Bank of America’s mortgage business has lost more than $50 billion since the Charlotte bank bought Countrywide Financial for $2.5 billion, according to an Observer tally, and more losses are coming in an expected Justice Department settlement.
After announcing the deal for the ailing subprime lender in January 2008, then-Bank of America chief executive Ken Lewis called it a rare chance to become No. 1 in home loans. Instead the bank’s shareholders have spent six-plus years paying for Countrywide’s slipshod lending practices.
The disastrous purchase not only harmed investors but also employees, homeowners and the Bank of America headquarter’s city, which had risen to national prominence as its banks spread across the country in the 1980s and 1990s.
“It was a crippling deal for Bank of America,” said Ken Thomas, a Miami-based banking consultant, “and Bank of America is still in recovery mode because of it.”
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Former Bank of America executives say some insiders had concerns about the purchase at the time, but the bank forged ahead. Lewis has said regulators didn’t pressure him to buy Countrywide, but government officials were clearly pleased to check a problem off their list as the financial crisis was emerging.
Since July 1, 2008, when the deal officially closed, the bank’s mortgage business has lost $52.7 billion through the first half of this year, the Observer found. This number – more than double North Carolina’s recently approved annual state budget – includes settlements, payments to investors for soured loans, accounting writedowns, and operating losses and profits. The rest of the bank made about $75 billion over the same period.
The latest Justice Department settlement, which could come within days, would resolve a variety of probes with federal and state authorities, including allegations related to the sale of faulty mortgage-backed bonds. The agreement, not yet finalized, is expected to include roughly $9 billion in cash, plus $7 billion to $8 billion in consumer relief, such as reduced loan balances for struggling mortgage holders.
Bank of America doesn’t disclose the total amount it has set aside for legal reserves, but it has taken $10 billion in litigation expenses in the first half of this year. Some of this has gone toward other settlements, but analyst John McDonald of Sanford C. Bernstein estimates the bank has set aside $5.5 billion for the Justice Department pact. “We believe additional charges could continue to weigh on core earnings going forward,” Paul Miller, a bank analyst with FBR & Co., wrote last month.
It’s not possible to break out exactly how much of the losses in the bank’s mortgage unit came from Countrywide. But the California-based lender was the much larger mortgage company, with about 17 percent market share, compared with Bank of America’s 8 percent, according to Inside Mortgage Finance, an industry publication.
Bonds covered by the latest settlement also show Countrywide’s lopsided role in the losses. Of the loans packaged into securities by Bank of America and companies it later bought from 2004 to 2008, about three-fourths of those that soured were originally issued by Countrywide. Bank of America produced just 4 percent, with Merrill Lynch accounting for most of the rest.
“Clearly, it’s the worst acquisition in history,” said Guy Cecala, publisher of Inside Mortgage Finance. “No one really appreciated the liability that was going to be associated with large lenders from the past. Bank of America paid for it.”
‘What are they thinking?’
The acquisition started as a $2 billion investment by Bank of America in Countrywide in August 2007 at a time when crashing credit markets had spurred rumors that the lender could face bankruptcy.
The bank had a long-standing relationship with Countrywide CEO Angelo Mozilo, helping him start his mortgage company with a $75,000 loan in 1969. Lewis flew to California to meet with his counterpart, known for his year-round tan, to seal the deal.
But as financial markets continued to roil, Bank of America and Countrywide began discussing an acquisition in mid-November 2007, according to securities filings. On Jan. 11, 2008, the bank announced it was buying the company for about $4 billion in stock, a price that would slip to $2.5 billion by the time the deal closed six months later.
“We view this as a onetime opportunity to acquire the best mortgage platform in the business at a time when the value is very attractive,” Lewis told analysts that morning. Less than seven years after succeeding the legendary Hugh McColl Jr. as CEO, the son of a single mother who worked as a nurse had cemented his goal of making the bank a nationwide leader in mortgages, credit cards and deposits.
But some former executives at the bank now say there were doubts internally about the acquisition.
Only a small group of people from Bank of America’s smaller mortgage business were involved in the deal’s “due diligence,” the review of Countrywide’s books and operations, said a former mortgage executive familiar with the deal. Disappointed they had little say in the deal, Bank of America mortgage executives were concerned about the strategic fit and the reputational risk of joining with Countrywide.
In 2001, Bank of America, under Lewis, had exited the business of making subprime mortgages, higher-priced loans to borrowers with riskier credit profiles. And in fall 2007, the bank had stopped selling mortgages through brokers, a major business for Countrywide but one that Lewis had criticized for producing loans he called “toxic waste.”
“It was like, ‘What are they thinking?’ ” said the former mortgage executive, who like other colleagues agreed to speak only on the condition of anonymity to protect business relationships. “We are two totally different companies.”
