Bank of America: Smarter Than We Think?

The New York Times' “Bank of America Is Firm on Countrywide Buyout” reports that Bank of America (BAC) CEO Kenneth D. Lewis is aware of the critics of the Countrywide Financial (CFC) deal. Lewis said the deal is “compelling” and “we don’t have our heads in the sand.”

The critics endlessly reiterate Countrywide’s concentration in California and Florida, poor underwriting standards and high default rates, and the intense regulatory scrutiny. Analyst Paul J. Miller (Friedman, Billings, Ramsey (FBR, FBCM)) estimates that these problems will add $10B to $15B to the deal’s $4B purchase price.

The critics are even attacking the $1.5T mortgage servicing business, which generated $1.4B in first quarter revenue. They contend the cost of dealing with problem loans is increasing. The servicer still has to forward investors up to three months payments on delinquent loans. Judges are making forecloses and evictions more difficult, and Countrywide’s documentation has not always been in order. This has led to an $817M loss in servicing for the first quarter. Countrywide values its servicing business at $17B; Miller estimates its value at $3.5B.

Bank of America already told us it intends to replace Countrywide’s leadership, and instill the Bank of America culture. In essence, Countrywide’s culture is rotten to the core; but they have great technology and connections to the most productive real estate agents. Bank of America wants to use Countrywide’s infrastructure to build a better “number one” mortgage company. Lewis said the Countrywide name will be dropped after the merger.

The New Times reported on May 6, 2008 that “Bank of America added a new paragraph to merger documents suggesting that it might not guarantee some or all of Countrywide’s publicly traded bonds.” This statement and the recent insistence that the deal will close leads me to believe that Bank of America is going to separate the Countrywide savings bank from the mortgage company, and find a way to force bondholders into negotiations. The Countrywide bondholders might not be getting a Bear Stearns-like (JPM) sweetheart deal.

Depending on how Lewis structures Countrywide after the purchase, he might able to substantially reduce debt and other liabilities. He might even send parts of Countrywide into bankruptcy. I think it’s worth gambling on Lewis. I will buy Bank of America if panic ensues.

Disclosure: Author is long CFC, FBR and JPM (not by choice).

Comments

[SoCal Scott:]

Are you kidding? Panic has already ensued. I'm long BAC (in part because of some of the reasons you mentioned), but who would have seriously thought BAC would be trading in the 20s?

2008 Jun 09 02:14 PM

[TA:]

For weeks now it's a been a true definition of a falling knife. Doug Kass is calling it capitulation.

I am also long and wouldn't be suprised to see 25.

'He might even send parts of Countrywide into bankruptcy' - That would interesting, I'd like to see how it could work.

2008 Jun 09 03:12 PM

[pochovilla:]

BAC buying CFC is similar to buying a house that failed the termite inspection. In the long run it might be worth it. But it could be a slow and expensive process.

2008 Jun 09 03:16 PM

[stay-a-float:]

the moment BAC agreed to purchase CFC is the moment for us to re-evaluate the BAC valuations, I believe its over valued now and I expect to see more bleeding, that said opportunity is lurking.

2008 Jun 09 03:45 PM

[Donald Johnson:]

Buy BAC for an 8.5% yield, sell July calls and get an annualized yield of about 18%. The dividend's at risk, but would eliminated it, cut in half or what? I'm figuring BAC could cut the dividend in half, but that's just a guess. I blogged my strategy yesterday.

2008 Jun 09 03:51 PM

[jerrrygarcia:]

My biggest question is, "What is the risk gain ratio?" From that standpoint, I believe this is a misallocation of capital yet again by this management team. Ken always seems to go for size rather than return on capital. I don't believe they have accurately assessed the potential loan losses, litigation costs from customers and state regulators, plus the potential for adverse rulings by judges on foreclosure cases. Remember Home Equity = 2nd Lien = Very high Severity Rates on Delinquincies. And I am way more long this stock than anyone else on this message board.

2008 Jun 09 03:55 PM

[TA:]

Donald E. L. Johnson - intesting summary of the recent opinions of BAC on your site.

I already sell covered calls on all stocks I own and recently repurchased my $55 calls for .05 so I can re-sell a lower strike for some decent money.

2008 Jun 09 04:43 PM

[The Real Ex...:]

"Bank of America: Smarter than We Think?" Let's see...a bank that has yet to integrate its IT systems from its California branches into its nationwide systems, despite around 10 years of saying it would? Mike you should know about this.


If BAC is smarter than we think, it surely isn't showing it with its abysmal level of customer service, marathon-like phone wait times,
and complete organizational chaos. BAC grew by acquisition and by flooding the nation with ATMs but it has failed miserably to properly integrate its banks and other holdings into its archaic IT platform. BAC is the worst run mega bank in one of what is now and has been (for about 4 years) the worst run industry in America, and the results are just now starting to show.

Get ready to buy BAC Michael, because panic is about to ensue. What I find strange though is that with already some lameduck financials in your portfolio, why you would buy another (BAC), especially when you already have BAC exposure via CFC.

blah-blah, sorry to say but only a clown would buy the 55 calls. Those way out of the money calls are almost always bought by "joes" who have no money and think they are going to hit it "big" if the stock goes up. Don't be a cheapo. If you like BAC (and I cannot see why you would given the current situation) spend more money and buy calls closer to the money. If the stock price moves up your percent gains will be higher. That is the way options work.

Donald Johnson, dividends don't do much when the stock craters. And selling calls won't ease the pain because the stock will most likely fall to $20 over the next few months. Any type of long strategy in the financials is complete stupidity at this point. I recommmended a long-term short in BAC 8 months ago and I would not be covering here (except maybe for a short-term cover then another short after rally).

