Bank of America
Invests $2 Billion
In Countrywide
By JAMES R. HAGERTY, VALERIE BAUERLEIN and LINGLING WEI
August 23, 2007; Page A1
Bank of America Corp. acquired a $2 billion equity stake in Countrywide Financial Corp., a move aimed at dispelling a crisis of confidence among creditors and investors in the nation's largest mortgage company.
The deal, which received quick approval from regulators, provides a strong dose of security for Countrywide. In recent weeks, the company had struggled to raise the financing it needed to fund its business, stoking concerns among investors about its prospects and pummeling its stock. Worries about the health of Countrywide, which originates or funds roughly one out of every six mortgages in the U.S., have contributed to the recent tumult in financial markets.
News of the Countrywide deal came late yesterday afternoon, just hours after Wall Street investment bank Lehman Brothers Holdings Inc. announced that it was closing down a subprime-lending business and two days after another big lender, Capital One Financial Corp., closed its GreenPoint mortgage arm. Those operations joined scores of small to midsize lenders that have collapsed over the past six months amid growing anxiety over a surge in home-loan defaults and a weakening housing market.
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"Countrywide is a survivor," Angelo Mozilo, chief executive officer and co-founder of the Calabasas, Calif., company said in an interview late yesterday.
Though the deal doesn't give Countrywide automatic access to Bank of America's capital, it is likely to persuade investors that the company has a powerful ally ready to help in any crisis. And it removes a major source of uncertainty hanging over the nation's credit markets at a time when investor confidence has been shaky.
Mr. Mozilo said Countrywide would have survived without help from Bank of America but will be strengthened by this "vote of confidence to the world."
In after-hours trading yesterday, shares of Countrywide jumped $4.06, or nearly 19%, to $25.88.
Bank of America invested in Countrywide nonvoting convertible preferred stock yielding 7.25% annually. The preferred can be converted into common stock, subject to restrictions on trading for 18 months, at a conversion price of $18 a share. A full conversion would give Bank of America a 16% to 17% stake in Countrywide's common shares, Mr. Mozilo said.
Mr. Mozilo dismissed as "frivolous" for now any speculation that the investment could lead to a full merger between Bank of America and Countrywide, but he said the two companies would explore "where we can provide services to them better than they do themselves, and vice versa.... We'll continue discussions."
Countrywide had long argued that it would endure the current mortgage meltdown and emerge even stronger as competitors vanished. But the company was caught up last week in a storm of speculation as it found it could no longer tap the market for commercial paper, or short-term corporate IOUs, a major source of its financing, and a Merrill Lynch analyst warned in a report that it could face bankruptcy in a worst-case scenario. To shore up its finances, Countrywide borrowed $11.5 billion from a syndicate of 40 banks.
Though the capital injection from Bank of America is a big plus, investors shouldn't get "too euphoric," said Frederick Cannon, an analyst at Keefe, Bruyette & Woods in San Francisco, who expects Countrywide to post a sizable loss for the third quarter. Mortgage defaults and foreclosures are expected to keep rising over the next year or two as borrowers run into trouble on loans that started out with relatively low payments, only to "reset" later to much higher ones.
During the housing boom of the first half of this decade, Countrywide was a big promoter of pay-option adjustable-rate mortgages, known as option ARMs. These give borrowers several choices each month, including paying no principal and less than the full amount of interest normally due. If they take that route, their loan balance grows, setting them up for much higher payments later on. Countrywide's banking arm holds $27.8 billion of option ARMs on its books. Payments were 30 days or more overdue on 5.7% of these loans as of June 30, compared with 1.6% a year earlier.
Countrywide reduced its subprime lending -- or lending to borrowers with shaky credit histories -- to 4% of loans originated in the second quarter from 10% a year earlier. But it retains exposure to many past subprime and other risky loans sold to other parties.
When loans are packaged into securities and sold, lenders such as Countrywide often keep a portion of the securities known as "residuals." This portion bears the first losses from defaults. As of June 30, Countrywide had $1.46 billion of those residuals, whose value will drop or even vanish if defaults continue to mount rapidly.
Mr. Mozilo noted that Bank of America has provided financing for Countrywide's lending since 1970, shortly after the founding of the home-loan company. He declined to specify when the two sides began discussing the equity investment but said it came together "over a relatively short period of time," and that regulators were kept informed.
