Countrywide Rescued
By Bank of America

Bank of America Corp. agreed to buy tottering mortgage giant Countrywide Financial Corp. in a $4 billion all-stock deal, a move that could build a bulwark against the mortgage-default crisis by protecting one of its biggest casualties from collapse.

The deal would give Countrywide 0.1822 share of Bank of America for each share they own. Based on Thursday's closing prices, that values each share of Countrywide at $7.16 each, a 7.6% discount. Countrywide shares slumped in premarket trading to $6.60.

The deal, which Bank of America doesn't expect to impact 2008 earnings excluding items, is expected to close in the third quarter. The bank expects to see $670 million in cost savings, but doesn't expect to fully realize them until 2011. The combined company doesn't plan to originate subprime loans, a key cause of the continuing credit crunch.

"We believe this is the right decision for our shareholders, customers and employees," said Countrywide Chairman and Chief Executive Angelo R. Mozilo.

Bank of American Chairman and CEO Ken Lewis said, "We are aware of the issues within the housing and mortgage industries. The transaction reflects those challenges. Mortgages will continue to be an important relationship product, and we now will have an opportunity to better serve our customers and to enhance future profitability."

Countrywide's fall and rescue mark a milestone in the unfolding international financial crisis. The turmoil was triggered more than a year ago by the bust of the American housing market and the resulting wave of mortgage defaults, but it is spreading -- and authorities are struggling to contain it.

A weakening economy and rising mortgage delinquencies have begun to feed off each other in a dangerous spiral, as falling home values and tightening credit begin to sap consumers' spending. Retailers yesterday reported weak December sales, and American Express Co. reported reduced spending and increased delinquencies among its customer base, known for its affluence. Unemployment last month jumped and economists have dramatically raised the odds of a recession to 42%, according to the latest WSJ.com survey.

To combat those trends, Federal Reserve Chairman Ben Bernanke yesterday indicated a new willingness to cut interest rates more deeply. That came after the Bush Administration began floating the idea of direct economic stimulus such as tax rebates. Bank of America's move provided an immediate shot in the arm, as the battered stocks of Countrywide and some other mortgage lenders rose on optimism that the takeover by Bank of America could signal an end to the relentless bad news from lenders.

More broadly, a failure of Countrywide would have posed a major risk to the U.S. economy, since the lender services about one of every six loans in the country. Bankruptcy likely would have shifted huge financial risk to Fannie Mae and Freddie Mac. A spokesman for the U.S. Treasury Department said agency officials didn't encourage Bank of America to rescue the huge mortgage firm.

The acquisition marks the end of a mortgage lender long known as an innovator, survivor of slumps and fierce competitor that rocketed to No. 1 in U.S. mortgage lending by the early 1990s. Countrywide lost its No. 1 position in the mid-1990s but regained it in 2004 and continued expanding its market share by hiring aggressive sales people and lowering its lending standards -- leading recently to a rising tide of defaults.

During the housing boom, Countrywide was a big promoter of option adjustable-rate mortgages, which give borrowers choices of how much to pay each month and can increase a loan's balance. A smaller chunk of Countrywide's business came from subprime loans, a type of lending that now has nearly vanished, but Countrywide still has exposure to past subprime loans and other risky mortgages.

"From the Countrywide stockholder perspective, this is manna from heaven," said analyst Richard X. Bove of Punk Ziegel & Co. "They've got this lousy stock and if Bank of America paper replaces Countrywide paper, they own one of the best banks in the country and they're bailed out." Countrywide shares surged 51% on the news to close on the New York Stock Exchange at $7.75. Bank of America stock closed at $39.30, up 1.5%.

For Bank of America, the deal would instantly allow it to realize its ambition of becoming a dominant mortgage lender. But it also would bring some ticking time bombs, whose powers to destroy value won't be clear at least until the housing market bottoms out, which may not be for a year or more.

Bank of America has suffered on its initial investment in the Countrywide in August, when it bought preferred shares convertible to a 16% stake for $2 billion. In the next few months, Countrywide's stock fell by more than half, including a plunge in recent days amid intensifying anxiety among investors. The bank was forced to deny earlier this week that it planned to file for bankruptcy. Its overall market value sank to $2.8 billion -- equivalent to about two months of profit for Bank of America -- before yesterday's bump in the stock price raised that figure to $4.5 billion.

