Depressing News

It was pretty depressing reading the paper this morning.  The first article I read was about Bank of America and its potential acquisition of Countrywide, a deal made several months ago but not yet consummated.  Several analysts were questioning whether BofA should go ahead with the deal.

A little background information is in order. Countrywide was, like many lenders, running short on cash last year as the credit crisis started. In August 2007 they stuck a deal wherein BofA purchased $2 billion in Countrywide Preferred stock. The capital thus injected allowed Countrywide to continue normal operations in spite of the beginnings of the capital market freeze that is now obvious to everyone.

At the time, Countrywide's common stock was selling for about $22 per share, just about half what it had been earlier in the year.  While Countrywide maintained a positive outlook, even forecasting profitability after their first quarterly loss in its history, the reality of the marketplace was that losses were mounting, as has now been acknowledged.

There was obviously a lot more going on behind the scenes and in January 2008, BofA and Countrywide announced that they were merging. At the share price on the day it was announced, Countrywide shareholders would have gotten about $7 in BofA stock for their Countrywide stock. The stock closed today at about $5 per share.

The questions that was being posed today was, "Should or will BofA go ahead with the merger?"  The question revolves around the issue that everyone in mortgage lending faces today: maybe the assets worth less than I think they are and maybe the liabilities are larger than they appear today.

On the one hand, they are buying a company for about $4 billion that had a market value of $25 billion the year before.  Plus they have access to Countrywide’s customer base and can sell them other BofA products. Sounds like a good deal. But the crown jewel is the Countrywide servicing portfolio.

Remember that servicing is the collecting of payments from borrowers and transmitting the money to the institution that bought the loan. In round numbers, the value of servicing varies as to type of loan but in general the servicing is worth a little less than 1% of the value of loans being serviced.

Countrywide's servicing portfolio is almost $1.5 trillion. That means that the value of servicing is a little less than $15 billion. The way I see it, if you pay $6 billion and get a servicing portfolio worth $15 billion, you got yourself a good deal. You get all the rest of the company, its many offices, its tens of thousands of employees, and all the rest of those assets for free.

But then again there are those liabilities. As Countrywide noted in a press release of first quarter 2008 results:

"securities retained in prior securitizations and nonagency inventory subject to fair value adjustments were written down."

The question is what else is there in the woodpile that you don't know about. 

As much as I worry about am insensitive, bureaucratic, behemoth lender that will have a market share of the mortgage business in excess of 25%, I worry even more about what might happen if they don't do the deal. I don't see how Countrywide can avoid bankruptcy and who knows where that will lead.

As if that wasn't depressing enough, in the next article I read about analysts questioning whether FannieMae and FreddieMac have enough capital!  I'll talk more about that next week.  Stay tuned.