess you have absolutely no idea how expensive that proposition is. BOA has lagged the mortgage market ever since they moved away from the more expensive dedicated mortgage rep model under the assumption they can do it all cheaper through the huge branch network. Sure they could build it themselves, but hiring reps, underwriters, processors, managers and building systems and processing centers all take money. Why not buy the largest mortgage distribution organization in the world, plus millions of existing customer base for a song? This thing will be generating huge returns for BOA by 2010.

Your argument makes some sense if Lewis were paying $20 a share, but at the deal price of ~$7 it is simply a demonstration of the kind of thinking that will ensure you never make it to the big boy chair!

[Tom B]

I think BoA did a lot of diligence and will squeeze water from this stone. I'm holding-- neither buying nor selling.

[dinod]

Yes, bofa's acquisition seems totally unnecessary. CFC's market was profitable high risk mortgages that are no longer acceptable bets. I have no idea why BOFA wants to but this albatross, they can make their own crappy loans if they want to under their current mortgage umbrella. CFC has NOTHING to offer BOFA.

[fpinphx]

It's a coup for BAC. CFC is a mortgage servicing machine. They have the technology and infrastructure to easily service the combined number of mortgages of both companies (~14M loans) with plenty of room to scale. BAC could then eliminate their existing more-costly mortgage servicing infrastructure and increase profitability.

[Arohan]

The deal looks bad if you cannot think beyond the present time. It would be a stretch to imagine that the mortgage market will remain in dumps forever. People will start buying houses. Do you think BAC should wait until the market comes back up, Countrywide gains marketshare and profitability, and then buy Countrywide for $50 a share? Why would Mr Lewis make such a boneheaded decision?

Yes, there are risks in this acquisition, but nothing that Bank of American can't fix by supporting this in the short run with additional capital. Once the market stabilizes, this should be a huge score for BAC. One forgets that Countrywide was (or maybe still is) simply the best mortgage company in the country. You also forget that BAC has been a growth oriented company and is now hitting a limiting factor in its growth (deposit accounts cap) and buying Countrywide is probably the best way for them to continue growth. Sure they can acquire internationally and they will probably do that but as a shareholder I sure as hell hope that they do not let this golden opportunity to get Countrywide for a pittance go by

You did the right thing by buying BAC stock, but for the wrong reasons

[KostyaTszyu'sright hand]

It is my humble opinion that if CFC had a 'good' reputation, then the deal would make sense.
It doesn't, thus it doesn't.
Perhaps BAC is simply angling for the mortgage servicing rights of a soon-to-be defunct CFC?

[RichShinnick]

Very interesting comments. One one side you have those who think BoA will do best if the shed the deal on the other you have those (like me) who think this is a great deal. I guess if either side is right it will be good for BoA, only if BoA buys CFC and it turns out to be a mistake will BoA be a bad deal.

As far as those who think tha BAC is getting CFC's network for a song: The deal has two components which are the price (dillutive to BAC shareholders) and assumption of liabilities. The second is the real price and the real question.

Yes, CFC's servicing unit has value but it comes with the mortgage portfolio. Here is another example, E*Trade, it's brokerage has huge value, but it has 30-40 billion in stated income lonas hanging around it, look at what happened to that stock. I wrote on that too and got smacked around on that thread.

Time will tell. I will note that Mr. Lews himself does not seem to have personally affirmed the deal since January (as I read it). All deals are "on" until the precise moment in time when they are off.

BTW, I don't think anybody here is saying tht BAC actually needs this deal or would suffer without it. That is the interesting thing.

[blah-blah]

How many times do companies aquire other companies when they're cheap and near bankruptcy? This is one of those rare opportunities that shareholders complain, do not happen enough. You need to be a true value guy to appreciate this.

I have no doubt BAC will get their 6B(buyout + earlier purchase) value out of the stock. Relax, sit back and stop watching your stocks all the time. In 2 years people will be calling Ken a shrewd guy for this.