Bank of America had been seen as a potential buyer of the troubled lender since acquiring the stake in August. The Charlotte, N.C., company has first right of refusal in any sale of Countrywide, and Bank of America has a long history of opportunistic takeovers of banks facing distress going back to 1988, when predecessor NCNB Corp. purchased remnants of failed FirstRepublic Bank of Dallas at the urging of federal regulators and got nearly $1 billion in tax credits.

There appeared to be a big obstacle for a Countrywide takeover after the Federal Reserve approved Bank of America's acquisition of LaSalle in September. The combined bank grew to hold 9.88% of the country's deposits. Federal law prohibits a bank-holding company from controlling more than 10% of U.S. deposits after acquiring another bank.

But the law includes an obscure caveat: The 10% limit doesn't apply to federally chartered thrifts, meaning a bank-holding company may control more than 10% of deposits in the U.S. following a thrift acquisition. Since a Countrywide subsidiary called Countrywide Bank is a federally insured thrift, that may give Bank of America room to maneuver around the deposit cap.

Bank of America is the only bank that has ever neared the 10% deposit cap. Many seasoned banking attorneys were not familiar with the caveat, as no bank has ever tried to acquire a thrift to vault above the 10% limit.

"This could be the biggest loophole in the world," said Gilbert Schwartz a partner at Schwartz & Ballen LLP and former Fed attorney. It was unclear when or how the loophole first became known to the banks.

Retail Network

Bank of America's Mr. Lewis has often said he likes "the product, not the business," when it comes to mortgages. He has particular disdain for mortgage-servicing rights, which can fluctuate widely in value because they reflect future streams of income. But the chance to sell additional products and services to mortgage customers has strong appeal to Mr. Lewis, who also thinks those borrowers tend to be financially stable. Bank of America's huge network of retail branches and ATMs could help it lure Countrywide borrowers.

Many on Wall Street snickered as the value of Bank of America's $2 billion investment in Countrywide tumbled. But some analysts and investors have wondered if the driving reason for making the August investment was to plant a flag at Countrywide and keep any competitor from swooping in.

Just last month, Mr. Lewis told analysts at the Goldman Sachs conference that at some point "arithmetic overcomes all your issues." He also said: "If I ever did anything in the mortgage business, I would have to eat about seven years of my words, so it would have to be pretty compelling."

The financial institutions involved in the deal are overseen by myriad federal regulators in Washington. The Fed oversees Bank of America's parent company, while the Office of the Comptroller of the Currency regulates the Charlotte company's national bank. The Office of Thrift Supervision oversees Countrywide's federal thrift charter, and the Federal Deposit Insurance Corp. insures deposits at both Bank of America and Countrywide Bank.

Former Bank of America Chief Financial Officer Marc D. Oken compared the deal to the buyout of troubled MNC Financial Inc. The former CEO of MNC, Frank Bramble, sits on the Bank of America board.

The takeover would call into question the future role of Angelo Mozilo, a New York-born executive known for his deep tan and frank speaking style, who co-founded Countrywide in 1969 and now serves as chairman and chief executive. Mr. Mozilo, who turned 69 last month, was long praised as an innovator and wily survivor in the U.S. mortgage industry.

But he has run into a barrage of criticism over the past year as Countrywide has stumbled. Critics say the company lowered its lending standards too far in pursuit of market share and squandered capital through heavy repurchases of its own stock. Meanwhile, Mr. Mozilo undermined confidence in the company through his sales of Countrywide shares he has acquired over the years through stock-option awards.

Payday for Mozilo

A takeover could result in another big payday for Mr. Mozilo. David Wise, a New York-based consultant for Hay Group, a compensation-advisory concern, estimated that Mr. Mozilo could receive cash severance payments totaling $36 million.

From 2004 through 2007, Mr. Mozilo sold about $414 million of Countrywide shares. The Securities and Exchange Commission last year opened an informal investigation into the stock sales, which were made through prearranged plans known as 10b5-1 programs. These plans are designed to allow senior executives to sell shares at regular intervals automatically. If executives pledge they don't have insider information at the time the plans are established, they can be used as a defense against insider-trading charges.

Mr. Mozilo modified his longstanding 10b5-1 plans late last year to increase sales of stock. Mr. Mozilo has said he increased the pace of selling to diversify his personal investments in an orderly way ahead of his retirement, scheduled for December 2009. He has denied any wrongdoing in connection with the share sales and argued that the options were a tax-efficient way for Countrywide to pay him.

-- Ann Carrns in Atlanta, Greg Ip in Washington and Dow Jones Newswires contributed to this article.

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