It's been a rollercoaster ride for Countrywide Financial Corp. (NYSE:CFC) with the market-moving news of Bank of America (NYSE:BAC) buying out the troubled mortgage lender in an all stock transactions (worth approximately $4 billion). Despite its impact being overshadowed by deeper than expected problems at Merrill Lynch (NYSE:MER), this news is a positive for Bank of America and it saves Countrywide from a certain path to bankruptcy.

Countrywide Teetering On The Edge
The financial stocks have been hit so hard during the subprime fallout that some have dropped below their value and are starting to look like good prospective buys. But with uncertainty of the future write-downs there is still considerable risk. Countrywide, at least in the eyes of BofA, is a different story. Just days before news of the deal, Countrywide's shares were down around 85% to $5.47 per share and rumors of the company's imminent bankruptcy were flying. The Wall Street Journal reported that despite much effort to revive the business, Countrywide CEO Angelo Mozilo had told his BofA counterpart Ken Lewis that he had considered throwing in the towel this past December ("Behind Bank of America's Big Gamble", January 12, 2008).

This must have spooked Lewis, who made his first bet on Countrywide back in August, when BofA invested $2 billion in preferred stock convertible to common shares at $18. Clearly, with the share price down $13 into the $5 range, it was not working out well. This new deal not only saved BofA's original investment from being tied up in the bankruptcy courts, but also gave the company a bargain basement purchase of the nation's largest mortgage lender - a substantial addition to the formidable Bank of America brand.

Fire-Sale Prices
Despite Countrywide being in shambles, BofA is now able to pick up the business at very attractive price of $4 billion. This is a company whose market cap was $24 billion a year ago, and BofA reportedly has had its sights on Countrywide even then. Back in January of 2007, MarketWatch reported that BofA was interested in buying Countrywide for $30 billion! The latter's apparent refusal to sell back then has saved BofA a lot of money now.

After Mozilo's distress call to Lewis, BofA sent dozens of bankers to Countrywide's headquarters to examine the situation. Lewis said that he was impressed with Countrywide's liquidity, but I think that may be putting too much of a positive spin on things. There is no doubt CFC would have fallen apart on its own, but combined with BofA's broad foundation it could possibly flourish and become a very valuable investment for the company.

Potential Damage To BofA
There was financial chatter on Friday, January 11, about how this rescue affects BofA's credit quality, considering they are now taking on the deteriorating credit of Countrywide. While Moody's announced it may cut BofA's credit rating, S&P and Fitch reaffirmed their ratings while keeping their future outlook negative. Moody's announcement was dependent on BofA's willingness to raise additional capital to offset the negative effects of the Countrywide acquisition. Let's put that to rest, since on the conference call following the announcement CFO Joe Price announced that the company will issue more capital to avoid reducing the firm's Tier-1 Capital basis. When asked how much, he said that it would likely take a couple billion, and later in the call an estimation of the $2 billion ballpark was given.

I think this will put a little pressure on the company's shares, but combined with the potential value of this investment, the result should be insignificant. BofA is increasing its behemoth position in consumer banking, and in my opinion it is moving further away from its investment banking operations. Given Lewis' consistent record of acquiring solid consumer businesses and consumer banking growth, I do not think this is necessarily a bad thing. Especially for the stock, since consumer banks are generally afforded higher valuations than investment banks in the market. Bank of America will still have to face the problems with Countrywide's portfolio of risky loans, but at this super-low price the margin of safety on the investment is substantial enough to absorb most problems. (To read more about banking systems, check out What Are Central Banks? and The Evolution Of Banking.)

The Bottom Line
BofA's rescue of Countrywide had many positive effects for the companies involved and the market as a whole. BofA saved its original $2 billion investment and Countrywide from certain doom, meanwhile gaining a valuable investment opportunity. A bankruptcy of Countrywide would have had a highly negative impact on the market, but with BofA taking it into its strong capital base, I think the Countrywide's assets will be stabilized and provide strong benefits to BofA with little downside risk. There is certain to be continued pressure on shares of BofA in these tough market conditions, but the company's long-term value remains.

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