How High Can You Go?

Here’s an amazing statistic as reported in “B of A says merger on despite Countrywide woes:”

Countrywide said last week that 90-day delinquency rates in its $28.42 billion adjustable rate mortgage portfolio climbed more than 900% from a year earlier, up to 5.4% from 0.6% during the same period last year.

The lender also warned that 71% of its ARM borrowers are making only the minimum payment allowed — and that 80% of those loans had not required borrowers to verify their income prior to receiving funding.
[emphasis added]

An increase in delinquency rates of 900%? OK, I can see how this can happen given the unwinding of the credit and housing bubble. I can also understand that these numbers can/will get worse. What I do not get is the fact that B of A is continuing with its acquisition of Countrywide after having squandered a few billion dollars already:

Bank of America announced in January that it would acquire the rapidly devaluing thrift in a $4 billion deal to be completed in the third quarter of 2008.

The merger would make Bank of America the nation’s largest mortgage lender, with the potential to eventually originate or service more than a quarter of all mortgages in the United States. Analysts said they were not surprised by the uptick and wagered that Bank of America had expected significant increases in delinquencies.

“It would be my guess that [Bank of America] priced a lot of that in and weren’t surprised that the delinquencies are up,” Gary Gordon, an analyst for Portales Partners who has been following Countrywide for almost two decades. “They built in a lot of cushion for the price and were being pretty conservative.”

Gordon said that Bank of America may be willing to take on a greatly depreciated loan portfolio in exchange for the underlying business model Countrywide brings to the table.

“Countrywide built up possibly the best loan servicing and loan origination businesses in the country and Bank of America will basically get those for free and the loan portfolio for a 10% discount,” Gordon said.

The leaves Bank of America ideally positioned if and when the U.S housing slump ends, he said, despite any rough sailing along the way.

“Those delinquency numbers would have probably been known ahead of time, so there no big surprise here,” Gordon said. “All in all, they probably got some benefits that they didn’t pay for, even if delinquencies do keep rising.”

The lender lost $422 million in the last three months of 2007, despite CEO Angelo Mozilo’s pledged to return the company to profitability by the end of January.

I understand that B of A is trying to buy an undervalued asset, but what if that asset no longer exists or becomes worthless by the time the housing slump ends? Those odds seem pretty high to me, so if you know of any reason why this purchase is a financially sound decision for B of A, please share it with me.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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