BOA Averaging Down

To me, averaging down means you totally ignore the fact that you were terribly wrong in the first instance, and went in with fuller gusto the second time around at lower prices. That's Bank of America. Bank of America offered an all-stock deal valued at $4 billion for Countrywide - a fraction of the company's US$24 billion market value a year ago.

The deal is a landmark in the housing crisis, given Countrywide's prominence as the nation's largest mortgage lender, at least until recently. Bank of America's move is a gamble that the U.S. is nearing a housing bottom and crystallizes the divide on Wall Street over whether now is the time to buy housing-related assets on the cheap - or flee from them to avoid further losses.

Or is it a gamble. BOA did invest back in the middle of last year when trouble first hit Countrywide. A loan which is convertible into Countrywide shares at an effective US$18 or so. The share price has since fallen to US$5. BOA is buying a deeply troubled company, and it faces the risk that Countrywide's assets could continue deteriorating.

As of Sept. 30, Countrywide's savings bank held about US$79.5 billion of loans as investments. Three-quarters of these loans were second-lien home-equity loans - where Countrywide doesn't have first crack at the collateral in case of default - or option adjustable-rate mortgages, which let borrowers make minimal initial payments and face sharply higher ones later. Overdue payments by Countrywide borrowers are surging as house prices drop and loans reset to higher payments.

Bank of America already has a full plate. It is still digesting its US$3.3 billion acquisition of U.S. Trust and the US$21 billion purchase last year of Chicago's LaSalle Bank. The same team that reviewed the Countrywide acquisition is also leading the restructuring of Bank of America's troubled corporate and investment bank, which has taken its own big hits in the credit-market turmoil.

BOA made its initial investment in Countrywide in August, purchasing preferred shares convertible to a 16% stake in the company. The deal looks like a sorry deal that the CEO has to follow through. Well, if you though it was good around US$20, it must be better at US$5. To me, that's totally ignoring the fact that he read it wrong in the first place. Great CEO strategy. All within 5 months.

BOA was one of the least affected among the big banks with sub prime write downs. The company should have stayed the course and not try to be too smart. Well, they have dug a hole for themselves already, might as well continue digging.