Why BofA Should Sell Countrywide
Karen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
CEO Brian Moynihan is breathing a sigh of relief now that Merrill Lynch’s wealth management non-U.S. unit is sold to Swiss company Julius Baer Group for about $880 million. The sale puts much needed cash into Bank of America’s (NYSE: BAC) coffers while eliminating a unit that had a negative cost-to-income ratio of 114% last year.
Former CEO Ken Lewis purchased the mortgage giant in 2008 to get hold of Countrywide’s juicy mortgage loan portfolio. But regulatory settlement payments and fines now dwarf the $4 billion dollar acquisition cost. In 2008, the bank agreed with state regulators to grant $8.4 billion in loan modification to Countrywide homeowners, which is over twice the acquisition cost. And in January this year, Bank of America agreed to pay another $1 billion to regulators for defrauding the FHA by “fraudulently and recklessly” underwriting loans to unqualified buyers. The bank estimates future mortgage repurchases will cost an additional $7 billion to $10 billion dollars.
But according to Bank of America’s second quarter earnings report, the bank holds $103,313 billion in Countrywide mortgages, down from 1st quarter’s $103,786 billion. When the 2Q12 allowance for bad loans of $1,593 billion is deducted, the net value of Countrywide’s residential mortgages stands at $101,720 billion.
With Bank of America struggling to meet the Federal Reserve’s new capital requirements, selling Countrywide would provide cash and an end to the legal entanglements that came along with the acquisition. Countrywide’s substantial problems mandate the mortgage portfolio be sold at a discount, but given the bank’s current financial situation, this would still be a very profitable solution.
So who might the potential buyers be? It’s interesting to note that JP Morgan Chase (NYSE: JMP) is opening commercial banking outlets deep in Bank of America’s hometown territory. JP Morgan reported 2Q12 earnings of $5 billion and, as the top U.S. bank ranked by assets, could easily put together an all-cash or cash-and-equity deal to purchase Countrywide. This would boost their residential mortgage unit’s value and substantially cut into Wells Fargo’s (NYSE: WFC) lead as the largest U.S. mortgage provider.
If JP Morgan CEO Jamie Dimon and Mr. Moynihan were to seriously discuss sale terms, would that be enough to make Wells Fargo present their own offer? Countrywide’s acquisition would add over $100 billion in home loans to Wells already respectable portfolio and leave rival JP Morgan and others unable to catch up.
But given the current climate, securing government approval to sell Countrywide to another large bank might be almost impossible. Spinning Countrywide off into a separate company, a strategy that certainly worked for Time Warner (NYSE: TWX), might be the bank's only option. After merging with AOL (NYSE: AOL) in 2001, Time Warner’s stock slowly lost 80% of its value. After making the decision in May 2009 to spin off AOL into a separate company, Time Warner’s stock has doubled from the May 30, 2009 closing price of $23.42 to $46.21 last Friday.
The announcement of Merrill’s non-U.S. wealth management unit sale last week helped push the stock past the $8.00 mark on Friday, and Countrywide’s fate now depends on whether Brian Moynihan believes Bank of America might be better off without it. If Merrill is an omen, then selling or spinning off Countrywide might be the best step Bank of America takes to put its financial house in order.
kprogers has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America and Wells Fargo & Company and has the following options: short OCT 2012 $33.00 puts on Wells Fargo & Company and short OCT 2012 $36.00 calls on Wells Fargo & Company. kprogers has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America and Wells Fargo & Company and has the following options: short OCT 2012 $33.00 puts on Wells Fargo & Company and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.