BofA-Countrywide May Be A Bargain, But Risks Are Many

Bank of America bac's new real estate buy is a fixer-upper that will be a bargain long-term, most analysts expect. But at $4 billion, mortgage giant Countrywide cfc could be a money pit.

Friday's deal will turn BofA into the nation's dominant mortgage lender and may have spared Countrywide from bankruptcy. It also may spur consolidation, as banks retake control of mortgage lending after largely ceding the business to specialty lenders.

BofA will swap 0.1822 of a share for each Countrywide share -- equal to $7.01 as of Friday's close. Countrywide's shares -- which surged 51% Thursday on reports of a looming deal -- sank 18% to 6.33 on Friday. Countrywide hit a record high of 45.22 in January 2007.

'A Rare Opportunity'

"Countrywide presents a rare opportunity for Bank of America to add what we believe is the best domestic mortgage platform at an attractive price," BofA Chief Executive Kenneth Lewis said.

"We are aware of the issues within the housing and mortgage industries," he said. "The transaction reflects those challenges."

Analysts said the price could still be too high if the worst housing recession in more than a decade lasts longer and runs deeper than Bank of America expects.

BofA already has lost more than half of the $2 billion it invested in Countrywide in August, as soaring subprime loan defaults and a credit crunch pummeled the mortgage lender's shares.

Countrywide on Tuesday denied rumors that it might go bankrupt. But it also reported that delinquencies and foreclosures hit record levels in December.

"The inherent risks are what happens with housing," said Kris Niswander, associate director at SNL Financial. "If BofA was thorough in their due diligence, then this could potentially be very rewarding."

BofA shares fell 2% on Friday. Moody's Investors Service said it may downgrade the bank's credit rating. It cited the need for BofA to raise capital, as well as risks from integrating the top U.S. mortgage lender and exposure to further losses and lawsuits.

More Banks May Follow

While analysts acknowledged those concerns, they said the deal undervalues Countrywide by a large enough margin to cover any unforeseen losses.

"I don't think there's any question that they got a great deal," said Guy Cecala, publisher of Inside Mortgage Finance.

He expects the deal to fuel more acquisitions given that BofA now controls about 25% of the mortgage-lending business, about double the share of No. 2 Wells Fargo.

"You don't want somebody like BofA to have twice the number of customers that you have," Cecala said.

"This deal is going to trigger" consolidation, he added.

CNBC reported Friday that Washington Mutual wm, which also has suffered from soaring defaults of subprime mortgage loans, had held "very preliminary" merger talks with JPMorgan Chase jpm.

Washington Mutual shares rose 4% to 14.69.

BofA has grown into the No. 2 U.S. bank via a series of acquisitions, including the $21 billion purchase of Chicago-based LaSalle Bank last year from Holland's ABN Amro abn.

The latest deal will let BofA expand by selling products and services to Countrywide's customers.

The mortgage business outside of subprime is "still the very best business that a bank can get involved in," said Richard Bove, an analyst at Punk Ziegel. "Once they stabilize the situation, they'll start to grow."

BofA expects the deal to close in the third quarter pending regulatory and shareholder approval.

The bank said Countrywide will operate separately but will no longer write subprime loans.

It wasn't clear how many Countrywide jobs might be cut. The lender has about 50,000 employees, most in Southern California. It has cut 11,000 jobs in recent months.

Countrywide and other mortgage lenders had prospered in recent years by bundling home loans into securities and selling them to Wall Street investors.

But investor interest dried up when defaults started rising, depriving lenders of funds to write new loans and forcing dozens into bankruptcy.

But don't expect subprime loans and securitization to disappear.

"It will all come back," Cecala said. But for now, "the market is broken."

"Securitization will go through a short adjustment period," Bove said, "but it's not going to go away and it's not going to decline. It's a growth sector."