The best banking deals are done in bad times. Think of the fortunes made in the wake of America’s savings-and-loan debacle, or by the acquirers of Japan’s Long-Term Credit Bank, since renamed Shinsei. But gambles taken in the fog of a financial crisis can also prove horribly misguided. Which of the two is Bank of America’s embrace of Countrywide, due to close on July 1st?
The $4.1 billion deal, announced in January, was a dramatic moment in the credit crunch. By stepping in to rescue America’s largest mortgage lender after injecting $2 billion into it in August, BofA helped to calm fraught markets. Countrywide’s copious subprime woes ensured a low price: a mere sixth of its stockmarket value before the crunch. But what looked like a steal is now widely viewed as a stinker, thanks to still-accelerating falls in house prices. Nevertheless, BofA has resisted calls to renegotiate, insisting it can make the deal work (and unsure whether it would have grounds to pull out anyway).
Countrywide’s balance sheet is not pretty. Of its $95 billion loan book, more than a third is home-equity lines of credit and second-lien mortgages, both much riskier than the typical home loan. Assets in foreclosure or delinquent, up fivefold from a year ago, continue to climb. The lender will also have to take back the worst of the loans it sold on. And it will have to fork out billions to settle accounting probes and numerous legal disputes. The latest blows are three separate suits from the states of Illinois, California and Washington, targeting its lending practices. They were filed on the same day that shareholders gratefully approved the BofA deal. No wonder the Countrywide name is to be dropped.
Paul Miller, an analyst with FBR Capital Markets, thinks BofA could face $20 billion-30 billion of write-downs when Countrywide’s loans are marked at “fair value”, as they will have to be under acquisition-accounting rules. This would far exceed estimates when due diligence was performed, and could force BofA to raise new capital. The fair-value issue is one reason why other troubled lenders, such as National City, have failed to find buyers.
Ken Lewis, BofA’s, has admitted that things are worse than expected. But he insists the bank left plenty of room for error and that the deal remains compelling. It has a cushion of around $13 billion: the difference between the purchase price and Countrywide’s tangible book value. It remains confident losses will be within sight of that number. If so, it will get the franchise for a song and not have to raise more equity (on Countrywide’s account, at least).
Countrywide still has much to offer. Its mortgage-origination network and technology are both formidable. Its giant servicing business, which collects payments and passes them on to investors, is struggling, but could still be worth more than $3 billion on its own. Critics have “lost sight of the fact that such services are very difficult to replicate,” says Dick Bove of Ladenburg Thalmann, an investment boutique.
Mr Lewis has long wanted to expand in mortgages, the only “cornerstone” retail-banking business in which his bank is not a force. This deal gives it 20-25% of the American market. It also offers a chance to flog BofA cards, insurance and investment products to Countrywide customers. And it handily allows the bank to sneak past a 10% limit on national deposits. Regulators, desperate to see Countrywide in good hands, seem happy to turn a blind eye.
So it may yet prove a masterstroke, if BofA’s number-crunchers have got their sums right. But that is a lot to ask in the middle of a storm.