On January 11, 2008, Bank of America announced that it planned to purchase Countrywide Financial for $4.1 billion in stock. On June 5, 2008, Bank of America Corporation announced it had received approval from the Board of Governors of the Federal Reserve System to purchase Countrywide Financial Corporation. On June 25, 2008, Countrywide announced it had received the approval of 69% of its shareholders for a planned merger with Bank of America. On July 1, 2008, Bank of America Corporation completed its purchase of Countrywide Financial Corporation. In 1997, Countrywide had spun off Countrywide Mortgage Investment as an independent company called IndyMac Bank. Federal regulators seized IndyMac on July 11, 2008, after a week-long bank run.

Countrywide Financial (NYSE: CFC) has been in the mortgage business since its founding in 1969. In 2006, Countrywide raked in $4.3 billion in pretax earnings, funding $463 billion in home loans, a 7% year-on-year decline. Countrywide’s mortgage servicing portfolio, however, grew to $1.4 trillion, a 17% increase over 2005. Notably, Countrywide served the United States as the leading home lending bank and the second leading mortgage service provider.

In light of the recent contraction in the subprime mortgage market, Countrywide has reduced the number of subprime mortgages it originates, which accounted for 9% of Countrywide’s total mortgage originations in 2006. Recognizing the riskiness of focusing too heavily in any one market, Countrywide also acquired Balboa Insurance Group Inc. in 1999 and Treasury Bank in 2001 to diversify its business lines. In addition to these acquisitions, Countrywide has also taken opportunities to grow and diversify its business organically, financing the growth of its fixed-income assets divisions through debt issuance and bank loans.

On January 11, 2008, Countrywide and Bank of America (BAC) announced that Bank of America would be acquiring Countrywide for $4.1 billion in stock.[1] The deal will not be completed until the second half of 2008, and the firms will not be fully integrated until 2009 at the earliest. On June 25, 2008, Countrywide's shareholders voted to approve the all-stock sale, which was valued at about $2.8 billion given Bank of America's stock price on that day.[2] On the same day, the states of California, Illinois, and Washington filed three separate lawsuits against Countrywide, alleging that its "unfair lending practices" had contributed to the subprime bust.[3]

Business Segments

Currently, Countrywide Financial consists of five business segments: Mortgage Banking, Retail Banking, Capital Markets, Insurance, and Global Operations.

Mortgage Banking

Mortgage banking remains the largest financial services segment within the Countrywide family. Countrywide's mortgage banking operations consist of three divisions: production, servicing, and closing services.

  • Production (Countrywide Home Loans) - This division offers both prime and non-prime home loans directly to consumers, facilitating purchases, refinancing, and other home loan transactions. These sales are performed in one of three ways: directly through a Countrywide realtor, through a network of independent mortgage bankers, or thorough a mortgage bank that has purchased a closed home loan originated by Countrywide.
  • Servicing (Countrywide Servicing LP) - Countrywide Servicing LP serves to maintain mortgages written by Countrywide or other mortgage banks. Servicing collects the interest and principal payments and provides customer service, third-party administration, investor accounting, collections, loss/risk consideration, and foreclosure services.
  • Closing Services (LandSafe) - LandSafe provides services such as appraisals, credit reports, title checks, and flood risk determination, to its own branch of home loan providers and the Countrywide Home Loans division, as well as to external customers.

Retail Banking

In an effort to expand beyond its mortgage business, the company created Countrywide Bank through the acquisition of Treasury Bank in 2001. This division offers products aimed at both consumers and businesses, such as interest-bearing checking and savings accounts, residential mortgage loans, long-term deposits (certificate of deposits), and mortgage foreclosure. In addition to Countrywide Bank, Countrywide Warehouse Lending provides short-term loans to other mortgage lenders and operates within the retail banking segment of Countrywide.

Capital Markets

Countrywide’s management has made it very clear that any new business, whether acquired or developed from within the organization, needs to be within the scope of its fixed-income security specialization, particularly mortgage loans. The Capital Markets segment was formed to provide more products within the mortgage derivatives markets. Through the Countrywide Securities Corporation, Commercial Real Estate Finance, Asset Management, and Servicing Exchange divisions, Capital Markets serves as Countrywide’s full service mortgage derivatives segment.

  • Commercial Securities Corporation facilitates the purchase, sale, and origination of debt-related securities. This division serves financial institutions, pension funds, banks, insurance companies, and money managers.
  • Real Estate Finance deals with the origination, sale, and securitization of commercial real estate mortgage loans to brokers, mortgage bankers, and institutional investors (such as mutual, pension, and hedge funds).
  • Asset Management specializes in managing, assessing, and maintaining the condition of physical assets (single, multi-family homes, commercial properties, et cetera) for mortgage companies and investors as well as customers of the Countrywide Lending Division.
  • Servicing Exchange acts as a broker of bulk mortgage servicing rights in addition to providing valuation services for institutional firms that buy and service these products.

