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Countrywide Plummets on Deal, Debt Fears

A Friedman, Billings Ramsay analyst says BofA should "walk away" from the deal, due to the poor quality of Countrywide's loan portfolio.

Countrywide Financial


shares plunged as much as 17% Monday after an analyst suggested that

Bank of America

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should "walk away" from the deal.

Friedman, Billings, Ramsey analyst Paul Miller said troubled Calabasas, Calif.-based lender Countrywide faced $20 billion to $30 billion of loan writedowns in a note Monday morning. Similar concerns led rating agency Standard & Poor's on Friday to

cut Countrywide's debt to junk status

and Fitch Ratings on Monday put the lender's debt on its "Rating Watch Evolving" list.

BofA will "likely renegotiate the transaction down to the $0 to $2 level and force

Countrywide bondholders to absorb the remainder of the potential writedowns," he wrote. "

BofA should completely walk away from the

Countrywide deal, as

Countrywide's loan portfolio will prove a drag on earnings and could force

BofA to raise additional capital."

Charlotte-based banking giant BofA agreed to pay $4.1 billion in stock, or approximately $7 a share, for Countrywide in January. The deal is expected to close in the third quarter.

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Calls to representatives for both companies were not returned.

Countrywide shares fell 62 cents, or 10.4%, to $5.36. BofA's stock slid 82 cents, or 2.1%, to close at $38.97.

Miller, who cut Countrywide's equity rating to underperform, the equivalent of a sell, from market perform, said 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. With a market capitalization of $172 billion, BofA can absorb the deal, Miller said.

Still, he likened Countrywide to

Washington Mutual

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National City


-- two other big mortgage lenders that also had trouble sealing deals as a result of the poor quality of their loan books, despite market rumors surrounding both companies that sales were imminent.

WaMu and Nat City recently received $7 billion of capital injections each from private equity firms and other large institutional investors. Seattle-based WaMu received the infusion from investors led by private equity group TPG, while Corsair Capital led a consortium to invest in the Cleveland-based Nat City.

Countrywide "has significant credit risk in its loan portfolio, which in our opinion, could experience significant writedowns when market to fair value when the acquisition closes," he writes. "The issue of fair value marks was a significant part of the reason that National City failed to find an acquirer."

"We've heard throughout a lot of different sources

that other banks ... could not get the accounting to work

for either Nat City or WaMu because of the huge marks they would have to take" on the loan portfolios at either of the two troubled banks, Miller said in an interview with

. With Countrywide, "you start getting into big numbers" for the writedowns, he adds.

Countrywide's $95 billion loan portfolio includes option adjustable-rate mortgages, home equity lines of credit and second lien mortgages, among other things. Miller estimates that if the marks to the portfolio are less than $22 billion, then BofA can "offset the adjustments with fair value debt adjustments and the difference between tangible equity and its purchase price of

Countrywide. If the loan portfolio marks exceed $22 billion, Bank of America becomes increasingly likely to renegotiate transaction terms."

Miller's pessimistic outlook on the conclusion of the BofA-Countrywide saga adds fuel to the fire as investors are increasingly jittery when it comes to whether or not the deal will get done. In a filing with the

Securities and Exchange Commission

last week, BofA said among other things, that it may not guarantee all of Countrywide's debt.

Countrywide, once the nation's largest independent mortgage lender, likes its peers crimped by the housing downturn such as WaMu, Nat City,


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, has seen its loan portfolio go from bad to worse.

Last week Countrywide reported

a first-quarter loss of $893 million

, or $1.60 a share, more than double the lender's loss in the fourth quarter. It took $3.05 billion in credit-related writedowns and provisions for the first three months of the year.

While it is unlikely BofA will renege on the acquisition in total, observers, including Miller, agree that it is likely that BofA will renegotiate how much it pays for Countrywide given the rapid worsening of the loan portfolio.

"Everybody is puzzled by this thing about the debt," says Nancy Bush, an independent analyst in Aiken, S.C. "To me that does not signal that they are willing to walk away from this deal. My guess is they are looking for some innovative approach to get the deal done."

Bad loans aside, "at the core there is a real mortgage company with prime loans," Bush says. "We just don't know at this point what the loss content is. ...We haven't had a long enough experience of these

loans actually going through foreclosure and the realization of actual losses to really know. There has been this massive amount of hysteria and no data really to back it up."

Fitch Ratings placed Countrywide's debt ratings on "Rating Watch Evolving" and removed the lender from "Rating Watch Positive," as a result of the "uncertainty over the transaction's final structure" and BofA's treatment of Countrywide debt. The move added to the general malaise affecting Countrywide's stock on Monday.


The probability that the transaction is completed remains extremely high," according to a note by Fitch. "However,

BofA has been unusually silent regarding the ultimate structure of the transaction.


Countrywide's operating difficulties and the stressed environment,

Countrywide's ratings would likely be downgraded absent the capital and liquidity support already provided by

BofA, and more likely still if the merger is not consummated," Fitch adds.

S&P had lowered its ratings on Countrywide and Countrywide Home Loans Inc. to BB+/B from BBB+/A-2 and Countrywide Bank to BBB/A-3 from A-/A-2. The rating agency cited BofA's May 1 filing, which said it was "evaluating alternatives for the disposition of the remaining Countrywide indebtedness," including "allowing it to remain outstanding as obligations of Countrywide (and not Bank of America)."