The investment puts Bank of America much more deeply into the turbulent but sometimes highly profitable home-mortgage market. In the first half of this year, Bank of America was the fifth-largest originator of home loans in the U.S., with a market share of about 7%, according to Inside Mortgage Finance, a trade publication. Countrywide was No. 1, with a market share of 17%, well ahead of No. 2 Wells Fargo & Co., at 10.5%.
After he became chief executive of Bank America in 2001, one of CEO Kenneth D. Lewis's first acts was to remove Bank of America from the subprime-mortgage business. Bank of America cited the risk and volatility of that business. At the time, the bank took a $1.25 billion charge, about half of it tied to subprime loans.
But Mr. Lewis has been eager to build scale in prime mortgage loans. Bank of America, the nation's largest retail bank, with 5,700 branches, hasn't been a major mortgage player, relative to its size. It originated $95 billion in mortgages in the first half of 2007, less than half of Countrywide's $245.13 billion, according to Inside Mortgage Finance.
Bank of America, which reached its coast-to-coast size with a dazzling string of acquisitions, is also bumping up against a regulatory cap that bars any U.S. bank from an acquisition that would give it more than 10% of the nation's total bank deposits. That leaves pursuing more mortgage customers as one of the bank's few potential avenues for growth. Bank research shows that its customers with a mortgage tend to be credit-worthy and profitable, with an average of five accounts at the bank.
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Bank of America in May rolled out a national "no-fee" mortgage program. Under the program, Bank of America doesn't charge borrowers for loan applications, title insurance, appraisals and flood certifications or require them to get private mortgage insurance -- part of a bid to secure customers' long-term business. To qualify, borrowers must have at least one account with Bank of America and obtain their loan through one of the bank's retail channels.
Elsewhere in the mortgage industry yesterday, the dwindling number of large lenders still active in the market sought to regain their balance. IndyMac Bancorp Inc. said it will resume offering large prime loans known as "jumbo" mortgages, those exceeding the $417,000 ceiling on loans that can be sold to government-sponsored mortgage investors Fannie Mae and Freddie Mac.
Over the past two weeks, investors have been so spooked by doubts over possible losses on mortgages that they have shunned even relatively high-quality loans simply because they don't carry a Fannie Mae or Freddie Mac guarantee on payments of interest and principal. IndyMac's move is a sign that the market for jumbo loans might be settling down after a spike that has sent rates on 30-year fixed-rate jumbos to an average of around 7.5% from just under 7% in early July, according to HSH Associates, a financial publisher.
IndyMac said it plans to keep the jumbo loans in its portfolio until demand from investors improves.
Countrywide last week outlined a strategy under which it planned to use its Countrywide Bank unit, a federal savings bank, to fund nearly all its loans, up from more than 70% at present. The bank provides a more stable source of funding than the commercial-paper market and other short-term instruments that were the only source of funding for dozens of smaller lenders that have collapsed in recent months. The savings bank also can borrow from the Federal Home Loan Banks, government-sponsored cooperatives.
After announcing the Bank of America investment, Countrywide's Mr. Mozilo said Countrywide would proceed with its plan to rely more heavily on its bank.
Bank of America, which earned $21.1 billion last year, has increasingly been willing to take equity stakes in other companies, agreeing in April to join two private-investment funds and J.P. Morgan Chase & Co. in paying $25 billion for student lender SLM Corp., more widely known as Sallie Mae. The Charlotte, N.C., company also agreed last year to pay $2.5 billion for a 9% stake in China Construction Bank, one of China's Big Four lenders.
Bank of America's Mr. Lewis said in a statement that the $2 billion should prove to be a very profitable investment. "We believe that in the current turmoil the stock market has been underestimating the value in Countrywide's operations and assets," he said.
But Mr. Lewis also said the investment was an important step to restore confidence and liquidity in the nation's credit markets. "This investment reflects our confidence in their business and recognizes the importance of the company in providing home financing across the country," he said.
Write to James R. Hagerty at bob.hagerty@wsj.com, Valerie Bauerlein at valerie.bauerlein@wsj.com and Lingling Wei at lingling.wei@dowjones.com
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