Interest Rate Roundup

Friday, January 11, 2008

More on Countrywide this a.m.

Some excerpts from the Wall Street Journal's coverage of the Bank of America-for-Countrywide buyout/bailout saga -- a deal that's being confirmed this morning:

"Bank of America Corp. is near agreement to take over tottering mortgage giant Countrywide Financial Corp., in a move that could build a bulwark against the mortgage-default crisis by protecting one of its biggest casualties from collapse.

"Bank of America had insisted for months no takeover was in the works, but people familiar with the talks said a deal could come very soon. It isn't clear how much Bank of America, the largest U.S. bank in stock-market value, has offered for Countrywide, the biggest mortgage lender, whose stock had dropped 88% in the past year. It is still possible that an agreement could be delayed or fall apart. For federal approval, the deal could depend on exploiting a little-known regulatory provision to allow the merged bank to hold more than 10% of the nation's deposits."

* Was the government involved in putting this deal together? Treasury denies it in the WSJ, but clearly a Countrywide failure would have widespread ramifications for the mortgage market, as this paragraph notes:

"More broadly, a failure of Countrywide would have posed a major risk to the U.S. economy, since the lender services about one of every six loans in the country. Bankruptcy likely would have shifted huge financial risk to Fannie Mae and Freddie Mac. A spokesman for the U.S. Treasury Department said agency officials didn't encourage Bank of America to rescue the huge mortgage firm."

* Is this a good deal for Bank of America? Only time will tell, but I'm skeptical. Here's what the WSJ has to say:

"For Bank of America, the deal would instantly allow it to realize its ambition of becoming a dominant mortgage lender. But it also would bring some ticking time bombs, whose powers to destroy value won't be clear at least until the housing market bottoms out, which may not be for a year or more.

"Bank of America has more than $100 billion in its own home-equity loans, second mortgages that have shown signs of strain as the housing crisis spreads. Bank of America would be taking on more than $30 billion in Countrywide home-equity loans. Though Countrywide has virtually stopped making subprime loans, it has exposure to its past originations. As of Sept. 30, Countrywide's savings bank held $26.84 billion of option ARMs, which allow borrowers to start with minimal payments and face far higher ones later.

"Home-equity loans and option ARMs accounted for three-quarters of Countrywide's loan holdings at the end of the third quarter. Countrywide says some of that risk is covered by mortgage insurance, but some investors are nervous about mortgage insurers' ability to pay off all the claims they face in the next few years.

"Bank of America already paid $21 billion for Chicago's LaSalle Bank over the summer, and could drain its capital more if it takes big write-downs for Countrywide's loans. That short-term hit, however, could become a long-term boon should the loans perform better than expected."

* Finally, the WSJ notes that an obscure loophole in banking law could be what allows a deal to occur. Banks are generally restricted from acquiring more than 10% of the country's deposits, but ...

"There appeared to be a big obstacle for a Countrywide takeover after the Federal Reserve approved Bank of America's acquisition of LaSalle in September. The combined bank grew to hold 9.88% of the country's deposits. Federal law prohibits a bank-holding company from controlling more than 10% of U.S. deposits after acquiring another bank.

"But the law includes an obscure caveat: The 10% limit doesn't apply to federally chartered thrifts, meaning a bank-holding company may control more than 10% of deposits in the U.S. following a thrift acquisition. Since a Countrywide subsidiary called Countrywide Bank is a federally insured thrift, that may give Bank of America room to maneuver around the deposit cap.

"Bank of America is the only bank that has ever neared the 10% deposit cap. Many seasoned banking attorneys were not familiar with the caveat, as no bank has ever tried to acquire a thrift to vault above the 10% limit.

"This could be the biggest loophole in the world," said Gilbert Schwartz a partner at Schwartz & Ballen LLP and former Fed attorney. It was unclear when or how the loophole first became known to the banks."

Meanwhile, here's what BofA has to say about the deal in their release:

"Bank of America will benefit from Countrywide's broader mortgage capabilities, including its extensive retail, wholesale and correspondent distribution networks. The Calabasas, California-based company operates more than 1,000 field offices and has a sales force of nearly 15,000. Countrywide also has a leading mortgage technology platform, a well known brand in home lending and management expertise in a number of key areas.

"Bank of America would gain greater scale in originating and servicing mortgages in the U.S. Countrywide had $408 billion in mortgage originations in 2007 and has a servicing portfolio of about $1.5 trillion with 9 million loans. The purchase also includes Countrywide's Lender Placed insurance and other businesses.

"Countrywide presents a rare opportunity for Bank of America to add what we believe is the best domestic mortgage platform at an attractive price and to affirm our position as the nation's premier lender to consumers," Bank of America Chairman and Chief Executive Officer Kenneth D. Lewis said. "Countrywide customers will gain access to a broad set of consumer products including credit cards and deposit services. Home ownership is a fundamental pillar of the U.S. economy and over time it will be a key area of growth for Bank of America."

"We are aware of the issues within the housing and mortgage industries," Lewis continued. "The transaction reflects those challenges. Mortgages will continue to be an important relationship product, and we now will have an opportunity to better serve our customers and to enhance future profitability."

"Countrywide's deep retail distribution will enhance Bank of America's network of more than 6,100 banking centers throughout the U.S. After closing, Bank of America plans to operate Countrywide separately under the Countrywide brand with integration occurring no sooner than 2009."

UPDATES (some more headlines and details on this transaction):

* S&P says it may raise Countrywide's credit ratings due to the deal. Moody's, for its part, said it may lower its rating on Bank of America. Clearly, a transaction would lower funding costs for Countrywide, and alleviate some turmoil in the debt markets. As this story from Marketwatch notes:

"Countrywide debt due in 2016 was trading at roughly 41 cents on the dollar before news of a potential deal broke Thursday, while the company's bank debt was changing hands at about 70 cents on the dollar, she said."

* BofA says it won't exceed the 10% deposit cap for the reason cited in the WSJ story. It also indicated the bank will need "a couple billion dollars" to maintain regulatory capital levels. The transaction is slated to close in Q3.


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