The Wall Street Journal-20080111-Countrywide Seeks Rescue Deal- Bank of America Eyes Stricken Home Lender As Crisis Grinds On
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Countrywide Seeks Rescue Deal; Bank of America Eyes Stricken Home Lender As Crisis Grinds On
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.
But Countrywide's fall and expected rescue mark a milestone in the unfolding international financial crisis. The turmoil was triggered more than a year ago by the bust of the American housing market and the resulting wave of mortgage defaults, but it is spreading -- and authorities are struggling to contain it.
A weakening economy and rising mortgage delinquencies have begun to feed off each other in a dangerous spiral, as falling home values and tightening credit begin to sap consumers' spending. Retailers yesterday reported weak December sales, and American Express Co. reported reduced spending and increased delinquencies among its customer base, known for its affluence. Unemployment last month jumped and economists have dramatically raised the odds of a recession to 42%, according to the latest WSJ.com survey.
To combat those trends, Federal Reserve Chairman Ben Bernanke yesterday indicated a new willingness to cut interest rates more deeply. That came after the Bush Administration began floating the idea of direct economic stimulus such as tax rebates. Bank of America's move provided an immediate shot in the arm, as the battered stocks of Countrywide and some other mortgage lenders rose on optimism that the possible takeover by Bank of America could signal an end to the relentless bad news from lenders.
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.
Bank of America declined to comment on any deal, citing a longstanding policy on not commenting on rumors and speculation. Countrywide representatives didn't respond to requests for comment.
Countrywide's acquisition would mark the end of a mortgage lender long known as an innovator, survivor of slumps and fierce competitor that rocketed to No. 1 in U.S. mortgage lending by the early 1990s. Countrywide lost its No. 1 position in the mid-1990s but regained it in 2004 and continued expanding its market share by hiring aggressive sales people and lowering its lending standards -- leading recently to a rising tide of defaults.
During the housing boom, Countrywide was a big promoter of option adjustable-rate mortgages, which give borrowers choices of how much to pay each month and can increase a loan's balance. A smaller chunk of Countrywide's business came from subprime loans, a type of lending that now has nearly vanished, but Countrywide still has exposure to past subprime loans and other risky mortgages.
"From the Countrywide stockholder perspective, this is manna from heaven," said analyst Richard X. Bove of Punk Ziegel & Co. "They've got this lousy stock and if Bank of America paper replaces Countrywide paper, they own one of the best banks in the country and they're bailed out." Countrywide shares surged 51% on the news to close on the New York Stock Exchange at $7.75. Bank of America stock closed at $39.30, up 1.5%.
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.
Investors in mortgage securities are looking to force Countrywide to repurchase many loans it sold in recent years, another concern for Bank of America. Those sales provide for repurchases when loans default early or otherwise don't live up to the "representations and warranties" Countrywide originally provided. "It is our intention to defend our positions vigorously" against those efforts, Countrywide said in a recent securities filing.
A purchase of Countrywide, however, could be coming at a big discount, and could ease the losses Bank of America has suffered on investment in the company in August, when it bought preferred shares convertible to a 16% stake for $2 billion. In the next few months, Countrywide's stock fell by more than half, including a plunge in recent days amid intensifying anxiety among investors. The bank was forced to deny earlier this week that it planned to file for bankruptcy. Its overall market value sank to $2.8 billion -- equivalent to about two months of profit for Bank of America -- before yesterday's bump in the stock price raised that figure to $4.5 billion.
Bank of America has been seen as a potential buyer of the troubled lender since acquiring the stake in August. The Charlotte, N.C., company has first right of refusal in any sale of Countrywide, and Bank of America has a long history of opportunistic takeovers of banks facing distress going back to 1988, when predecessor NCNB Corp. purchased remnants of failed FirstRepublic Bank of Dallas at the urging of federal regulators and got nearly $1 billion in tax credits.
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.
Bank of America will have strong incentive to work with Countrywide borrowers to minimize delinquencies and other problems. It also is likely that Bank of America is trying to structure the takeover in a way that would help shield it from loan losses at Countrywide. While unusual, such protections have been crucial elements of some previous acquisitions of troubled lenders.
