Tuesday, July 22, 2008

Looking at Bank of America and Countrywide

On Monday, Bank of America (BAC) announced net income of $3.41 billion, or 72 cents per share, on $20.32 billion in revenue, for the 2nd quarter. That compared with net income of $5.76 billion, or $1.28 per share, on $19.63 billion in revenue a year earlier. Analysts expected a profit of 53 cents per share on $18.37 billion in revenue. Obviously, these were good numbers to beat analysts expectations by so much.

On July 1, after the end of the 2nd quarter, BAC completed its acquisition of Countrywide Financial Corporation. During the 2nd quarter, BAC says it spent $212 million in merger and acquisition costs. Since Countrywide was not part of BAC during the 2nd quarter, Countrywide announced its own earnings of a net loss of $2.33 billion including $4 billion in credit related losses.

BAC, in its statement, said that the Countrywide purchase will generate profits by the end of the year. Some of those profits will come from purchase accounting, which requires that the assets and liabilities of an acquired company, including estimates of future credit losses, be marked at fair value at the time of the deal (mark to market). Before including Countrywide in its results in the third quarter, BAC wrote down the value of the lender's assets by $12 billion to $13 billion. That means future credit losses, as long as they don't exceed $13 billion, won't flow through BAC's income statement in the future, according to BAC on Monday.

BAC expects $900 million of cost savings by 2011 from integrating Countrywide, up from an estimated $670 million at the time the acquisition was announced. BAC has already announced plans to cut about 7,500 jobs as Countrywide is incorporated into its own operations. The cuts amount to about 12.5 percent of the combined companies' mortgage, home equity and insurance businesses.

What does all of this mean? Well, BAC had reached a cap in terms of the percentage of assets that they could hold in the United States. Essentially, they had reached a limit and could not grow, save some non-core business acquisition. Enter Countrywide.

Countrywide originated purchases, securitized, and serviced mortgages. In 2006 Countrywide financed 20% of all mortgages in the United States, at a value of about 3.5% of United States GDP, a proportion greater than any other single mortgage lender.

One of the most lucrative arms of Countrywide is the servicing side. Loan servicing collects payments from the borrower, handles escrow accounts, tax and/or insurance payments, then remits "advances" to the investor's trustee as specified in the Pooling and Servicing Agreement (PSA). Loan Servicing typically retains a fraction of the payment made (typically 25 - 45 basis points of the unpaid principal balance) as a "servicing fee". Loan Servicing also generates income in the form of interest on monies received and held prior to paying scheduled advances to the trustee, fees charged for late payments, force-placed insurance, document requests, legal fees, payoff statements, etc. They do not hold the note, they only collect the money.

All of this may sound somewhat trivial, but when Countrywide services in excess of 8.3 million loans totaling over $1.3 trillion, it becomes more than trivial.

BAC has tapped into a company with an extreme reach that puts it upfront with 8.3 million customers. Banking, credit cards, auto loans, student loans, etc. are all within easy reach for whatever part of these customers are new. Toss in BAC's current loan portfolio (which will continue to be conservative), and you have a leader in loans and loan servicing.

In the end, it looks as though the giant company is gobbling up the smaller company after a "fire" sale, and the future looks positive. The continuing credit issues will force alterations somewhat, but as they subside, BAC will be more and more powerful with an even broader range of services to offer its residential and corporate clients.

Sources - AP, CBS Marketwatch


Anonymous said...

Thanks for the explanation of why BAC wanted PR plaqued Countrywide. I never quite got it all. Who is dealing with the lawsuits filed by various states against Countrywide?

Rollins Financial Advisors, LLC said...

Bank of America will be ultimately responsible. Much like when Bear Stearns was acquired by JP Morgan Chase, JP Morgan Chase assumed the liability of the lawsuits, and they have raised their litigation reserve in response to the pending lawsuits.

It would be normal to think that Bank of America would do the same in acquiring Countrywide. There would undoubtedly be some liability insurance for the directors of the board anyway.

One would imagine that some of these considerations were also made when putting together a final figure for the acquisition. BAC will now control 20-25% of the mortgage loan market, and they believe that will be much more lucrative than any lawsuits.

Thanks for your comments.