Insurance

Balboa Insurance Group Inc. was acquired in 1999 to further diversify Countrywide's operations. Already a full-service property, casualty, and life insurance provider, Balboa gave Countrywide a great base in the insurance industry from which to expand. Extending services to include auto and home insurance products, Countrywide set out to expand into the insurance industry while keeping its loss exposure to a minimum. Acquiring Balboa has also given Countrywide significant cross-selling opportunities to commercial and residential mortgage customers in need of insurance. Additional insurance products offered include disability and renters' insurance, reinsurance on primary mortgage insurance, and employee benefit products.

Global Operations

Located in India, outsourced providers facilitate maintenance and execution of the call center, information technology, and related services through CFC International. Countrywide International Technology Holdings Limited holds annual service contracts with Barclays (BCS) and Prudential Lifetime Mortgages Limited for software licensing and support.


Industry Analysis

Countrywide is a financial institution dedicated to originating, maintaining, and securitizing mortgages and related financial products. 47% of 2006 Countrywide’s pre-tax earnings were generated by its mortgage segment. The Consumer Financial Services industry is small and consists of primarily mortgage companies, only seven of which have market capitalizations of $10 billion or greater. When the subprime mortgage market began to contract and mortgage default rates rose, many investors lost confidence in the ability of small, specialized mortgage firms to continue generating revenue and meet their obligations to shareholders. This has resulted in widespread bankruptcies and buyouts across the industry. Although Countrywide continues to face losses in the subprime mortgage market, it has taken many steps to diversify its business lines, establishing Countrywide as a leader in the prime mortgage market as well. For this reason, to normalize the volatility of number and size of firms currently in the Consumer Financial Services, it would be more appropriate to compare Countrywide to the more diverse, money center financial institutions. Although the mortgage portfolios of Wells Fargo, JP Morgan, Citigroup, Bank of America, and Washington Mutual are not as large as Countrywide’s, their financial stability and presence in the prime mortgage market make them good comparisons for Countrywide.

Trends and Forces

Subprime Lending

Subprime lending refers to the practice of extending credit or loans to borrowers to who fail qualify for prime or market rates due to their less-than-optimal credit scores. The interest rates on subprime loans are typically higher than those associated with prime loans; the rationale is that borrowers with lower credit scores present a higher risk of default and must therefore pay a considerable risk premium. Subprime borrowers can be extremely sensitive to interest rates, due largely to the proliferation of adjustable-rate mortgages, whose rates change with current prevailing interest rates. As rates (and monthly payments) rise, these borrowers often find themselves unable to meet their debt obligations.

Recently, there have been a large number of defaults on subprime mortgages, hitting subprime lenders as more and more customers miss their payments. Countrywide has taken steps to mitigate its losses from this downturn by reducing the number of subprime mortgages it originates. Nonetheless, Countrywide has been a regular in financial headlines talking about the subprime fallout. In August 2007, Countrywide had to take out an $11.5 billion loan to continue making its own loans to customers; the company has also begun laying off employees in an attempt to cut overhead and ride out the current credit crunch. As of June 2008, so many of Countrywide's customers had defaulted on their mortgage loans that Countrywide has repossessed over 1,600 homes in the state of Florida alone.[4]

Interest Rates

As both a lender and a deposit-taking bank, Countrywide is very sensitive to changes in interest rates. Rising interest rates mean that it can charge more for its mortgages, which still form the largest portion of the company's overall business. At the same time, however, higher interest rates also mean that it has to pay more on customers' deposits. The same applies in reverse; lower interest rates equal lower revenue on new mortgages but lower outlays for interest on deposits. Lower rates can help stimulate the housing market as it becomes cheaper to borrow money, whereas higher rates make it more expensive to take out a mortgage to buy a house.

Since Countrywide is also involved in the securitization of mortgages, interest rates have a doubly strong impact on its mortgage business. Not only do they impact mortgage revenues, but interest rates affect the value of Countrywide's securities as well. As interest rates rise, investors become less willing to invest in debt-backed securities when a regular savings account will pay a decent return. Countrywide and other issuers of mortgage-backed securities have to offer higher returns to entice people to buy them; this is all fine and well as long as interest rates remain high, but falling rates can put Countrywide in a difficult position. As new mortgages make less and less money, the company's high-return securities can suddenly become very expensive.

Interest rates have been stable since early 2006, which is the last time the Federal Reserve changed the target federal funds rate, or the general interest rate for consumers. It did, however, lower the inter-bank lending rate (the rate at which it lends money to banks) from 6.25% to 5.75% on August 17, 2007. This was aimed at maintaining economic growth in the face of a growing credit crunch without letting inflation get out of hand. This rate cut made it cheaper for business, such as Countrywide, to borrow money to continue to fund their operations.

References

  1. Bank of America to acquire Countrywide - Mortgage Mess - msnbc.com
  2. COuntrywide's Pressures Mount - WSJ.com
  3. Countrywide's Pressures Mount - WSJ.com
  4. Countrywide Troubles for Bank of America
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