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No Savior for Mortgage Biz

Laurie Kulikowski

Waiting to see big banks piling into the mortgage business a la Bank of America (BAC Quote)? Don't hold your breath.

BofA surprised Wall Street last week by making a $2 billion bet on struggling Countrywide (CFC Quote). The news, announced after the close last Wednesday, gave Countrywide's sinking stock a one-day reprieve.

The linkup also boosted smaller stand-alone lenders such as Thornburg Mortgage (TMA Quote) and IndyMac (IMB Quote), as investors wagered that commercial banks such as Wells Fargo(WFC Quote) and Wachovia(WB Quote) might make copycat moves.

Countrywide's shares leapt $2.48, or 11.3%, to $24.30 in overnight trading Thursday after news of BofA's cash injection. Thornburg shares tagged along, rising 86 cents, or 6.7%, to $13.70, as did shares of IndyMac, which jumped $1.05, or 4.5%, to $24.50.

But since last Thursday's mortgage industry relief rally, the shares of the big lending companies have resumed their swoon. In recent trading Tuesday, Countrywide was back down at $19.34, 20.9% below its Thursday high. Thornburg, meanwhile, had fallen 21.3% from Thursday's high to $10.98, and IndyMac was down 8.2% to $22.74.

The reason? The U.S. housing industry keeps getting sicker -- and observers are starting to appreciate what favorable terms BofA chief Ken Lewis wrung out of struggling Countrywide.

"It was a layup, basically," Mark Batty, a financial services analyst at PNC Wealth Management in Pittsburgh, says of the terms BofA got in its deal with Countrywide. "A lot of investors would have an interest in that type of investment opportunity."

Indeed, a lot would have to go very wrong at Countrywide for Bank of America's $2 billion preferred-stock investment to look like a loser. Much was made of the fact that the bank could wind up with a 16%-17% stake in Countrywide should BofA convert all its preferred shares into common stock. The preferred stock converts into common at $18 a share.

But even if Countrywide shares plunge and BofA decides not to convert the shares, it gets preferred stock paying 7.25% annually for two years -- a nice payout with the 10-year Treasury yielding less than 5%.

Shares of Countrywide have lost half their value this year. The company was forced earlier this month to draw down an $11.5 billion credit line after it was unable to get funding by selling mortgages in the secondary markets.

Countrywide's stock fell 2.9% Tuesday on news that sales of existing homes fell in July for a fifth consecutive month to the slowest pace in five years. The other stand-alone lenders were hit as well, with jumbo mortgage provider Thornburg dropping 5.76% and IndyMac sliding 3.51%.

IndyMac and Thornburg also have been hit hard by the collapse of the secondary market for mortgage securities, though so far these smaller mortgage players have been less exposed to the defaults and delinquencies that are scaring investors away from Countrywide's securities.

But buyers are likely staying away from IndyMac and its Alt-A mortgage business -- at the very least until market conditions improve, says Jason Arnold, an analyst at Royal Bank of Canada's RBC Capital Markets, who covers IndyMac and Thornburg.

"IndyMac, until recently, really didn't have a big need to partner with another institution in the past as compared to now. It seems like it would make sense for them to be looking at something like that," Arnold says. "The problem here is that the things are so tumultuous."

IndyMac tightened its underwriting guidelines this month to restrict itself to loans that can be sold to the government-sponsored agencies.

CEO Michael Perry said earlier this month that the Pasadena, Calif.-based company has "very strong liquidity," and that "there are no realistic scenarios that I can foresee that would impair IndyMac's viability," in a letter to employees.

Thornburg, which specializes in jumbo adjustable-rate mortgages, might have an even tougher time finding a partner if the mortgage industry gets any worse.

Last week Thornburg sold a third of its mortgage securities portfolio in a bid to reduce its exposure to margin calls and improve liquidity.

Analysts say about the only thing the Santa Fe, N.M.-based firm has going for it is its assets. Its balance sheet consisted of $24.6 billion in ARM loans and another $31.7 billion in purchased ARM assets, at the end of the second quarter.

Rather than paying any sort of premium for the company as a whole, a buyer is likely to purchase the loans at a discount, they say.