Handing over $2 billion to a mortgage lender may seem crazy considering the recent credit panic. But investors are roundly applauding Bank of America for doing exactly that.
Late Wednesday, Bank of America bac said it was investing $2 billion in the nation's No. 1 mortgage lender, Countrywide Financial. cfc That was a lifesaver for Countrywide, which had found itself pinched for cash after some of the sources of financing it relied on in the credit markets dried up.
"A lot of what is driving this is a lack of confidence; it's panic," Countrywide CEO Angelo Mozilo told CNBC. "This is one of the greatest panics I've seen in 55 years in financial services. Something has to be done to restore confidence in the market."
But despite the risks, given the lucrative terms, Bank of America "got a really solid investment," says Jefferson Harralson, bank analyst at Keefe Bruyette & Woods. The deal is a winner for Bank of America in several ways. It gives the bank:
•A robust yield. Bank of America gets a preferred stock that pays a 7.25% annual dividend. "That's a tremendous return," says Richard Bove, bank analyst at Punk Ziegel.
•An option to own a slice of Countrywide. The preferred stock may be converted into common stock for $18 a share. That option is already valuable: Countrywide's shares Thursday closed 20 cents higher, at $22.02, and if exercised, the options would give Bank of America about 16% of Countrywide. So Bank of America is buying into Countrywide at depressed prices while making the company less depressed by adding cash, Harralson says.
•Indirect access to additional deposits. After completing its acquisition of LaSalle Bank, Bank of America will have 10% of the nation's deposits, which is the maximum it's permitted to have by law, Bove says. So, Countrywide gives Bank of America a "backdoor way to control another institution and well above 10% of the nation's deposits," Bove says.
While the contract gives Bank of America the first chance to buy Countrywide, Harralson doesn't think it is using this investment as a precursor to a deal. Bank of America exited the subprime mortgage business in 2001 and probably isn't looking to get back in now. "This is an investment," Harralson says.
Investing in depressed financial institutions can be lucrative. Saudi Prince Alwaleed bin Talal stepped up in 1991 when Citicorp was struggling from commercial real estate loans and invested $590 million. He got preferred shares that paid an 11% dividend. He also got the right to convert his preferred shares into common stock for $16 a share, 25% below the stock price at the time. Since then, Citigroup stock has rocketed 1,779%. Alwaleed bin Talal's stake now is unknown, though any stake of 5% or more must be reported.
There are risks, though. More mortgage lenders will likely fold before the credit debacle finally stabilizes, says John McCune of financial analysis firm SNL Financial. All bets are off if the economy struggles and further impairs Countrywide, says Gary Townsend of Friedman Billings Ramsey. "It looks like a good deal (for Bank of America), but it has its risks," he says.