Countrywide Bailed Out by Bank of America?

Forbes is reporting Bank of America Bails Out Countrywide.

Bank of America knows when it's time to buy.

The Charlotte, N.C.-based bank is making a $2 billion equity investment in the beleaguered Countrywide Financial. Bank of America will purchase $2 billion worth of preferred Countrywide stock yielding 7.3%, and that can be converted into common stock at $18 per share, giving the mortgage lender a much-needed cash infusion amid a crippling credit crunch.

Countrywide shares soared 20.01%, or $4.37, to $26.19 after hours Wednesday on the news. Bank of America shares rose 1.9%, or 98 cents, to $52.63.

Bank of America is buying low, and Peter Slatin, founder of the Slatin Real Estate Report, believes it’s a good bet on Countrywide, which he said has been an aggressive lender, not a stupid one.

“It’s not just propping up a bad company, but showing faith in a reasonable company,” Slatin said, “and I think the future of the American housing market, if not the immediate future.”

Well so much for that 20% after hours soaring of Countrywide. When the dust settled at the end of the trading day, Countrywide was up less than 1%. Let's see if it can hold that.

But the question remains was it a good opportunity or not and if so for who. While we ponder that Countrywide CEO Mozilo sees recession ahead.

Countrywide Financial Corp Chief Executive Angelo Mozilo said on Thursday the U.S. housing downturn is likely to lead the country into recession, but that the largest U.S. mortgage lender will survive.

In an interview, Mozilo also said that to promote liquidity, the U.S. Federal Reserve should cut the rate it charges banks to borrow.

Countrywide faced a credit shortage this month as mortgage defaults rose and capital markets tightened. On August 16, it announced an unexpected drawdown of an entire $11.5 billion credit line because it had trouble selling short-term debt.

But on Wednesday, Bank of America Corp said it would invest $2 billion in Countrywide, buying preferred securities convertible into common stock.

"I've seen this movie before, and the ending of the movie always ends up in some form of recession," he said. "I can see the economy slowing down substantially enough to give the regulators, the Fed some pause in what's going to happen next."

Mozilo called on the Bush Administration and Fed Chairman Ben Bernanke to state that they will not allow the housing environment to get out of control.

[Mish comment: Exactly what good would another fool yapping about control or containment do? And if Mozilo wants to know who is responsible for the situation at Countrywide he should of course look into a mirror. He made a ton of subprime mortgage bets that he simply should not have made. But he did learn how to cash out and that he did hand over fist]

In an interview with CNBC television, Mozilo said markets are in "one of the greatest panics I've ever seen in 55 years in financial services."

[Mish comment: Panic? This is just getting started. Watch what happens when commercial real estate blows up. For more on that idea see Foolish Concerns, Foolish Optimism, Foolish Logic]

Still, he rejected as "irresponsible and baseless" an August 15 report by Merrill Lynch & Co analyst Kenneth Bruce that downgraded Countrywide to "sell" from "buy" and said the company might face bankruptcy if market conditions worsen.

[Mish comment: Exactly what is irresponsible about telling the truth? Countrywide is not out of the woods yet.]

Herb Greenberg also defended the analyst in his Market Blog.

In his interview on CNBC today, Countrywide (cfc) CEO Angelo Mozilo said the analyst at Merill Lynch who put a "sell" on his company was "irresponsible" and not unlike yelling "fire in a crowded theater." Sorry, Angelo, you are wrong. The analyst, who used to work at Countrywide, was merely doing his job. At that point there was no telling what would happen to Countrywide -- a public company. The analyst's obligation was to his clients, not to Countrywide's customers or the image of Countrywide.

On Seeking Alpha, Robert Craig-Stephenson is asking Who Wins?

What comes to mind is that this is a really good deal for BAC- they can't lose under any scenario.

If CFC survives, then they collect a hefty coupon (at the time of this writing, the Fed discount rate is 5.75% and the CFC loan was 7.25%), and own a call to CFC stock at $18 strike. Effectively, assuming 2 yr holding period after the loan is made, BAC would earn about 10%+ effective interest rate.

If CFC fails (and my personal opinion is that they are very likely to do so), then BAC can still make a lot of money because I imagine they will hedge the position by selling CFC common stock.

Sorry. The terms of the deal do not allow for shorting. There are plenty of ways for Bank of America to lose.

On Minyanville, Todd Harrison remarked "Bank America, already a massive presence in the California real-estate market, is effectively doubling down on that bet. And suffice to say, after the MBNA acquisition, they've already got a fair amount of exposure to the consumer."

So Bank of America has indeed taken on risk, and lot's of it too. But the deal was struck at terms that show just how desperate Countrywide was for cash as the Wall Street Journal article Bank of America Invests $2 Billion In Countrywide shows.

Bank of America invested in Countrywide nonvoting convertible preferred stock yielding 7.25% annually. The preferred can be converted into common stock, subject to restrictions on trading for 18 months, at a conversion price of $18 a share. A full conversion would give Bank of America a 16% to 17% stake in Countrywide's common shares, Mr. Mozilo said.

See those "trading restrictions". No shorting for 18 months. And the shareholder dilution was massive.

As for 7.5% annual yield, is that enough yield for the risk Bank of America took on? Somehow I doubt it. Yes, the deal looks good right now, $4 in the money, but that can vanish in a day the way this stock is trading.

And what about the Class Action Lawsuit against Countrywide?

Thomson Financial - Law firm Lerach Coughlin Stoia Geller Rudman & Robbins LLP yesterday filed a lawsuit against mortgage lender Countrywide Financial Corp (NYSE:CFC) that seeks class action status.

The suit was filed in the US District Court for the Central District of California on behalf of purchasers of Countrywide common stock between Jan 31 2006 and Aug 9 2007, the firm said in a statement.

The complaint alleges that during the class period, defendants issued materially false and misleading statements regarding the company's business and financial results.

I do not have any idea of the odds of success of that lawsuit but between August 2nd, and August 9th there was a massive change in opinions presented by Countrywide as detailed in Countrywide Bets the Farm.

So who wins? Perhaps no one. There is certainly no guaranteed winner in this mess. OK, Countrywide stopped its short term slide but it paid a very hefty price to do so. If it runs into further trouble, who's going to stop it from sinking again? There are still massive problems in the sector and Bank of America did not change those fundamentals overnight. Yes, BAC has a free call option so to speak, but that option comes with restrictions for 18 months. And Bank of America had to take on a lot of risk at a time the market is not rewarding risk. On closer examination this deal does not look remarkably great for anyone.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/