Friday, January 11, 2008

How many days left?

Apparently not many for CFC. A note on Tuesday asked “Countrywide: How many days are left?” A mere three days later the lead financial article is focused on Bank of America buying Countrywide.

As expected, CFC was sold for pennies on the dollar. Countrywide was in a financial position in if they did not find either 4 billion dollars in funding or a buyer in the next two weeks then the bank was going to have shutter the doors. All windows were shut to the bank for further borrowing; clearly the end was near. Bank of America purchased CFC for $4.1 billion in stock; the enterprise value of the Countrywide is around $89 billion according to most analysts. At 4.6 cents on the dollar, it is little wonder that BoA is stating that the pricing was “attractive”.

The deal is still seen as having significant risk for Bank of America. An immediate cash infusion of $4B is needed at Countrywide on top of the earlier preferred stock transaction that provided BoA as seat at the table to perform this deal. The Countrywide group is likely to be an unprofitable sink hole for a couple years before the operation can be turned around.

Most market pundits consider this as a bold risky step by Bank of America CEO Ken Lewis. BoA views the existing 9 million home loans and mortgage operations held by Countrywide as a valuable asset, which would be a valuable addition to the bank’s service portfolio. This is counter-balanced by the money, energy, and time needed to sort out the situation, and turn Countrywide around.

Regulators are breathing a sigh of relief and probably shipping a crate of champagne to Mr. Lewis’ office. Shortly regulators would have been in the difficult position of attempting to salvage the wreckage of Countrywide. The BoA deal averts this crisis. A number of market commentators deem that some sort of buy out deal was inevitable because an institution the size of Countrywide was “too big to fail”.

The purchase of Countrywide by BoA is likely to serve as a leading edge indicator that the banking sector will upturn shortly. Several major banks hold 4th quarter earnings reports next week and most are expected to announce significant write-downs. The proper disclosures of these impairments will probably clear the air for the banks and provide a positive change in momentum for many of the financial stocks after the reporting cycle.

Some readers viewed Tuesday’s HingeFire note as a great market opportunity. CFC stock soared 51% on Thursday afternoon to $7.75 when rumors of the BoA buyout spread. While the thank you emails are appreciated, I will disclose that I did not take advantage of this merger arbitrage opportunity.