Bank of America's biggest conundrum is what to do about the Countrywide Financial situation. This 2008 acquisition called by some the worst corporate acquisition ever, has become the primary albatross hanging around B of A's neck — one that CEO Moynihan confesses is on his mind nearly every day.
Countrywide Financial and its founder, Angelo Mozilo were at the heart of the sub-prime mortgage debacle and the company nearly failed until salvaged in 2008 by Kenneth Lewis, then B of A's CEO, in a hastily constructed $4 billion deal.
Over the past few months B of A has been confronted with a plethora of Countrywide-related suits and claims. These include multi-billion dollar actions from state attorneys general related to foreclosure processing, mortgage buy-back demands from securities purchasers, mortgage insurer claims, accusations of misleading action by FHFA, AIG claims of misrepresentation and many others. There are billions and billions of dollars of potential liabilities that B of A is trying to resolve.
The market value of B of A stock has fallen to only a fraction of book value due to the uncertainty and potential financial impact of these issues. In addition, the company has necessarily set aside more than $15 billion as a litigation reserve for the possible claims.
The alternatives to achieve a speedy resolution are very limited but some have suggested that placing Countrywide in bankruptcy could ring-fence the potential costs and offer more leverage in resolving the claims. Such action could also provide greater certainty of the potential impact, increasing public confidence in the stock value.
Moynihan recently passed off questions regarding this possibility to his in-house counsel charged with resolving the growing lawsuits and claims. Some information is publicly available, but a fuller understand requires more information regarding the structure and governance within the B of A family.
Countrywide Financial is a wholly owned subsidiary within the B of A family of companies. Yet Countrywide Bank F.S.A which was the primary funding component of Countrywide Financial was separately merged into B of A's savings bank in 2009. It is unclear whether the claims and suits run to the past actions of the now consolidated Countrywide Bank F.S.A., Countrywide Financial, B of A's savings bank or its original mortgage operation or perhaps all of the above. How many of the claims or suits would be covered by a Countrywide Financial bankruptcy proceeding?
It is unclear is how the asset holdings and operation of Countrywide Financial are funded. They are most likely not externally financed but funded with credit lines from B of A holding company or one of its banking subsidiaries. Would these funds have preferences or become just unsecured creditors in a bankruptcy proceeding need to be considered?
Do any of B of A's business contracts or public debt offerings contain provisions restricting placing a company subsidiary into bankruptcy without breaching the agreement? Some breaches could be very costly or have a serious impact on B of A's reputation.
Has B of A operated Countrywide Financial to limit possible bankruptcy claims attempting to "pierce the corporate veil" carrying the claims to the assets of B of A or its holdings? These factors include the elements of independent governance and records, intermingling of assets and basically maintaining an arm length relationship to its operations.
There are more unknowns than answers to these questions posed by the bankruptcy option. I'm sure that all of these and many more considerations are in the hands and minds of B of A's management and lawyers.
Unless there is a quick, clear fix such as the bankruptcy option identified, resolution of the suits and claims surrounding Countrywide Financial will continue over a prolonged period and remain a deep black hole. With continuing uncertainty B of A stock will continue to languish as the market will always assume the worse.
Another question surrounding the Countrywide Financial uncertainty is whether B of A will need to add more capital. Any return to the market at today's price would be very costly. It remains to seen if the current process of small asset sales will be sufficient or if B of A will have to place a bigger prize, such as Merrill, up for sale — or perhaps just place another call to Mr. Buffet.
Robert H. Smith, the former chairman and chief executive of Security Pacific Corp., is a founder and director of Commerce National Bank in Newport Beach, Calif.
