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Friday, June 29, 2012

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Bank of America's $40 Billion Mistake

By DAN FITZPATRICK, WSJ Front Page, June 29, 2012

Bank of America Corp. BAC +4.39% thought it had a bargain four years ago when it paid $2.5 billion for tottering mortgage lender Countrywide Financial Corp. But the ill-fated decision has already cost the Charlotte, N.C., lender more than $40 billion in real-estate losses, legal expenses and settlements with state and federal agencies, according to people close to the bank.

"It is the worst deal in the history of American finance," said Tony Plath, a banking and finance professor at the University of North Carolina at Charlotte. "Hands down."

The acquisition of Countrywide, which was completed almost exactly four years ago, turned Bank of America into a huge mortgage lender just as the U.S. housing market collapsed.

Trouble by the Numbers

Deal Journal breaks down the deal
Of all the purchases Bank of America made during its two-decade-long climb to the top of the U.S. banking heap, the takeover of Countrywide has spawned more regret inside the company than probably any other acquisition by former Chief Executive Officer Kenneth Lewis or his predecessor, Hugh McColl.


Bloomberg News
CEO Brian T. Moynihan (right) and Kenneth Lewis, in 2009.

Current Chief Executive Officer Brian Moynihan, who took over in 2010, has acknowledged that his bank purchased Countrywide "just when you shouldn't have done it." At the time of the takeover, Mr. Moynihan was running Bank of America's investment-banking unit.

"Obviously, there aren't many days when I get up and think positively about the Countrywide transaction," Mr. Moynihan said in August 2011.

Countrywide, founded 43 years ago, became the nation's largest originator of home mortgages under the leadership of co-founder Angelo Mozilo, the son of a Bronx butcher. Mr. Mozilo emerged as one of the most vocal advocates for homeownership during the company's rise but turned the company into a pioneer of subprime and adjustable-rate mortgages that were some of the worst made during the housing boom. Once some of those mortgages started to go bad, he sold a $2 billion stake to Bank of America in 2007 and agreed to sell the rest in January 2008. The deal closed on July 1, 2008.

Bank officials say they finally have their arms around the many problems spawned by Countrywide and that it won't get much worse. Indeed, hopes that the worst is behind it on Countrywide and other fronts has propelled Bank of America's shares to a gain of more than 40% this year, making it the best-performing stock in the Dow Jones Industrial Average.

The total costs from Countrywide to date, according to people close to the bank, include $34.5 billion chewed up by a combination of consumer real-estate losses since mid-2008 and funds set aside to pay back investors who allege Countrywide wasn't honest about the quality of mortgage-backed securities it issued before the crisis. Additional legal costs from various settlements with federal and state agencies and the initial Countrywide purchase amount push total costs over $40 billion, these people said.

But the tally could go higher. Bank of America has said it could face an additional $5 billion in possible losses, and scores of lawsuits seeking to pin Countrywide's liabilities on Bank of America are pending in courtrooms around the U.S. Both Mr. Lewis and Mr. Moynihan, for example, were asked about Countrywide while sitting for depositions in April and May hosted by lawyers representing bond insurer MBIA Inc., said a person familiar with that case. MBIA has said in a lawsuit that it was misled when it insured Countrywide's mortgage-backed securities before the housing bust.

The 2008 Countrywide bid was a bet the U.S. housing market was bearing a bottom and a play by Mr. Lewis to become the nation's No. 1 mortgage lender. Regulators were in favor of the deal, believing a Countrywide failure could pose a major risk to the economy.

Some at the bank sought assurances that U.S. regulators would protect the company in exchange for going through with the transaction.

One deputy to Mr. Lewis asked the Federal Reserve in early 2008 if the U.S. government might be willing to provide some sort of protection if Countrywide's assets went bad, said four people involved in the negotiations. The request wasn't authorized by Mr. Lewis, said another person close to the bank. The Fed, worried about rewarding other companies for excessive risk taking after coming to the aid of tottering investment bank Bear Stearns in March 2008, said no.

"They said they wouldn't entertain anything," one of these people said.

Other bank officials sought assurances from the Federal Reserve that it would go easier on Bank of America on the issue of capital, an acknowledgment that the lender wouldn't be punished for taking on more risk. That also didn't materialize, these people said. The Fed eventually pressured the bank to raise more capital in the fall of 2008 and forced it to slash its quarterly dividend to a penny in early 2009 as the bank accepted a second slug of U.S. aid to help complete a separate purchase of Merrill Lynch.

Countrywide saddled Bank of America with hundreds of thousands of delinquent borrowers, thrust it into the middle of a foreclosure-paperwork scandal and exposed the bank to countless lawsuits from mortgage-bond investors and insurers. The number of people handling poor-performing real-estate loans for Bank of America ballooned from 5,000 at the time of the Countrywide purchase to 50,000. Those people occupy at least 4.5 million square feet of office space around the country, the equivalent of 78 football fields.

The crush of lawsuits and losses forced Mr. Moynihan to shift the bank away from its long-standing emphasis on growth. He sold off more than $50 billion in assets, shut down unprofitable branches and announced plans to cut more than 30,000 employees. He told regulators it could sell off parts of its U.S. franchise or its U.S. trust business if economic conditions were to worsen significantly. The moves collectively have pushed Bank of America below J.P. Morgan Chase as the nation's largest bank by assets.

Mr. Moynihan and his team have concluded there is no easy way out of the Countrywide mess. The CEO toyed with the idea of placing Countrywide into bankruptcy but feared that a Countrywide default might damage other subsidiaries. The board concurred with Mr. Moynihan's recommendation last summer, and the bank hasn't moved from that initial assessment, said a person close to the bank.

Write to Dan Fitzpatrick at dan.fitzpatrick@wsj.com

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