The big news in financial markets last week was Bank of America’s proposed $4 billion acquisition of Countrywide Financial. Let's call it the pied piper of reckless mortgage-lending practices. It encouraged brokers to push the limits on subprime, interest-only, and negative amortization mortgages. It provided the raw materials for Wall Street’s mortgage-backed security machine. And it now faces a choice between bailout and bankruptcy. Countrywide shareholders are lucky Bank of America is bailing them out.
The same can’t be said for Bank of America. I expect B. of A. shareholders will regret this investment. Rather than buying just a division of Countrywide, or waiting to scrounge through the post-bankruptcy rubble, B. of A. is acquiring it outright. This package includes Countrywide’s assets and liabilities. B. of A. executives believe the low purchase price -- about one-third of Countrywide’s book value -- will compensate them for the risk.
I don’t agree that book value is an accurate gauge of Countrywide’s intrinsic value; a mere 7% drop in Countrywide’s fishy assets would wipe it out completely. Countrywide’s assets ballooned during the housing bubble, having doubled since December 2003.
B. of A. is taking a huge leap of faith that this mortgage portfolio is worth anything close to $80 billion. This portfolio may be hard to value, but if the housing market remains stubbornly weak, it won’t be worth $80 billion much longer.
“Bankruptcy litigation is among a list of potential legal liabilities Bank of America may inherit,” notes today’s Wall Street Journal . “These include inquiries from the Securities and Exchange Commission and several state attorneys general, as well as shareholder lawsuits tied to Countrywide’s financial decline and other class action and individual suits brought by borrowers for alleged abuses by the company.”
Countrywide CEO Angelo Mozilo, already under investigation for his suspiciously well-timed stock sales, has already grabbed his golden parachute. In yet another example of poor oversight by the board of a publicly traded company, Mozilo is expected to receive a severance package measured in the tens of millions of dollars.
On last week’s conference call, Lewis mentioned that he wants Mozilo to stay on until the deal closes. Mozilo, long regarded as a mortgage industry “expert,” should have spent less time working on his famous tan and more time in the office thinking about Countrywide’s balance sheet risk. He squandered shareholder capital on hefty share repurchases when the stock was multiples of its current price -- capital that would have come in handy to survive the current financial hurricane.

The Bank of America/Countrywide deal doesn’t mark a bottom in mortgage finance -- just another gamble with other people’s (i.e., shareholders’) money that it has, or has not.

When it does bottom buy KRE for a long term buy.