BofA to Buy Countrywide

BofA's original purchase of a stake in the mortgage lender, which won it praise on Wall Street, provided the bank with a rich 7.25% yield on convertible preferred stock and the right to buy 111 million shares at a strike price of $18. But with Countrywide's share price precipitously dropping in value, the BofA purchase began to look more an more like a bad investment by the bank's CEO Kenneth Lewis.

Shares of Countrywide surged as much as 74% on the news Thursday, but closed up more than 51% to $7.75. BofA's stock closed up 1.5% $39.30.

Countrywide shares had plummeted as much as 47% earlier this week after the bankruptcy rumors, dragging many other mortgage lenders with it. After word of the potential BofA deal leaked, IndyMac Bancorp(IMB Quote), which slipped to a 52-week low of $3.95 Wednesday, closed Thursday up almost 23% to $5.78.

Government-sponsored entities Fannie Mae(FNM Quote) jumped 6.5% and Freddie Mac(FRE Quote) rose 2.7%. Banks with big mortgage origination businesses like Washington Mutual(WM Quote) -- which itself may now be an acquisition target -- and Wells Fargo(WFC Quote) climbed almost 15% and more than 3%, respectively.

Although a logical move for Lewis's BofA, which had a right to trump any bid for Countrywide as a part of its original stake purchase, acquiring the mortgage lender is fraught with challenges.

For one, Countrywide's business could continue to flounder for the next several years, because the high-margin business of originating loans to borrowers with questionable credit has all but disappeared. Moreover, Countrywide revealed on Wednesday that it still has a portfolio comprised of nearly 10% in such subprime-rated mortgages, which it is hard pressed to unload.