2008 Jun 09 06:28 PM

[The Real Ex...:]

SoCal Scott, it's a shame you have not been patched into the real experts. If you had, you'd have made a lot of money. If you never expected BAC to see the 20s, what are you goingto say WHEN it hits $18? In my opinion there is a 70% chance of BAC reaching $18, an 80% chance of it reaching $20 and 90% chance it's headed to $25.

2008 Jun 09 06:32 PM

[groty:]

Investors have taken off $45 billion of market cap since May 1. I'm guessing they are anticipating a dividend cut, an equity offeirng and more writedowns.

Plus, no matter how much due diligence BAC is doing on CFC, it's impossible to estimate with any degree of accuracy the litigation risks they are facing and how regulatory mortgage/banking reforms will impact the business.

Seems like a value trap.

2008 Jun 09 06:39 PM

[TA:]

The Real Expert - You didn't read what I wrote carefully enough. I said I sell covered calls and I 'repurchased' as in buying back the calls I sold to close out the contract.

I didn't see the point in waiting till Jan 09 for the calls I sold at far higher prices to go from .05 to 0 when I can reseller lower strike prices.

Get it now smart guy?

2008 Jun 09 08:10 PM

[Gabo:]

Time will be the judge. The servicing platform worth that money.

2008 Jun 09 10:57 PM

[sharksm:]

Lewis should lose his job. He is no better than Jimmy Cayne at Bear Stearns. Throwing good after bad is the sign of a moron. I am a long time holderr of 6,000 shares

2008 Jun 10 08:49 AM

[jackooo:]

The stock market is designed to screw the small guys and make the bog guys more wealthy. That is the way it has always been and it will never change.
Totally agree with the above statement you made. the real expert.
Also agree with blah blah. I sell calls on my loser stocks but do not buy them back when they drop. Been doing that for years in order to get some cash back from them.

2008 Jun 10 12:41 PM

[jackooo:]

Bank of America smarting than us? lol lol
I never lost as much in value as those smarties....

2008 Jun 10 12:43 PM

[lsuavecito:]

I would think that for those interested in BAC a more prudent move than the common might be BAC-PL; 7.25% conv. pfd., converts 20 to 1, 5 year call protection, *qualifies for the 15% tax treatment, pays 1/4ly, A1/A+ current rating, etc. If BAC(common) slashes the dividend, one may have a 4%-5% yield. Currently, BAC-PL is trading at 970, almost a 7.5% yield and a bit more secure than the common with the possibilty of capitol gain down the road, AND you are being paid to wait until the smoke clears.
Make sense?

2008 Jun 10 12:44 PM

[bill d:]

Sorry blahblah - but your original post was way too simple for the RE (Don't worry - he'll never figure out who we're talking about) - too bad we can't draw little pictures for him but he probably would have trouble staying inside the lines anyway. I do the same as a means to get dividends and still get a return on a stock that is currently below what I want to sell it for. I also sell naked puts on stocks that I want to own anyway but I'm sure he'd NEVER figure that strategy out. I assume he's one of those poor little guys he refers to. I think we know who the REAL clown is !

2008 Jun 11 02:08 AM

[Short, Shor...:]

I do not like the Countrywide deal at all right now, I think it would make sense to walk away from it and pick up the pieces before bankruptcy auction as far as Countrywide deal is concerned.

As a contrarian, I believe the company will be fine long term but it seems they are trying to sweep too much under the rug as if we the public are stupid, better to come clean, cut the dividend, drop the countrywide deal as an equity purchase (pick up bonds and debt of the company, and take over the skeleton or bones from bankruptcy or pre-bankruptcy deal), get all skeletons out such as write downs as we know there are more bombs to drop with many of these companies.

The contrarian view is at some point BAC and other major banks will be realizing gains from their totally written off portfolio, and they will be substantial as most companies are doing complete write-offs of assets that have a value thay are just unloved or illiquid at the moment.

Not that I am bullish on the sector or BAC for the short term (there is just too much negative sentiment) but ussually when you have all the little guys are so negative on a company and everyone is bearish, buying puts, going short, it usually means that much of the unheard news or stuff that is expected to come out of the closet is already reflected in the price of the stock and the big guys want to drive it lower so they an A) Buy and B) Cover short positions at an even juiceier profit

My 2 cents!

2008 Jun 11 03:13 PM

[fxtrader07:]

Hi Michael - these comparisons to 1990, 1995 or 2000 are completely useless. the bull market in securitization and ever higher leveraging has ended. and banks profits have been driven by it all those years.
the current credit crisis in unprcedented. every bank exec agrees at least on that. you have to go back to the 1980s and further down to the 1930s for real comparisons.
using the datapoints you suggested is a bit like referring to 1998, 1999 and 200 to determine a bottom for dot-coms in 2001/2002

a huge part of the business model of the banks is effectively broken. so what do you think "normalized" (i.e. non-bubble) earnings will look like? and when can they be achieved? banks struggle to get cash and deleverage - unless they are done with it they have no resources to write new business. and if there is little new business, a zero fed funds rate doesn't make a dent in their earnings

2008 Jun 12 10:24 AM

[The Real Ex...:]

For all of you who for some reason want the highest risk sector with at best, mediocre potential returns, you will have plenty of time to buy the financials. As I have been saying for a while now, there is much more downside, especially with LEH, BAC, and AIG. I might consider going long BAC for a trade when it hits $22. In the meantime, I'm buying gold, Chinese assets, commodities, and other investments that will continue to do well.

Food for thought guys. If the banks are such "great values" why haven't they used some cash to buy back their shares? Because they have no extra cash (very dangerous situation) and because they know the end is nowhere near. Think about it..the Fed has opened its presses to them yet they are still not buying back shares????? WHAT DOES THAT TELL YOU????

2008 Jun 12 05:15 PM