[kurt walter]

BAC should not buy CFC, a dead dog. If BAC management was smart it would wait for CFC is fail and then pick up the loan servicing dept. The rest of CFC is worthless.

[just.a.guy]

kurt, I think that's what could be happening here. BAC has right-of-first-refusal on the assets as part of its $2BB convertible death-spiral financing last year.

I see the current deal on the table as just a call option for BAC, since it will have/has had a serious chilling effect on any other potential bidders.

Why would the deal just be a call option and not binding? Here, I assume that Countrywide's financial position will only continue to deteriorate, that the quality of its portfolio held-for-sale will only decline, and thus a Material Adverse Change to CFC is pretty much inevitable.

BAC will have front row seats, have done their diligence, and be in the driver's seat when this turns into a pre-packaged bankruptcy with BAC walking away with the servicing business.

Just a theory. Not one I believe in strong enough to hold onto my CFC puts, though. I sold those last month.

[william ofsan antonio]

my stake in countrywide is a substantial portion of a small, bank-brokerage account. i bought from 22 aug (BOA's action date) through mid september. the nest of analysts watching CFC have a mean of 'hold'. and i wonder what my stake will be worth 2-3 years after the BOA purchase is concluded in late 2008. any puts here?

[User 161139]

I live in Western Massachusetts. In my area Bank of America is still one of the primary sources for 100% financing of real estate purchases. Additionally, Bank of America is agreessively pursuing equity credit lines and expansion of existing equity credit lines. The purchase of Countrywide is defensive to shore up a failing real estate market. I would short Bank of America.

[KostyaTszyu'sright hand]

Richard, the entire loan portfolio doesn't necessarily go with the servicing. I once spent a week, in a failed S&L's board room, cherry-picking seasoned performers and chucking the ugly ones back to the RTC. Could this happen again?

[User 161373]

This is a typical case of the human brain putting way too much emphasis on what's happening today vs. the long run. It's why so many people sell at the wrong time and buy at the wrong time. As Jason Zweig wrote in his article, Can't Save? Blame your brain, "New discoveries in neuroscience labs are helping to explain why it's so hard to resist the allure of instant gratification. It turns out that your brain is much more aroused by $1 today than by $1 tomorrow. And $1 six months from now barely registers", and then again "... the temptation to buy dotcom stocks in 1999, energy stocks in 2005, real estate in 2006, emerging markets in 2007 or gold right now - what's hot when it's hot - is overpowering for many people, no matter how often they've been burned before."

BoA's acquisition of Countrywide is an excellent long-term deal. Sure, today it looks like a terrible bet. CFC recently reported that 71% of their ARM's are making only the minimum payment allowed. That could sound scary, but ... they're paying! I think we tend to forget that people DO NOT want to loose their home. It's a dream of everyone to own your own house. With all the programs to save peoples homes, prevent foreclosures etc, I would say that most of the 71% paying right now will be able to move to products that are fixed and that they can afford, and they will CONTINUE paying their mortgages to avoid loosing their dream.

The nightmares of Countrywide are happening now, and BoA knows it and that's why they scooped it up so cheap. In a few years, it will look like a bargain and Ken Lewis will be in the cover of Money magazine. In fact, many big time investors of CFC feel that CFC shouldn't accept BoA's offer because after the nightmares are over, CFC will be worth SO MUCH MORE than BoA is paying.

So Richard, question for you: Have you sold all your investments lately?

[RichShinnick]

Hi User,

"So Richard, question for you: Have you sold all your investments lately?"

Uh, no. I think that is clear above. I like this discussion. It kind of centers on what the RIGHT reason to own BAC is. But, lets all agree on one thing, the price is unknown. CFC's value on the day the deal closes will determine the ultimate price and its mortgage book will set that value. Look at all the banks trying to dump mortgage books right now, BAC is buying when they are selling. Helluva time to try to catch a falling knife, but maybe Lewis is the guy to do it.

Maybe not, he still has time to punt.

[RichShinnick]

Now, throw in a reported FBI investigation. Come on Ken!!!! Get real!!!