Jan. 11 (Bloomberg) -- The risk of Bank of America Corp. defaulting rose to the highest since at least November 2001 after the biggest U.S. bank by market value said it will rescue Countrywide Financial Corp.

Credit-default swaps tied to the bonds of Charlotte, North Carolina-based Bank of America increased 9 basis points to 89 basis points, according to broker Phoenix Partners Group in New York, suggesting deteriorating perceptions of credit quality.

Bank of America may take on too many liabilities in its $4 billion acquisition of Countrywide, the money-losing mortgage lender besieged by bankruptcy speculation, the contracts show. Bank of America would inherit the ``heightened'' credit risk of Countrywide's home equity loans and option adjustable-rate mortgages, analysts led by David Hendler at bond research firm CreditSights Inc. said in a report today.

``There's probably a little doubt here,'' Brian Yelvington, a strategist at CreditSights in New York, said in an interview. ``They say the due diligence is done, but is it?''

Moody's Investors Service today said it may cut Bank of America's A financial strength rating. Countrywide's ``volatile mortgage asset valuations'' and pending litigation may weigh on the company's already-strained capital position. The ratings company said it may raise Countrywide Home Loans' Baa3 ranking.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality.

Rising Risk

Credit-default swap prices suggest that investors for the first time in about three months see Bank of America as risky as Citigroup Inc., the U.S. bank that replaced its chief executive officer after writedowns on subprime mortgage securities. JPMorgan Chase & Co. and Bear Stearns Cos. analysts today said New York- based Citigroup may write down as much as $16 billion when it reports fourth-quarter earnings.

Bank of America contracts have traded an average 17 basis points below Citigroup in the past three months. The gap has narrowed to 1 basis point, according to CMA Datavision and Bloomberg data.

While the perceived risk of Bank of America failing to meet its obligations rose, the credit-default swaps imply the chance of a default is less than 8 percent over five years, according to a JPMorgan Chase & Co. valuation model. Countrywide's contracts were implying a 78 percent chance of default earlier this week as they soared on speculation the company was headed for bankruptcy.

Bank of America's 5.75 percent note due in 2017 was little changed at 100.4 cents on the dollar, according to Trace, the bond price reporting service of the Financial Industry Regulatory Authority. The extra yield investors demand to own the bonds over government debt widened 13 basis points to 185 basis points.

Capital Replenishment

Bank of America will buy Countrywide for about $7.16 a share in stock, the company said in a statement today. The offer is 7.6 percent below yesterday's closing price on the New York Stock Exchange. Countrywide gives Bank of America about 9 million borrowers and fees from servicing $1.5 trillion of mortgages.

The purchase would put Bank of America in an ``all-out capital replenishment phase'' to ensure it meets regulatory guidelines, Hendler said in today's report.

``There are risks in taking on this much exposure to the mortgage sector at a time when with all the indicators and concerns about recession we're only seeing negative trends,'' Kathleen Shanley, an analyst at Gimme Credit LLC in Chicago said in an interview. ``They're making a bet that they're getting it at a very good price and that ultimately it's going to be very profitable for them.''

An Advantage

Shanley, who maintained her stable outlook, said the discount Bank of America is paying will help it absorb potential strains on capital ratios.

``They have the advantage that they're buying it at a fraction of book value, so they can absorb some of the exposure that way,'' Shanley said. ``And they're buying the largest mortgage originator in the country, so they've filled the one gap in their franchise.''

Contracts on Calabasas, California-based Countrywide fell to about 350 basis points, Phoenix prices show. Investors yesterday sought 7.25 percentage points, or $750,000, upfront and 500 basis points a year for five years to protect Countrywide bonds.

Sellers of default protection on Countrywide demanded an upfront fee of as much as 31 percent, or $3.1 million, earlier this week. Soaring defaults on mortgages as the U.S. housing market endures its worst slump in 27 years prompted Countrywide's market value to drop 82 percent in the past 12 months.

Narrowing Gap

Countrywide's 5.8 percent note due in 2012 rose as much as 38 cents on the dollar to 98 cents on the dollar early yesterday, according to Trace. The yield plummeted from as high as 20.2 percent on Jan. 8 to 6.3 percent today. The extra yield investors demand to hold Countrywide's five-year note narrowed 14 percentage points to 3.22 percentage points.

The Markit CDX North America Investment Grade Index, a benchmark gauge of default risk tied to the bonds of 125 companies including Countrywide, rose 4.25 basis points to 97.25 on renewed concern the economy is shrinking, according to Deutsche Bank AG.

A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

American Express

Contracts on American Express Co., the third-largest credit- card network, widened as the company said it adopted a ``cautious view'' for the year after December cardholder spending slowed and delinquencies rose. The credit-default swaps climbed 21 basis points to a record 130 basis points, according to CMA Datavision.

Federal Reserve Chairman Ben S. Bernanke yesterday said in his first speech on the economy since Dec. 11 that recent data suggests the outlook for 2008 ``has worsened and the downside risks to growth have become more pronounced'' as the housing slump continues.

``He basically said it was going to be a drag on the economy for some time, and that kind of tells you that all of the information is not out there yet,'' Yelvington said. ``That's kind of an impediment to any healing.''

In Europe, credit-default swaps on the Markit iTraxx Europe benchmark index of 125 companies with investment-grade ratings fell 0.75 basis point to 65.75, according to JPMorgan. The index rose to 67.5 basis points this week, the highest since the start of the credit slump in July.

To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Hamish Risk in London hrisk@bloomberg.net

Last Updated: January 11, 2008 17:38 EST