You've Been Warned: Bank of America Eyeing Countrywide
If the pending Countrywide-Bank of America combination were a wedding ceremony, Friedman, Billings, Ramsey Group analyst Paul Miller would be the guy in the back of the church raising his hand in objection.
In spite of rumors of bankruptcy and liquidity concerns, Bank of America (BAC) indicated in early January that it plans to purchase Countrywide Financial (CFC) for about $4.1 billion in stock. While some thought the price was too lofty given the potential risk, the fact is that BofA had the opportunity to pick up Countrywide’s vast mortgage business on the cheap (compared to historical levels) - and it acted.
Unfortunately, its low price hasn’t quelled all concerns. On Monday Miller disseminated a research note, which according to a Bloomberg report, said:
Bank of America, the second-biggest U.S. bank, may have to write down the value of Countrywide's loans by as much as $30 billion because of declining home prices.
Miller thinks there's a chance that the deal (more specifically Countrywide’s loan portfolio) could cause B of A to raise additional capital. This is particularly disturbing for both investors in both firms.
With regard to Bank of America, investors have enough to worry about. After all, its stock is well off its 52-week high. In addition, nobody knows for sure when the blood letting in the credit markets will abate. And so the prospect of obtaining an entity that Miller seems to think could have an adverse impact on earnings (at least for a period) doesn’t exactly inspire enthusiasm.
On the flip side, if indeed Bank of America did walk away or cut its offer, there is a chance the stock could pop.
With regard to Countrywide, Miller’s report is also a concern. That’s because, if Bank of America does go Miller’s route, its unclear if another suitor might emerge. In fact, given the uncertainties, one might assume that other players in the financial services industry won’t exactly be knocking down its door.
What are the odds that Bank of America will shy away?
The reality is, you never really know. However, Bank of America spokesperson Bob Stickler did reportedly come out and say that the transaction is on track to close in the third quarter. The fact that the company came out with such a statement, apparently to stifle speculation, seems to be a sign that it will stand by its word - at least for now.
Look for Countrywide to trade higher at the open based on the Bank of America statement. But keep in mind that the third quarter is still a ways a way and a lot could go wrong in the interim.
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If BAC walks away, Countrywide immediately goes under and the Fed would have to bail out the entire FHLB system.
This could potentially give BAC some leverage with the Fed to restructure the deal along the lines of JPM/BSC. I'm sure the thought has crosed their minds.
It should be noted that BAC has its hands full right now even without the dead weight of CFC hanging from its neck. A look at the most recent 10-K filing is quite revealing. You can view it at
http://sec.gov/Archives/edgar/data/70858/000119312508041665/d10k.htm
Non-performing Loans and Leases from BAC's last 2 overpriced and ill-timed acquisitions (La Salle Bank and MBNA) are exploding through the roof. These haven't even been written off yet, and still BAC's Tier I capital has dropped from 8.64% at year-end 2006 to just 6.7% by the end of 2007. We all know that things took a further turn for the worse in 1Q 2008.
If I were a BAC shareholder, I would be scared stiff.
BUT, the Fed cannot afford another JPM type bailout. It has no rate cuts left and 60% of its balance sheet has already been traded out for junk.
Meanwhile today's Fannie Mae number does not exactly inspire confidence that the taxpayers won't have to bailout the GSEs to the tune of trillions of dollars.
On top of that, S&P has already reported that it will start considering downgrading the debt of the USA given that the federal government is right about its debt limit, cannot practically become more indebted without further and drastically exacerbating the slide in the dollar, and that the GSEs have become such a risk.
Lastly, Helicopter Ben has floated a plan for Paulson and the boys at Treasury to print more greenbacks than the government needs to use for its operations and lend it to Ben so that he can lend it to the banks (probably in exchange for more junk of even greater toxicity).
But as long as everyone's drinking the Kool-Aid and the market can rally, who cares?
