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Countrywide CEO Takes the Punch Bowl Away

Excitement over a deal with BofA is erased by dour comments from the mortgage lender's chief.

By discrediting virtually every step taken thus far to help the housing market and the mortgage industry,

Countrywide Financial

(CFC)

Chief Executive Angelo Mozilo killed Wall Street's buzz about the credit crunch being over.

In an interview on

CNBC

Thursday morning, Mozilo also said he believes the U.S. is headed toward a recession, taking the wind out of any confidence boost that briefly came from news that

Bank of America

(BAC) - Get Free Report

took a $2 billion stake in the company via a convertible bond offering.

"When you have this level of delinquencies and foreclosures, there is no way it doesn't have an impact on psyches and wallets," said Mozilo.

"I don't see the light here," he added, noting that the current financial panic is among the worst he's seen in 55 years.

In the end, Mozilo's words popped the stock market rebound that had begun in earnest on Friday.

After posting early gains, the three major stock indices each ended down a hair. The

Dow Jones Industrial Average

dipped a fraction after trading as high as 13,298 intraday. The

S&P 500

shed 0.1% and the

Nasdaq Composite

slid 0.4%. Countrywide's shares ended up only 20 cents, or 0.9% after surging over 10% at the start of the day.

Credit-crunch metrics were still distressing on Thursday as a

Federal Reserve

report showed commercial paper outstanding declined for a second week in a row. The drop suggests many companies have been forced to make orderly exits from the commercial paper market, writes Tony Crescenzi, chief fixed-income strategist at Miller Tabak and

RealMoney.com

contributor. That will force companies to find funding elsewhere, and it won't be available to all, he notes.

Furthermore, the creep into corporate creditworthiness may soon start to show up in defaults, Moody's noted. The ratings agency said some companies with speculative-grade, or junk, credit ratings "continued to show signs of strain in July."

The agency has identified 71 issuers facing potential liquidity issues; of those, 20 "have weak liquidity, meaning they are reliant on highly uncertain sources of external financing," says Moody's. The other 51 rely on lines of credit from banks, which may not be there if they trip over covenants that would give lenders an out.

Mozilo has been shut out. The message from the banks Countrywide typically borrows from has been, 'We've got our own problems,' said Mozilo in the

CNBC

interview.

The mortgage executive had no kind words for the Fed either, saying the central bank has done nothing to help Countrywide with its liquidity problems. The Fed's discount rate cut, which brought down the rate charged to depositary institutions that borrow at the Fed's discount window, is useless to Countrywide because it cannot borrow there for regulatory reasons.

After Mozilo's gloomy comments, it was hard for the markets to perceive Bank of America's $2 billion stake in the company as anything but opportunistic for BofA, which like many banks and Wall Street firms faces some of its own liquidity and balance sheet issues amid the credit crunch.

Indeed, Bank of America's little "confidence boost" was quite a lucrative trade for the mega-bank, and maybe better considered in the context of distressed investing.

Firms like Blackrock, TCW Group and hedge funds like Citadel, among many others, are amassing funds to invest in the distressed assets that will wind up on the bargain basement sale floor. Why shouldn't BofA get in the game? Certainly the markets have been abuzz with what value investor might be sniffing around at Countrywide.

The art of this trade, however, is that BofA gets paid interest for taking the stake and making its bet that Countrywide will exist in 18 months. The banks also gets paid while considering a full-out purchase of the mortgage lender.

Countrywide will pay BofA annual interest of 7.85%, or $157 million a year in perpetuity. If BofA chooses after 18 months, the company can monetize its stake by converting the securities into shares of Countrywide at $18 per share. Countrywide closed Thursday at $22.02.

But let's say Countrywide's stock falls below $18. That would make the security less valuable because conversion would be at a cost to BofA. If that happens, the bank has the right of first refusal to buy the company outright if any other potential buyer comes knocking. Countrywide at $22.02 per share is already considered a takeover candidate.

So unlike Citadel, which just made a bet that it got Sowood's distressed credit portfolio at a great discount, BofA gets the automatic hedge of an interest payment and the option to buy more at any price. Not to mention, BofA may be shorting Coutnrywide stock, a common strategy used by convertible bond investors to hedge against stock-price declines.

It's good to see that innovation on Wall Street is not dead, notwithstanding the demise of the CDO market.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click

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