Consensus is building among analysts that
Bank of America
will have to lower its offer price for troubled mortgage lender
or pull out of the pending deal altogether.
Countrywide shares have taken a beating this week, after Friedman, Billings, Ramsey analyst Paul Miller on Monday wrote that BofA
should "walk away" or at least renegotiate
the $4.1 billion deal after Standard & Poor's downgraded the lender's debt to junk.
BofA itself already indicated last week that it was
about taking on some of Countrywide's debt -- which Miller suggested could be a "first step in renegotiating the entire deal." And while the bank publicly remains committed to closing the deal by the third quarter, a growing chorus of analysts is beginning to wonder how that can happen under the existing conditions.
"Things have deteriorated far beyond what anyone really expected," says Byron MacLeod, an earnings quality analyst at Gradient Analytics, an independent research firm in Scottsdale, Ariz. "BofA is probably going to need to renegotiate the terms for it to still go through."
Between the hundreds of lawsuits against Countrywide for fraud and other issues, regulatory investigations, including a probe by the Justice Department, in addition to the mounting losses and foreclosures Countrywide must deal with in its loan portfolio, "there is no way to get your arms around the diligence," according to Christopher Whalen, managing director of Institutional Risk Analytics.
"The bottom line is the transactional risk and the other types of risk that come along with Countrywide just says to me that there is no way to do this deal short of restructuring because you have got to quantify these claims," Whalen says.
Under the deal struck in January, BofA would pay Countrywide shareholders 0.1822 shares of its stock for each Countrywide share, making the deal worth just under $7 a share. At the time, the deal price amounted to about a 9% discount to Countrywide's share price.
Since January, however, the markets have worsened even further, prompting mortgage-heavy banks like
to raise capital. These days, the BofA offer now effectively constitutes a more than 40% premium to Countrywide's current share price.
Friedman Billings' Miller, in his note earlier this week, feared that given the continued deterioration in the lender's $95 billion loan book -- some of the more risky loans include option adjustable-rate mortgages, home equity lines of credit and second lien mortgages, among others -- and weak pricing for non-agency loans in the secondary market, BofA could face $20 billion to $30 billion of writedowns after the deal closes.
"If fair value marks sufficiently exceed
BofA's projections at the time of its due diligence, we believe the deal price for the purchase of
Countrywide could be renegotiated lower or
BofA could (and should) decide to walk away," he wrote.
Last month, Countrywide reported a
-- more than double its loss in the fourth quarter. The lender took $3.05 billion in credit-related charges related to writedowns and provisions in the quarter.
BofA in January said the acquisition would make the bank into the largest mortgage lender and loan servicer in the U.S. as well as propelling the company's vision to satisfy all of its customers' financial needs. In turn, the Calabasas, Calif.-based Countrywide would receive much-needed liquidity for its business as the credit crisis, combined with a housing deterioration not seen since the Great Depression, is putting a tremendous crimp on Countrywide's ability to originate and fund loans.
Last summer, BofA injected $2 billion into the struggling lender as the credit crunch intensified.
At the time of the deal BofA CEO Ken Lewis said the bank was "aware of the issues within the housing and mortgage industries" and that the deal "reflects those challenges." Still, there are similarities to Wachovia's 2006 acquisition of California option adjustable rate mortgage specialist Golden West for $25 billion -- a deal made right before the housing bubble burst, which has been the source of untold pain for the bank.
Wachovia's CEO Ken Thompson was criticized for his pricey deal at the time, but soon embarked on a campaign to assure shareholders that Golden West's option ARMs were of much better quality than those of the subprime block. But after the severe housing downturn, where home prices in some California areas dropped 20%, the company is now conceding that losses in the Golden West portfolio are rising.
Thompson recently admitted at the Charlotte-based bank's annual meeting that Golden West was an "ill-timed acquisition," according to media reports.
Wachovia was looking for retail branches and entry into the California market. BofA coveted a mortgage platform that it could append onto its already vast financial services platform.
BofA and Wachovia simply did not understand the depth of the problems that the companies they were acquiring had and therefore overpaid," says Richard Bove, an analyst at Ladenburg Thalman. "You can argue that a number of banking companies made this mistake. ...
The bottom line is they should have understood."
"You're dealing with a cyclical industry and ... it wasn't that hard to figure out where we were in the cycle," he says. "We have a long history with dealing with subprime borrowers and we know what happens. We know they don't pay back."
To be sure, not all analysts are convinced that BofA should reconfigure the deal
BofA "remains comfortable with the terms of its announced acquisition of Countrywide," according to a note written by Jeff Harte, an analyst at Sandler O'Neill & Partners, who met with several company executives this week. "This implies that the evolution of Countrywide since the acquisition was announced in January remains within the band of management's expectations."
Even FBR's Miller, the analyst who went so far as to suggest that BofA back away from the deal, said that is unlikely to happen. BofA may choose not to walk away from the deal or lower its offer, as doing so might result in "negative publicity" the firm does not want, he wrote.
Bove agrees that BofA will not walk away from the deal but is one of many in the camp that believes it should renegotiate the deal.
BofA will be "absorbing a company with huge losses, enormous amount of debt, and $200 billion of assets
requiring them to adjust capital ratios so dramatically that it might force them to raise more capital.
BofA could even cut their dividend," he says.
IRA's Whalen agrees. "Overall the Golden West business was so simple," he says. "If I had a choice between the retained portfolio of Countrywide and the retained portfolio of Golden West, I'd take Golden West."