Who gets the bigger benefit - Countrywide or the rescuer?

Implications: While many eyes are on the transaction as a proposed bailout for Countrywide, Bank of America will be solving a good many problems for themselves, while purchasing the fuel for tremendous growth.  The advantages for Bank of America are many but the largest are the resolution of their August 2007 investment of 2 billion in Countrywide for a 16% stake now devalued by the market, the availability of a full functioning nationwide sales and fulfillment channel for mortgage loans, the acquisition of a large and highly profitable servicing portfolio, advanced technology, and a top notch executive and management team.

Analysis:

Bank of America has made an exceptionally shrewd, well timed, and well priced stock offer for the shares of Countrywide.  In the process of offering up a lifeline to a competitor in a good degree of difficulty, they've delivered a large group of benefits to their shareholders.

The single largest benefit of the transaction will be immediate growth.  Bank of America, even with the large footprint it has in the US, has surprisingly not been a leader in loan origination.  They've had to silently sit back while many of their customers (large and small) chose to obtain mortgages elsewhere.  The idea of applying and getting approved for a mortgage in the time it takes to drink a cup of coffee with the branch manager never really materialized.  Countrywide has both the centralized and the distributed sales force, along with the best origination and underwriting technology in the business to deliver a tremendous cross sell of the bank's existing customers to their mortgage products.  While needing to keep a tremendous "brick and mortar" presence in every town and neighborhood in the US was one of the thorns that pricked Countrywide as volumes dropped, the opportunity, over time, to combine locations will allow for tremendous efficiencies.  While B of A and Countrywide both had sizeable presences in the non-retail (broker and correspondent) origination market, Countrywide has been in the number 1 or 2 position for years, and once again will bring incredible market presence, technology, and management to their new parent that will spur growth.

The next area for discussion is the mortgage loan servicing portfolio.  Estimated in this article at 9 million loans, representing over 1.5 trillion dollars in loans, this asset has tremendous income generation capability.  Though the article mentioned that the portfolio is "troubled," don't think this reduces the over all value of the servicing rights, nor the annual fees retained for servicing the loans.  In the current environment, with subprime and "alt-a" loans being harder to fund, and property values not rising - which affects "A" mortgages as well, loans are staying on the books longer and longer.  As servicers get paid for whatever term the note is being serviced, an increase in duration implies an increase in revenue.  Troubled loans do cause additional expenses (due to more interaction with borrowers), but many of the more costly and complicated steps and costs of servicing a defaulted loan are borne by the investor.  Countrywide is (in general) not an investor - they are a servicer.  For years and years and years, Countrywide has been telling us about their servicing portfolio being a macro hedge against diminshed origination volume.  That scenario is here, and while the high flying income statements in record orgination months are not being seen now, the macro hedge is of great relief to both the balance sheet and the P&L.  It would be naieve to think that a company as large as this would be able to survive forever on their servicing rights (which will extinguish over time), given the costs of operating such a large organization.  But combine the valuation and cash flow with a renewed opportunity to originate in collaboration with their parent (think synergies and large growth), and there is a clear path to improvements in earnings.

Related to this point is that Bank of America is getting a world class servicing system.   Over the course of several acquisitions, B of A has ended up with a variety of systems from different firms, used in different ways.  If they choose, they could easily unite their servicing technology under Countrywide's very capable systems.  Countrywide has always been a "builder" and not a "buyer" of best in class technology and the systems have been specified, designed, and built by people who really understood servicing, and that while modern, have already had the test of time applied.  Beyond technology, Countrywide does not outsource many of the sub-processes involved in servicing (thus keeping additional fee income for their own coffers).  B of A could greatly benefit by adopting a stable "in-sourcing" solution to many of their post funding loan administration needs.

B of A is also getting a top notch management team.  Much in the spotlight over the snowball effect of the subprime liquidity crisis, the group of leaders the company has are very well versed and have extremely long terms in both the mortgage business and at Countrywide.  There is little that is not measured, reported on, discussed, and acted on - this is an environment that gets things done in good times and bad.  B of A would be very smart to ensure these individuals are happy to stick around, as they are a very knowledgeable and decisive group that has braved many storms over many years, and kept the company in the spotlight of origination.  Not the least of the most valuable assets acquired will be the attention, focus, and advocacy of Angelo Mozilo.  When Lewis talks to Mozilo next week, let's hope he offers a compelling vision for the future, as in many regards, Mozilo has been the leader of the industry, and is a very active and involved Chairman and CEO.  Mozilo always kept the company equally focused on its roots and its future, and will help drive the combined companies to unprecedented growth in the space.

There are many more advantages and some things that will need to work out over time, but overall B of A bought itself what will prove to be a great winner.  Leverage the technology, adopt the nationwide origination, underwriting and closing capabilities for both retail and wholesale, and retaining the people is all it will take.