Wednesday, May 28, 2008

Bank of America CountryWide Watch

Bank of America today announced its management structure for the combined companies. This is certainly a signal that they do not intend to scuttle the deal despite my humble advice to the contrary. This also in despite of what the market seems to be telling them. BofA's stock is down nearly 20% YTD. In fact, BofA is trading at its 5 year low. By comparison, US Bank which I think is one of the best managed banks in the country, is up 10% YTD. I still can't imagine the bank assuming all of the legal and credit risk now peculating up at CountryWide. The managed bankruptcy I wrote about earlier must be the path they are on. But, that could prove costly as well because it will most certainly trigger additional lawsuits attempting to shift the liabilities to BofA. It will be interesting to watch this unfold.

Monday, May 19, 2008

Bank of America - CountryWide Update

I am more convinced than ever that Bank of America's prime motivation in taking over CountryWide was and is to avoid the huge write-offs that would be required if they allowed it to continue into bankruptcy. The cost of this maneuver, however, continues to rise. Last Friday a federal judge ruled that CountryWide, its officers and directors must deal with shareholder lawsuits claiming fraud. Also, the FBI is continuing its criminal investigation of CountryWide (and other lenders). In the face of these rising legal costs added to the mounting credit losses, it is becoming apparent that Bank of America's too clever by a half effort to bail itself out of a lousy investment is becoming intolerably expensive. I am looking for a possible announcement this Friday before the long holiday weekend. That seems to be the popular time to release unpopular information.

By the way.... I ran across an analyst's report of last August touting Bank of America's $2bb investment in CountryWide. He said 'this is no fly-by-night lender, it is THE preeminent mortgage lender in the nation'. Wow... wonder how much money this brain surgeon makes.

Saturday, May 3, 2008

Bank of America Bails Itself Out of a Problem - update

When the purchase of Country Wide Financial (CFC) was announced in January I wrote that I viewed it as a clever way for Bank of America (BAC) to bail itself out of a problem loan. Here is why. BofA had invested $2bb in preferred stock last August that is convertible to common at $18 per share. By year end with CountryWide heading for certain bankruptcy, that investment would need to be written off, likely against '07 earnings. Also, BofA had long been CountryWide's principal commercial bank so would have also had credit facilities likely in the range of multiple billions of $$'s. Add-in other possible exposures on swaps, etc and the total charge-off they were looking at was quite likely in the range of $10bb. So, for a mere $4bb in BofA stock (that's not real money, after all!!) they get to soak up the problem with nary a stain left on the floor. Worst case for them is that if the net value of the assets acquired were to fall below their $4bb purchase price, they would incur good will.

When I wrote in January I noted that one significant risk to BofA was the continued deterioration in the quality of CountryWide's assets and operation. Well, it looks like this is happening in spades. At quarter end, just under 10% of CountryWide's loan portfolio was more than 90 days delinquent. That looks to be an astounding $10bb of loans on the verge of foreclosure. And in this case the "trend is not their friend" as some like to say. There is no reason to believe this deteriorating trend will not continue. Operationally, the company is facing multiple investigations including at least one that is criminal. The potential cost from these cannot be quantified. Thus, in a matter of several months what may have seemed like a clever way of dealing with a problem borrower has become very costly. Several shareholders literally begged Ken Lewis to call off the deal at BofA's recent annual meeting.

With the cost of the "acquisition" ever rising it is little wonder that BofA has now let it be known that they may take steps to avoid direct liability for debts and presumably legal issues. (Or, perhaps this was their plan all along.) In their SEC filing on Thursday BofA indicated they would likely not assume all of CountryWide's liabilities. CountryWide has some $97bb in Notes Payable. How can they, you ask, if this is a stock for stock purchase not assume the liabilities? Fortune Magazine's on-line edition today has an article filling in the blanks a bit. It seems the actual entity doing the acquisition is a new subsidiary called Red Oak Merger Corp. The plan, according to Fortune, is for Red Oak to hold the CountryWide entity and then sell certain assets, such as CountryWide's commercial bank, directly to BofA. Red Oak would then hold whatever amount of cash that equaled the fair value of the assets transferred which could then be used to satisfy CountryWide's debt. BofA could also pay for assets transferred by assuming debt but cautions in their SEC filing that they cannot give any assurance that they will assume all debt. They did indicate that some $11bb in revolving bank debt would be assumed. (A big chunk of which is likely owed to guess who ... BofA, that's who) In the end, Red Oak would itself be put into bankruptcy.

What is fascinating about this is that it starts to look very much like what happens when a bank is closed by the regulators and then sold to an acquiring institution. It is also similar to what happens in a bankruptcy liquidation. All of which raises the question, was BofA given the OK by the regulators to pursue this strategy? It will be interesting to follow the drama.

Thursday, May 1, 2008

Margin Requirements

This is a tad off the general subject of business but yet seems appropriate given the current economic turmoil. Margin, as you know, is the percent of cash needing to be posted to purchase a position in securities like common stock, commodities and such. Currently, one must put up 50% cash to purchase and carry common stock on margin. But, should you prefer to purchase crude oil futures you need only put up 8%. If you don't know why this is important you have not filled your gas tank lately. While politicians talk of suspending gas tax for the summer, no one seems to be calling for an increase in margin requirements. Yet, some of the experts I read are saying that speculation on the price of crude oil has played a role in pushing the price ever higher. We also know that energy cost is then "fueling" (bad pun) the rise in the cost of food and other items. Anyone running a business today is grappling with the effects of the increase in energy cost.

While I am not certain which of the federal agencies sets margin requirements (likely the Fed), I do know a phone call from the White House is all that would be required to deal with this.