BofA's Countrywide deal a bold bet amid crunch
NEW YORK Jan 11 (Reuters) - By snapping up downtrodden mortgage lender Countrywide Financial Corp CFC.N, Bank of America Chief Executive Kenneth Lewis is betting that U.S. consumers are not poised for a prolonged slump.
Bank of America Corp (BAC.N) agreed to buy Countrywide, the nation's largest mortgage lender, for stock worth about $4 billion on Friday.
The deal will make Bank of America -- which earlier this year overtook Citigroup as the largest U.S. bank by market value -- the biggest U.S. home lender.
But it is buying a company suffering from rising losses and a cash flow crunch. Bank of America's Lewis acknowledged near-term challenges in mortgages, telling a conference call he expected loan volumes to fall. Analysts and investors say the deal could pay dividends down the road, but things will get rocky in the meantime.
"I think that when we look back two years from now, we'll say this was a smart deal. Between now and then, it will be difficult," said Peter Kovalski, who helps manage $12 billion of assets at Alpine Woods Investments. "The proverbial knife is still falling and it hasn't hit the ground yet."
Bank of America is the No. 5 lender in U.S. residential mortgages. The Countrywide deal will catapult to the No. 1 spot in this segment which is considered a revenue drive during periods of growth.
This is not one of those periods.
Sloppy mortgage underwriting industrywide in 2005 and 2006 led to an increase of defaults among risky "subprime" borrowers, which then sparked a slump in mortgage-backed bonds and related securities. By the summer of 2007, debt markets seized up and triggered massive losses among investment and commercial banks.
"We don't feel like we're anywhere near out of the woods," said Michael Mullaney, portfolio manager at Fiduciary Trust Co in Boston.
Lewis told investors the bank factored in potential credit losses and charges in calculating its offer, but he declined to explain how the bank assessed Countrywide's portfolio.
Bank of America projects the deal will not boost profit until 2009, and that assertion ignores the $1.2 billion in deal charges. Analysts see the takeover causing near term pain.
The bank "is going to have to absorb the massive losses in right-positioning Countrywide. It can be done, but the cost is going to be exorbitant," said Sean Egan, an independent credit analyst and head of Egan-Jones Ratings Inc.
Lewis also will inherit a number of legal headaches. Countrywide founder Angelo Mozilo faces lawsuits and regulatory probes for selling stock even as the company reassured investors it would survive.
WISE DEAL?
Indeed the timing of the deal fueled speculation that other factors forced the banks' hand. Some critics argued Lewis wanted to save face after the bank's $2 billion cash injection began to look ill-timed. The value of that investment has fallen by two-thirds since it was announced Aug. 22.
"You didn't come away from the conference call with the warm fuzzies that this was a great deal. Why else would they do it other than to protect their investment?" said James McGlynn of Summit Investment Partners.
Lewis is picking up the premier mortgage franchise at scratch-and-dent prices. Bank of America's offer was a discount to Countrywide's Thursday closing price and below its liquidation value.
Lewis may be betting the purchase fares better than the $24.2 billion acquisition by Charlotte-based rival Wachovia Corp WB.N of mortgage lender Golden West Financial Corp in Oct. 2006, just as the mortgage cycle was peaking. Wachovia has said that deal has not worked out as well as expected.
Most analysts agreed that the current weakness will end and let Bank of America enter the next upturn the largest U.S. home lender.
"I think this is a good deal for Bank of America," Punk Ziegel & Co analyst Dick Bove said. "They wind up with 9 million new customers, the best mortgage platform in the United States, the best distribution system and a commanding position in the industry."
(Reporting by Joseph A. Giannone; Editing by Leslie Gevirtz)
((joseph.giannone@reuters.com; +1 646 223 6184; Reuters Messaging: joseph.giannone.reuters.com@reuters.net )) Keywords: COUNTRYWIDE/BANKOFAMERICA RISKS
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