TowerGroup's Craig Focardi on Bank of America Acquisition of Countrywide

Needham, MA - 14 January 2008

News broke late last week that Bank of America Corp. (BofA) has agreed to acquire mortgage company Countrywide Financial Corp. in a $4 billion, all-stock deal. While BofA may be rewarded with long term benefits from this acquisition, this purchase makes a bold bet that an economic recession is avoided in the next 18 months, a real estate rebound occurs and further significant demons within Countrywide’s mortgage business do not surface. BofA might get better odds at a Las Vegas roulette table.

Craig Focardi, research area director for the TowerGroup Consumer Lending, Retail Banking, and Delivery Channels practices, has assembled the TowerGroup research team’s initial thoughts on the implications of this acquisition for the financial services industry:

The Good
• This merger would create by far the largest mortgage lender and servicer in the United States – with approximately 12.8 million customers and 23 percent market share
• BofA would gain the opportunity to cross-sell bank products to an estimated 9 million Countrywide mortgage customers
• BofA would gain Countrywide’s retail bank (thrift deposit) customers
• BofA would acquire leading – while proprietary – loan origination and loan servicing platforms

The Bad
• Managing through a potential culture clash between Countrywide’s aggressive mortgage operations and Bank of America’s professional retail banking environment may be a significant challenge
• With the prospect of this merger, BofA will test regulators anxiety levels associated with the 10 percent deposit rule by exploiting a little known, never used loophole
• BofA’s balance sheet status and capitalization requirement will come under further scrutiny, which started when it acquired LaSalle bank
• Identification and elimination of redundant lending and banking systems is complex, and will be a multi-year process

The Ugly
With a recession looming, capital markets becoming more nervous, an overspent consumer, rising energy rates and a collapsing real estate market, this acquisition is a very bold move by the BofA board. In fact, the timing of this acquisition seems on the surface little more than a bailout strategy to protect its earlier $2 billion investment in Countrywide.

Foreign bank merger activity in the U.S. has been ominously silent to date, even though the weak dollar and the strong capital position of many foreign banks gives them the ability to acquire large U.S. banks. Acquisitions of U.S. banks have historically been smaller in scale, focusing on regional banks. Merger discussions between Chase and Washington Mutual may indicate both a preemptive strike by U.S. banks against foreign acquisition – but may also reflect concern by foreign banks about the weakening housing market, ongoing increases in loan defaults and weak near-term growth prospects for banks.

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