naked capitalism

We’ve never been a fan of the pending acquisition of Countrywide by Bank of America. In fact, BofA’s apparent eagerness to buy a company clearly on the ropes seemed odd: why not wait until it went bankrupt, or at least was on the courthouse steps with a filing? We’re clearly old-fashioned, but in our day, not reputable company would risk its good name (and substantial litigation costs) by buying a large business that can only politely be described as ethically challenged.

The alleged reason for the deal was for BofA to get its hands on Countrywide’s servicing business. People who deal with servicers tell us they are now hemorrhaging cash. I am advised that it is a standard feature of servicing agreements for the servicer to guaranteed to pay whatever interest is promised to the investors for at least 90 days after default. Some agreements also require them to pay principal during that period. Even after the 90 days, the servicer has to continue to pay real estate taxes and insurance. The servicer can use any late payment or other penalties from the borrower to offset these costs. The agreements had built in some margin to allow for these outflows, but no agreements contemplated defaults at the level we are seeing. Of course, the other reason the Charlotte bank may have stepped forward is if it were encouraged by banking regulators, or if a fire sale of Countrywide would directly have a negative impact on BofA’s book.

So it looks like Countrywide is a walking mass of liabilities. Institutional Risk Analytics discusses why the deal may not go through (the article also contains a wonderful discussion of the oxymoron of business ethics):

First, it becomes clear, to us at least, that BAC is unable to close the CFC transaction due to uncertainty regarding the target’s liabilities….in our view: BAC (and its lawyers and accountants) is not willing to do a deal that leaves BAC shareholders facing a potentially staggering loss….

Second, run the numbers. If you accept that none of the funds of CFC’s $120 billion asset bank unit are available to repay parent company liabilities, except the $9 billion or so in book value representing the CFC equity in the sub, then the calculus comes down to about $50 billion in debt, vendors and other liabilities vs. the remaining assets of the parent, roughly a similar amount of loan servicing rights, conduit and investment assets, and whatever CFC can get for the bank unit.

Thus two billion dollar questions:

1) What is the estimated haircut for the ex-bank assets of CFC?

2) What is the estimated cost of settling all pending litigation?….

For BAC, a risky but better strategy than the course at hand may be to withdraw from the CFC merger, pay the $160 million breakup fee, and allow the entire company to slide into a managed default. As CFC’s funding runs away, the OTS will be forced to invoke its statutory authority to appoint the FDIC as receiver of the insured bank subsidiary, thus precipitating a bankruptcy filing by CFC.

In the event, BAC and no doubt a crowd of other suitors will be standing by, waiting to bid for some or all of the bank’s assets and liabilities in a competitive regulatory sale. But the claimants on the CFC bankruptcy estate would have to await the resolution of the bank receivership to see whether there were any net amounts from the sale of the bank that could be reclaimed.

To that point, while retail depositors of Countrywide Bank FSB have little or no reason to be concerned in such a scenario, the jumbo depositors of CFC above the insured limit- if any remain – should take advice about their options. The jumbo deposit holders may or may not be paid immediately by the FDIC depending on their assessment of the bank’s condition at the point of seizure.

Given the outline above, our view is that the equity of CFC is worth $0….if you are a fully cognizant bond holder of CFC… you… also understand that the equity holders are essentially toast….What are you waiting for?

If the BAC deal is not happening, then the only logical course is to pull the plug on the impossible dream of Ken Lewis, shoot the equity holders and get on with the CFC restructuring.