Bank stocks got a boost in the first week of October as upbeat economic data resulted in a widening ...
Bank’s Stake Will Stabilize Countrywide
09/04/2007 12:00 am EST
Jordan Kimmel of Magnet Investing says that Bank of America’s investment in the nation’s leading mortgage company should help put a floor under that troubled stock.
Shares of the nation's largest mortgage company Countrywide Financial (NYSE: CFC) rose after it announced that banking behemoth Bank of America (NYSE: BAC) has invested $2 billion in the company. The investment comes in the midst of an industry-wide shakeout following a severe credit crunch.
Under the terms of the deal, BAC has acquired $2 billion in the form of convertible preferred stock yielding 7.25% annually. BAC will not have any voting rights under the preferred shares, [but it] will have the option of converting its shares into common shares of CFC at $18 a share, a discount to the current value of CFC's stock price. (It closed Friday below $20, while Bank of America’s stock closed above $50—Editor.) If BAC were to convert all its shares into CFC common stock, the bank would become the largest shareholder of the mortgage company with roughly 17% ownership.
Commenting on the investment, CFC Chairman and CEO Angelo Mozilo said, "BAC's investment in CFC represents a vote of confidence and strengthens our balance sheet, enabling us to position CFC for future growth and success."
Bottom Line: BAC's $2 billion investment into CFC preferred stock is a dual-edged sword for CFC investors. On one hand, the issuance of the securities will dilute CFC's earnings. On the other, the transaction evokes confidence that CFC isn't headed towards bankruptcy, strengthens its balance sheet, and likely puts a floor under the stock.
When we took a position in CFC, we knew the mortgage market was under pressure, but we never expected a full-fledged credit crunch. If we had foreseen this coming, we would have never made this investment. However, we continue to own the stock, and looking back in the rear-view mirror won't get us to where we want to go.
While we don't see any near-term catalysts to drive CFC higher, we believe the intrinsic value of its franchise is worth much more than it is trading at today. Earnings per share will largely be depressed in the short to medium term due to the dilution and the fact that the secondary mortgage market is all but shut except for agency-backed loans, which will dramatically shrink origination volumes.
However, CFC is still the leader in servicing and originating mortgages and will survive, even if the next few quarters won't look pretty as loss-loan provisions rise and origination volume shrinks. With an underweight portfolio position, we think the best move is to still hold onto positions but not to add any additional capital at this time.
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