Portfolio.com is now out of beta, which means that color illustration, which
briefly appeared on this blog a couple of weeks ago, is now back for good. But
I’m still happily ensconced in a Lombardy villa, which means that y’all get
to enjoy Yves’ bearishness for a bit longer. (Yes, that is me in the picture,
not Yves.)
It turns out that part-time blogging is pretty much impossible for me: either
I’m keeping up with what’s going on, or I’m not. But I did notice, out of the
corner of my eye, that Bank of America has managed to nab itself a very attractive
investment in Countrywide.
Yes, attractive.
Now I so realize that received wisdom is not with me on this one. Gretchen
Morgenson has told
me about the dodgy mortgages Countrywide might be forced to buy back; Guambat
is talking
about "$2 billion out the window"; Rob Cox worries
that BofA’s market timing might have been "horribly wrong", and Herb
Greenberg defends
the Merrill analyst who put a "sell" rating on Countrywide stock.
But behind all of this commentary I see a simple – indeed, simplistic
– syllogism: mortgages are bad, Countrywide is mortgages, therefore Countrywide
is bad, at pretty much any price. Just look at all the mortgage lenders who
have already gone bust!
What I don’t see is any recognition that the Bank of America deal is a coup
for Bank of America CEO Ken Lewis, who has been
talking to Countrywide’s Angelo Mozilo, on and off, for
six years. And I can guarantee you that at no point over the past six years
has Mozilo had the slightest inclination to sell off a 16% stake in his company
at a significant discount to book value.
During the mortgage boom, pretty much any fly-by-night operator could set himself
up as a mortgage lender, get a huge line of credit from Merrill Lynch or Lehman
Brothers, and make money hand over fist by originating dodgy loans and then
offloading them sharpish into the MBS market. Those mortgage lenders have now
rightfully gone bust, mainly because their credit lines have long since been
pulled. Without credit, they can’t originate loans, and they’re forced to close
their doors.
Countrywide, however, is no fly-by-night subprime originator. Rather, it’s
arguably the best mortgage shop in the US. Yes, it’s still reliant on access
to lines of credit. All mortgage originators are, unless they’re owned by a
big bank, in which case they’re reliant on access to that big bank’s balance
sheet. But worrying about Countrywide because it needs liquidity is a bit like
worrying about hiring a new CEO because he needs oxygen. The mortgage business
does run on credit, but Americans will always need mortgages. So it makes perfect
sense for the largest bank in America to get itself a cheap stake in a first-rate
mortgage company. BofA alone has access to more than enough liquidity to tide
Countrywide over if the present crunch continues.
But what about the question of Countrywide’s book value? Buying in to Countrywide
at 0.8 times book might seem like a good idea at first glance, but book value
is ultimately the difference between two very large numbers: Countrywide’s assets,
and its liabilities. Its liabilities are fixed, but its assets are mortgages,
and those mortgages can certainly decline in value. If they do, Countrywide’s
book value could be wiped out very quickly.
Ken Lewis knows this, which is why he didn’t buy Countrywide stock. Instead,
he bought Countrywide bonds, which can be converted into stock should he so
wish in the future. And the coupon on those bonds is a very healthy
7.5% – higher, indeed, than the rate at which Countrywide itself is still
willing to lend to homeowners. You know that line about the company which loses
money on every sale but makes it up on volume? Countrywide, here, is borrowing
at 7.5% and lending at less than 7%, and the market bid up Countrywide shares
as a result, even though the real winner is Bank of America. If Countrywide
can’t navigate through the ARM resets which are coming up next year, Bof A will
simply clip its 7.5% coupons and go home.
So really the only risk facing Ken Lewis is that Countrywide will default on
his $2 billion loan. That’s possible, but there’s still well over $12 billion
of equity in the company which would have to be wiped out first. And even if
Countrywide does go bust, Bank of America, as one of Countrywide’s largest creditors,
would be very well positioned to snap up a large chunk of the company’s mortgage
expertise out of bankruptcy.
But the most likely outcome, I think, is that Countrywide will make it through
the ARM resets buffetted but still intact – and that Ken Lewis will buy
up a 16% stake in the company at $18 per share even as the stock is trading
at a significant premium to that level.