BofA to Get Big Tax Bennies on Countrywide Purchase (and Critiques of the Deal)

The Fortune article by Allan Sloan, “BofA’s awesome Countrywide tax break‘ was more blunt, pointing out that we taxpayers are helping subsidize Bank of America’s purchase and Mozilo’s payout.

The tax savings are reported to be worth a half a billion over the first five years after the deal close, due to Bank of America using Countrywide losses to reduces its own tax liabilty, and there may be additional saving year six. The article states that the strategy is so arcane as to defy easy summary.

Even with the reduction in the effective cost of buying Countrywide, Bank of America will come to regret this deal. Countrywide is an organization that has made an art form of just barely staying on the right side of the law, and even then screws up. There is certain to be more dirt, and therefore legal liabilty, that hasn’t yet risen to the surface. Furthermore, it is well nigh impossible to impose procedures and standards on rogue cultures. Look what happened to Bank of America when it purchased US Trust, a company that had a great franchise but one in which the account managers had more autonomy (and incurred more customer-related expenses) than Bank of America’s officers did. BofA succeeded in driving away the many of the best account officers, who took customers with them.

Now the cultural challenges of integrating a Countrywide are very different than dealing with a US Trust, but consider: US Trust was a highly valuable franchise in an area the North Carolina bank said was a priority, and they screwed it up just about every way they could. And US Trust was a much smaller organization too, so the acquisition should have been easier to manage.

Thus, Bank of America has shown itself to be an inept acquirer, at least of businesses with different cultures and business requirements. And this deal comes at a time when management is facing tough conditions is its core businesses, and senior management will find it hard to give the Countrywide makeover the attention it demands.

Housing maven Robert Shiller criticized the Countrywide acquisition for more straightforward reasons: the price is too rich. From Bloomberg:

Robert Shiller, Yale professor of economics and co-creator of the S&P/Case-Shiller Home Price indexes, said the falling U.S. housing market may cut the value of Countrywide Financial Corp., the mortgage lender being acquired by Bank of America Corp.

“There’s a tendency for people to underappreciate the risk of the housing market,” Shiller said. “I might have a lower valuation of Countrywide than Bank of America does.”….

A record number of foreclosures has contributed to home price declines that leave many borrowers owing more on their mortgages than their homes are worth. Shiller compared the housing slump to a “tidal force.”

“Maybe Countrywide and Bank of America are going to have some problems going forward,” he said. “When people see that their houses are worth a lot less than their mortgage balance, they have an incentive to default. The troubled mortgages that Countrywide already has will be followed by even more troubled ones.”

Similarly, Housing Wire reports that top-level Countrywide talent has started to depart. Its chief information officer, Richard Jones, is going to Fiserv.

Now the irony is that Jones, and likely many of his direct reports, would get canned after the transition period. There is inevitably redundancy in administrative and operational groups, and almost without exception, the acquirer’s team is kept on. But in an area like IT, you want the incumbents around through the integration, and perhaps a bit longer, since no system is every extensively documented (short-sighted managements won’t pay the additional costs, and the geeks don’t fight too hard, since it makes it more difficult to be rid of them).

Now Jones leaving is probably not much of a loss. In the great majority of cases, the CIO is not involved enough in the nitty-gritty of the systems to be invaluable. But he is likely to take the best of the next level with him, and that could be highly detrimental to the integration process.

From Fortune:

Guess who’s helping Bank of America pay for its $4.1 billion purchase of Countrywide Financial? Answer: The taxpayers of the United States.

That’s because Bank of America, which is solidly profitable, will be able to use some of Countrywide’s losses to offset its own taxable income. The tax break could total about half a billion dollars over the first five years, according to an estimate by tax guru Robert Willens, who left Lehman Brothers Friday after a 20-year run and will be in business as Robert Willens LLC starting next week. The losses could be worth considerably more to Bank of America starting in the sixth year, depending on how big Countrywide’s losses are when Bank of America formally acquires it.

At this point, of course, no one knows how much in losses Countrywide has run up since the junk mortgage market began souring and defaults accelerated. Countrywide itself probably doesn’t know. But it seems almost certain to ultimately be in the billions….. Willens estimates that Bank of America will be able to deduct $270 million of Countrywide’s losses annually for the first five years it owns the firm.

That’s based on a $6 billion purchase price – $4 billion to Countrywide’s common stockholders, plus the $2 billion of preferred stock that Countrywide sold to Bank of America in August. Willens says that you multiply that $6 billion by 4.49 percent – the so-called “long-term tax-exempt rate” – to calculate how much of Countrywide’s losses Bank of America can deduct annually for five years after the purchase.

A $270 million annual deduction would save Bank of America something more than $100 million a year in federal and state income taxes. The long-term tax-exempt rate, which is based on Treasury rates and other things so complicated that they make my teeth hurt. The rate changes each year, Willens says, but not by much. When I asked how it’s calculated, Willens, a master of tax arcana, threw up his hands. (Metaphorically, of course.) “It’s like the formula for Coca-Cola,” he said, “no one outside the circle knows it” and it’s so complicated that, “no one else wants to find out.”

So over the first five years, Bank of America can use a total of $1.35 billion of Countrywide’s losses to shelter its income. (That’s five years of $270 million annual losses.) If Countrywide’s embedded losses when Bank of America buys it exceed $1.35 billion, Willens says, the bank will be able to deduct the rest of the losses, without limit, starting in the sixth year.

Isn’t life fun?