Bank of America predecessor BankAmerica Corp.'s 1983 purchase of Seafirst Corp. included new nonvoting preferred shares that left Seafirst shareholders bearing the financial risk of bad loans for five years. Chemical New York Corp., now part of J.P. Morgan Chase & Co., was able to spin off problem energy and real-estate loans into a separate bank when it bought Texas Commerce Bancshares Inc. in 1987.
One possibility is that Bank of America would seek some sort of tangible regulatory "reward" for rescuing Countrywide, said analyst Nancy Bush of NAB Research in Aiken, S.C., such as having the government take some of the bad loans off its hands, or forbearance on the deposit cap that hinders Bank of America's ability to do deals. "We're in an environment in which you could really say anything can happen," she said.
Another likely scenario is that Bank of America could arrange an "earn out," a deal common in private equity where the buyer agrees to a price today but an additional payment should the company meet goals in a year or more.
Bank of America Chairman and CEO Kenneth D. Lewis has often said he likes "the product, not the business," when it comes to mortgages. He has particular disdain for mortgage-servicing rights, which can fluctuate widely in value because they reflect future streams of income. But the chance to sell additional products and services to mortgage customers has strong appeal to Mr. Lewis, who also thinks those borrowers tend to be financially stable. Bank of America's huge network of retail branches and ATMs could help it lure Countrywide borrowers.
Many on Wall Street snickered as the value of Bank of America's $2 billion investment in Countrywide tumbled. But some analysts and investors have wondered if the driving reason for making the August investment was to plant a flag at Countrywide and keep any competitor from swooping in.
Just last month, Mr. Lewis told analysts at the Goldman Sachs conference that at some point "arithmetic overcomes all your issues." He also said: "If I ever did anything in the mortgage business, I would have to eat about seven years of my words, so it would have to be pretty compelling."
The financial institutions involved in the deal are overseen by a myriad of federal regulators in Washington. The Fed oversees Bank of America's parent company, while the Office of the Comptroller of the Currency regulates the Charlotte company's national bank. The Office of Thrift Supervision oversees Countrywide's federal thrift charter, and the Federal Deposit Insurance Corp. insures deposits at both Bank of America and Countrywide Bank.
Former Bank of America Chief Financial Officer Marc D. Oken compared the deal to the buyout of troubled MNC Financial Inc. The former CEO of MNC, Frank Bramble, sits on the Bank of America board.
Mr. Oken argues that for all its problems, Countrywide still has the "finest mortgage-distribution network in the country," and that Bank of America is likely buying it for a fraction of what it would have cost a year ago.
"I'm proud of these guys," he said. "It's a bold move and it's indicative of the confidence that the board has in the company and the management."
The takeover would call into question the future role of Angelo Mozilo, a New York-born executive known for his deep tan and frank speaking style, who co-founded Countrywide in 1969 and now serves as chairman and chief executive. Mr. Mozilo, who turned 69 last month, was long praised as an innovator and wily survivor in the U.S. mortgage industry.
But he has run into a barrage of criticism over the past year as Countrywide has stumbled. Critics say the company lowered its lending standards too far in pursuit of market share and squandered capital through heavy repurchases of its own stock. Meanwhile, Mr. Mozilo undermined confidence in the company through his sales of Countrywide shares he has acquired over the years through stock-option awards.
A takeover could result in another big payday for Mr. Mozilo. David Wise, a New York-based consultant for Hay Group, a compensation- advisory concern, estimated that Mr. Mozilo could receive cash severance payments totaling $36 million.
From 2004 through 2007, Mr. Mozilo sold about $414 million of Countrywide shares. The Securities and Exchange Commission last year opened an informal investigation into the stock sales, which were made through prearranged plans known as 10b5-1 programs. These plans are designed to allow senior executives to sell shares at regular intervals automatically. If executives pledge they don't have insider information at the time the plans are established, they can be used as a defense against insider-trading charges.
Mr. Mozilo modified his longstanding 10b5-1 plans late last year to increase sales of stock. Mr. Mozilo has said he increased the pace of selling to diversify his personal investments in an orderly way ahead of his retirement, scheduled for December 2009. He has denied any wrongdoing in connection with the share sales and argued that the options were a tax-efficient way for Countrywide to pay him.
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Ann Carrns in Atlanta and Greg Ip in Washington contributed to this article.
