The Wall Street Journal-20080112-Behind Bank of America-s Big Gamble
Return to: The_Wall_Street_Journal-20080112
Behind Bank of America's Big Gamble
The endgame in Bank of America Corp.'s $4 billion takeover of Countrywide Financial Corp. began with a December phone call from Countrywide Chief Executive Angelo Mozilo to his Bank of America counterpart, Kenneth D. Lewis.
After more than six months of financial deterioration at Countrywide -- despite a $2 billion infusion of cash from Bank of America in August -- Mr. Mozilo said he was ready to throw in the towel, according to Mr. Lewis.
At the same time, having watched Countrywide dramatically retool its operations in a bid to survive, Bank of America executives began to believe Countrywide's big U.S. mortgage business might be worth having.
"The ability to get that kind of size and scale became more appealing as we saw the business model change to a model we could accept," Mr. Lewis said. "We considered the lawsuits, the negative publicity that Countrywide had. We weighed the short-term pain, versus what we think will be a very good deal for our shareholders."
Bank of America, based in Charlotte, N.C., deployed 60 analysts to Countrywide's headquarters in Calabasas, Calif. After four weeks analyzing Countrywide's legal and financial predicament, and modeling how its loan portfolio was likely to perform, Bank of America offered an all-stock deal valued at $4 billion for Countrywide -- a fraction of the company's $24 billion market value a year ago.
The deal is a landmark in the housing crisis, given Countrywide's prominence as the nation's largest mortgage lender, at least until recently. Bank of America's move is a gamble that the U.S. is nearing a housing bottom and crystallizes the divide on Wall Street over whether now is the time to buy housing-related assets on the cheap -- or flee from them to avoid further losses.
Terms of the deal call for Bank of America, the largest U.S. bank by market value, to give 0.1822 shares of Bank of America for each share of Countrywide. The deal could be renegotiated if Countrywide experiences a material change that adversely affects its business, but Mr. Lewis said he does not anticipate that happening. The deal is expected to close in the third quarter. Countrywide declined to discuss the deal.
Bank of America is buying a deeply troubled company, and it faces the risk that Countrywide's assets could continue deteriorating.
As of Sept. 30, Countrywide's savings bank held about $79.5 billion of loans as investments. Three-quarters of these loans were second- lien home-equity loans -- where Countrywide doesn't have first crack at the collateral in case of default -- or option adjustable-rate mortgages, which let borrowers make minimal initial payments and face sharply higher ones later. Overdue payments by Countrywide borrowers are surging as house prices drop and loans reset to higher payments.
Bank of America already has a full plate. It is still digesting its $3.3 billion acquisition of U.S. Trust and the $21 billion purchase last year of Chicago's LaSalle Bank. The same team that reviewed the Countrywide acquisition is also leading the restructuring of Bank of America's troubled corporate and investment bank, which has taken its own big hits in the credit-market turmoil. Mr. Lewis said the deals are "nicely sequenced" because each integration plan is at a different stage.
BofA made its initial investment in Countrywide in August, purchasing preferred shares convertible to a 16% stake in the company. The deal also gave Bank of America a first right of refusal for buying all of Countrywide. Initially, Countrywide shares rallied, but they fell precipitously toward the end of the year as Wall Street firms began taking huge write-downs on mortgage-related investments.
It became difficult for Countrywide to remain independent. It was in danger of losing its investment-grade rating, making it harder to borrow money and collect deposits. Another risk was that the eroding value of its assets might force it to break covenants with bank lenders, potentially triggering demands for immediate repayment of its debts. And a barrage of negative headlines about its lending practices during the housing boom was damaging the company's reputation.
After Mr. Mozilo's call in early December, Bank of America sent dozens of bankers to California, where they holed up at the West Lake Village Four Seasons near Calabasas, according to people involved in the process. A key player during the negotiations between Countrywide and Bank of America was Edward Herlihy, a senior partner with the law firm Wachtell, Lipton, Rosen & Katz, who represented Countrywide.
Mr. Herlihy has advised Bank of America for almost two decades and knows Mr. Lewis well. Those relationships proved crucial in brokering the deal, a person familiar with the matter said.