Elsewhere in the bank, other executives were familiar with Countrywide because the bank bought loans from the lender for its own investment portfolio. Some worried about diminishing loan quality and the possibility that investors who had bought securities backed by Countrywide mortgages could some day demand the bank repurchase the loans if they went bad, said a former Bank of America executive. That’s the exact scenario that played out in coming years.
“The people who understood the mortgage business were clearly providing candid and factual feedback to the diligence team,” the executive said. “What they did with that information, there is no way I could answer that question.”
At the time, Lewis said the bank’s “extensive due diligence supports our overall valuation and pricing of the transaction.” The bank got advice on the purchase from its own securities arm and the law firms of Cleary, Gottlieb, Steen & Hamilton and K&L Gates, according to a news release.
Lewis, who retired in 2009 and still has a home in Charlotte, declined to comment for this story.
To be sure, few inside or outside the bank envisioned the tens of billions of losses that were to come, and the peak of the financial crisis was still months away. Over its history, Bank of America had often profited by buying down-and-out companies at bargain prices.
Unlike the Merrill Lynch purchase forged later in 2008, the government doesn’t appear to have played a major role in the Countrywide acquisition.
In 2010, Lewis told the Financial Crisis Inquiry Commission that regulators were “interested” in the bank’s possible purchase of Countrywide “but no one asked us to do the deal.”
In January 2008, a Treasury spokeswoman, facing an inquiry from a reporter, emailed a colleague that she was going to “kill the idea” that Treasury encouraged the purchase.
“We were aware but that doesn’t mean we were picking up the phone asking for bids,” the spokeswoman wrote, according to emails obtained through a Freedom of Information Act request.
From praise to protests
Initially, some advocates for borrowers lauded Bank of America for being a white knight reforming an industry villain. From the outset, the bank pledged to abandon Countrywide’s subprime lending practices.
“Bank of America has the resources and the will to begin cleaning up the subprime mess that Countrywide has played such a large role in creating,” Martin Eakes, chief executive of the Durham-based Center of Responsible Lending, said at the time.
But praise for Bank of America would evaporate as foreclosures mounted in the recession, fueling homeowner anger and protests around the country.
Inside the bank, the criticism wore on some employees.
“I felt like we had done the country a big favor,” said another former Bank of America banker. “If we hadn’t bought Countrywide what would have happened if one of the worst actors went bankrupt?”
By the end of 2009, Lewis had retired, facing intense criticism mostly for his Merrill Lynch deal that had resulted in a government bailout. One of his lieutenants, Brian Moynihan, would replace him and soon discover that cleaning up Countrywide would become a nearly all-consuming task.
Moynihan, a onetime college rugby player, joined the bank in its 2004 FleetBoston Financial acquisition and became head of Bank of America’s corporate and investment bank just weeks before the Countrywide purchase. In four-plus years as CEO, he has wrestled with legal settlements, sold off assets and embarked on a program to cut 30,000 jobs as he sought to create a less risky and more profitable company.
The bank’s stock, which closed Friday at $15.22, has been essentially flat since he took charge.
“Obviously, there aren’t many days when I get up and think positively about the Countrywide transaction,” Moynihan has said.
Mortgage losses began to ratchet up at the end of 2010 and into 2011 as investors began lodging claims asking the bank to buy back defective mortgages. In June 2011, the bank announced an $8.5 billion settlement with private mortgage-bond investors in a sign of the eye-popping payouts to come.
Now, the Justice Department case appears close to resolution. The expected settlement of more than $16 billion would be the largest ever between the U.S. government and a company.
While a huge number, the settlement is likely to leave many unsatisfied. Some critics say Bank of America is getting off light considering the damage it caused in the financial crisis and question why individuals aren’t being prosecuted. Others say the bank is being punished for a deal that saved Washington from a costly bailout.
“Can the government really claim victory for squeezing money out of large banks like Bank of America to pay for the sins of some other lender?” said Cecala, the publisher of Inside Mortgage Finance. “Wouldn’t it be more appropriate if they went after Countrywide officials who were responsible for this kind of thing?”
Since the Countrywide purchase was announced in January 2008, Bank of America’s shares are down more than 60 percent, compared with a 37 percent rise in the S&P 500 index, a broad measure of stocks. Regulators this month allowed the bank to bump its quarterly dividend to 5 cents per share, far short of the 64 cents the bank paid in 2008.
The promise of becoming a dominant mortgage lender with more than a quarter of the market has also fizzled. Bank of America gained ground in the second quarter of this year but still originated less than 5 percent of U.S. home loans.
The damage to the company, however, is defined by more than dollars and cents, said Thomas, the banking consultant.
“It was reputational,” he said. “It has tainted Bank of America probably forever.”