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Mortgage Market Roundup: Five Things to Know About the Countrywide/BofA Deal

With arguably the most important event in recent mortgage banking history taking place this past week, I thought I'd replace this week's usual market roundup with a look at five key points to know about the Countrywide/Bank of America engagement:
1. We don't have all the details, but this isn't a merger. For all of the attention the announced deal has gotten this past week -- and rightfully so -- we still don't know exactly how this will work. There is still a chance that certain aspects of Countrywide's business aren't part of the deal or are carved out and sold as part of the purchase once BofA digs into the details. There are some parts of Countrywide's business that will be absorbed into existing operations at BofA; there are other parts that will not. I've read plenty of commentary on the merits of the deal in the past few days, but much of that speculation is just that -- speculation -- until it becomes clearer just how Bank of America intends to swallow its prey. Which brings up another point: this isn't a merger. This is a stronger financial institution swallowing a weaker financial institution. I'd expect we'll see plenty of this sort of consolidation going forward in 2008. Some unconfirmed sources have suggested that officials at the FDIC are allegedly ramping up for what they expect to be a larger spate of bank failures in 2008 and 2009, which suggests there will be plenty of wounded ducks waiting to be swept up. One such deal, JPMorgan's interest in Washington Mutual, HW covered on Friday. I wouldn't expect to see any deal, however, until WaMu is sufficiently wounded by its mortgage holdings; that's M&A 101. First day, first lesson. 2. Countrywide will exit wholesale operations. For all of the hand-wringing I've seen from brokers in the past few days -- and rightfully so -- all you need to know here is what BofA CEO Kenneth Lewis said in January 2007 when the BofA/Countrywide rumors first surfaced:
"We're not particularly interested in the wholesale and correspondent business ..."
The only thing Lewis feigned at that time was his lack of interest in Countrywide; the rest, I've been told, is exactly spot on. This is a change that will clearly be felt throughout the entire mortgage industry when it happens, but I don't think anyone should be surprised when it does. Numerous industry sources have suggested that Bank of America's interest in Countrywide can be summed in up three words: servicing and retail. And in that order, too. 3. Countrywide's capital markets division will cease to exist. BofA doesn't need to duplicate something it essentially already has; it will likely take what it needs from CCM and shutter the rest. This is just a guess, of course, but given the dearth of activity in the private-label secondary market right now -- and the fact that other outfits like WaMu have already shuttered their capital markets operations -- I don't see this sort of decision as a reach. 4. Industry effects will be felt throughout, and often where few are looking. I heard from an industry source at The First American Corporation over the weekend, musing on how the deal may impact First American's own business. That source noted that First American handles a majority of processing for BofA, but not for Countrywide -- which gets us to the nuts-and-bolts of this deal. Irrespective of any consumer-facing branding decisions that are made, which are essentially window dressing, there are going to be some important operational decisions that need to be made behind-the-scenes in regards to two very different mortgage banking businesses. Most of the commentary I've seen is taking the view that BofA and Countrywide will remain separate servicing entities; that may be true in the short-run, but I don't think you take the kind of risk that BofA is taking without figuring out how to best integrate wherever you can. Especially so in loan servicing, which is essentially a volume business. Those with experience in mortgage servicing know how critical some vendor relationships are; something that won't be reported anywhere else (but will be covered here at HW) is how the acquisition changes the vendor landscape for servicing and default management. There are some vendors that have staked their entire name and most of their revenue on the business they receive from Countrywide; those firms now find themselves wondering if they'll have lost their largest client by 2009. Other smaller firms may have been working with BofA in the past, and now face the prospect of seeing business ramp up very quickly. On the default management side of the business, I can think of at least five major examples of this off-hand. 5. Countrywide's loan portfolio will hurt BofA. It probably goes without saying that the largest reason Countrywide was in trouble was because of its loan portfolio. According to a report in the Wall Street Journal, out of nearly $80 billion in loans held for investment, 75 percent are second-lien HELs and option ARMs. Calculated Risk does a dynamite job covering the likely pain this could cause BofA in the short run, suggesting portfolio losses could approach $10 billion. The question, of course, is whether the long-term benefits justify what most expect to be short-term pain for BofA.
Next week kicks off the Q4 earnings season in earnest -- sure to be a wild ride -- and HW will cover what matters most for those in the mortgage finance industry, along with highlighting the best insight and analysis from across the Web. See you Monday. Disclosure: At the time this commentary was published, the author held various put option contracts on WM; no positions in any other companies mentioned.

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