On Dec. 28, Mr. Mozilo met at Countrywide's headquarters with Mr. Herlihy and other advisers, with Mr. Lewis participating by phone. The two sides agreed to pursue a deal, and on Jan. 4, Mr. Herlihy presented the plan to Countrywide's board along with investment bankers from Sandler O'Neill. They rushed to complete it this past week as speculators drove Countrywide's price below $5 amid rumors of a bankruptcy filing, which the company denied.
Bank of America said it believes that paying $4 billion for a company with a book value triple that amount gives adequate cushion for potential damages, settlements and other litigation costs involving mortgages that went bad. "I have confidence in our due- diligence teams that we made the right assessment of the downside," Mr. Lewis said.
The Securities and Exchange Commission, which was already looking into sales of stock by Mr. Mozilo, has expanded its probe to examine Countrywide's accounting, people familiar with the matter say. One area under scrutiny is whether Countrywide set aside enough reserves to cover potential losses on the loans on its books. A Countrywide representative declined to comment specifically on the SEC move, but said the company cooperates with regulatory inquiries and believes it has fully complied with the rules.
Bank of America and Countrywide's relationship dates back 40 years, when Mr. Mozilo sought an early loan from the company. Bank of America has long been one of Countrywide's biggest lenders.
Historically, federal regulators have played an active role directing a struggling financial institution towards a takeover, particularly because of the liability to the federal deposit insurance fund. Countrywide operates a thrift whose deposits are insured by the Federal Deposit Insurance Corp.
The Office of Thrift Supervision, a division of the U.S. Treasury Department, began regulating Countrywide in March, after the company converted to a federal thrift from a national bank. The OTS set up a full-time presence at Countrywide's headquarters in August. However, people familiar with regulators' thinking said they didn't actively encourage the BofA deal.
"There was no encouragement in all this," Mr. Lewis said. "It doesn't mean they're not happy we did it, but there was no pressure at all and no prior discussions."
Mr. Lewis said he was impressed with Countrywide's liquidity, and called the bankruptcy talk "malicious rumors."
Bank of America sees mortgages as a key product for deepening relationships with customers. Countrywide's technology, employees and national reach were attractive to Mr. Lewis. He said Bank of America may follow a similar playbook to its 2005 acquisition of credit-card giant MBNA Corp., where the bank kept MBNA's operating platform, management team and even its brand for use in Europe.
BofA says it will be more selective about acquiring mortgages issued by other banks or arranged by independent brokers, traditionally a large part of Countrywide's business. "Obviously, they had made some mistakes," Mr. Lewis said. "But the people who operated the business on a day-to-day basis did not make those decisions and they are very, very good at what they do."
It's unclear what kind of payday Mr. Mozilo will gain from the sale. Much of his cash severance will likely depend on his bonus for 2007, which hasn't yet been determined. If he gets no bonus, Mr. Mozilo could receive a cash severance of about $36 million, estimates David Wise, a consultant for Hay Group, a management-consulting firm.
Mr. Mozilo's total pension benefits, which he would have received regardless of the sale, reach about $24 million, in addition to restricted stock units and shares that he already owns outright, which could total nearly $9 million, based on Countrywide's closing share price Friday, Mr. Wise estimates. All told, Mr. Mozilo's exit package could be close to $70 million, or higher if the board adds payments not detailed in his most recent employment contract.
According to his most recent employment agreement, Mr. Mozilo could also keep using the corporate aircraft for business purposes and have the company pay his country-club dues through 2011 while he serves as nonemployee chairman. The perks could change depending on whether he keeps a nonemployee role after the acquisition and other factors.
Reports of Mr. Mozilo's personal windfall sparked criticism from Democratic Sen. Charles Schumer of New York. "Mr. Mozilo could display some good will by donating any severance pay he stands to receive to the nonprofit housing counselors trying to prevent foreclosures," Mr. Schumer said in a statement.
A Countrywide spokesman said: "During the past four decades, the company Mr. Mozilo founded has created tremendous value for shareholders and has provided millions of families with an opportunity for home ownership."
---
Damian Paletta, Matthew Karnitschnig, Michael Corkery and Kara Scannell contributed to this article.
