Bank of America’s Scheme to Stiff Countrywide Bondholders

A reader provided a link to a post by Institutional Risk Analytics, which in turn cites a merger filing by Bank of America with respect to its plan to acquire Countrywide. The document details what can only be called a scheme by which Bank of America intends to acquire Countrywide (specifically, the FDIC insured entity) but leave the debt behind.

Now I am not a bankruptcy expert, nor am I current on the state of the art in M&A, but the intent of this deal flies in the face of a fundamental precept of well established practice. A huge no no is what is called fraudulent conveyance, and this deal is a clear, flagrant effort to do precisely that.

Wikipedia provides a very good explanation. Forgive me for giving you the long form, but I believe details are important, and reading this (in conjunction with the post from IRA, which follows) should make clear how egregious Bank of America’s plans are. I am not at all impressed with the use of a Delaware LLC “merger sub” to accomplish the asset-stripping. This isn’t a terribly complicated structure, and the intent and the effects are crystal clear.

Even if the regulators sign off (very bad precedent, but anything is possible given the weird reluctance to let CFC fail), expect a lot of private lawsuits. Again, I am no expert, but if the plaintiffs can get their case in front of a bankruptcy judge, I don’t imagine there will be much sympathy for Bank of America’s position.

The problem is that the initial purchase of 20% of Countrywide by Bank of America was a bad move, and they are now trying to throw more money at it to validate their original buy (this phenomenon is called irrational escalation). Remember, CFC was very close to bankruptcy when Bank of America stepped in the first time. But the only valuable and comparatively trouble-free part of the mortgage lender was its servicing business. That would clearly be sold out of bankruptcy to the highest bidder. But rather than have to pay a full price for a good asset (and the business going for a top price now looks doubtful, given how many banks are shedding assets to raise capital), Bank of America instead tried to get control of the situation by taking a blocking position in the form of its stake in Countrywide.

Moral of the story: No one has ever come out a winner trading against Angelo Mozilo.

From Wikipedia:

A fraudulent conveyance, also fraudulent transfer is a civil cause of action. It arises in debtor/creditor relations, particularly with reference to insolvent debtors. The cause of action is typically brought by creditors or by bankruptcy trustees. The usual fact situation involves a debtor who donates his assets, usually to an “insider”, and leaves himself nothing to pay his creditors as part of an asset protection scheme. However, it is not uncommon to see fraudulent conveyance applications in relation to bona fides transfers, where the bankrupt has simply been more generous than they should have or, in business transactions, the business should have ceased trading earlier to avoid giving certain business creditors an unfair preference (see generally, wrongful trading). If prosecuted successfully, the plaintiff is entitled to recover the property transferred or its value from the transferee who has received a gift of the debtor’s assests.

There is an old equitable maxim: “One must be just, before one is generous.”

Fraudulent conveyances or transfers in the United States

In the United States, fraudulent conveyances or transfers[1] are governed by two sets of laws that are generally consistent. The first is the Uniform Fraudulent Transfer Act[2] (“UFTA”) that has been adopted by all but a handful of the states.[3] The second is found in the federal Bankruptcy Code. [4]

There are two kinds of fraudulent transfer. The archetypical example is the intentional fraudulent transfer. This is a transfer of property made by a debtor with intent to defraud, hinder, or delay his or her creditors.[5] The second is a constructive fraudulent transfer. Generally, this occurs when a debtor transfers property without receiving “reasonably equivalent value” in exchange for the transfer if the debtor is insolvent[6] at the time of the transfer or becomes insolvent or is left with unreasonably small capital to continue in business as a result of the transfer.[7] Unlike the intentional fraudulent transfer, no intention to defraud is necessary.

The Bankruptcy Code authorizes a bankruptcy trustee to recover the property transferred fraudulently[8] for the benefit of all of the creditors of the debtor[9] if the transfer took place within the relevant time frame.[10] The transfer may also be recovered by a bankruptcy trustee under the UFTA too, if the state in which the transfer took place has adopted it and the transfer took place within its relevant time period.[11] Creditors may also pursue remedies under the UFTA without the necessity of a bankruptcy.[12]

Because this second type of transfer does not necessarily involve any actual wrongdoing, it is a common trap into which honest, but unwary debtors fall when filing a bankruptcy petition without an attorney. Particularly devastating and not uncommon is the situation in which an adult child takes title to the parents’ home as a self-help probate measure (in order to avoid any confusion about who owns the home when the parents die and to avoid losing the home to a perceived threat from the state). Later, when the parents file a bankruptcy petition without recognizing the problem, they are unable to exempt the home from administration by the trustee. Unless they are able to pay the trustee an amount equal to the greater of the equity in the home or the sum of their debts (either directly to the Chapter 7 trustee or in payments to a Chapter 13 trustee,) the trustee will sell their home to pay the creditors. Ironically, in many cases, the parents would have been able to exempt the home and carry it safely through a bankruptcy if they had retained title or had recovered title before filing.
Even good faith purchasers of property who are the recipients of fraudulent transfers are only partially protected by the law in the U.S. Under the Bankruptcy Code, they get to keep the transfer to the extent of the value they gave for it, which means that they may lose much of the benefit of their bargain even though they have no knowledge that the transfer to them is fraudulent.

Now from “Are Countrywide Financial Bonds Bankruptcy Remote?” from Institutional Risk Analytics:

The announced acquisition of Countrywide Financial (NYSE:CFC) by Bank of America (NYSE:BAC) was in doubt on Friday because of reports that BAC may back away from the deal. Pity CFC shareholders, who are selling at something like 5% of book value (and this for BAC paper), but we wonder how many of the CFC bond holders understand that they may face an equal or greater haircut.

The CFC 6.25%s of 2016 closed at 79.125 on Friday or over a 10% YTM. The pricing reflects the expectation that BAC will assume responsibility for the CFC debt at par. But after hearing from some bankers in the know and reading the “Agreement and Plan of Merger” filed with the SEC by BAC last week, we think that CFC bond holders will soon get the joke.

Usually, when a company acquires another, the former assumes the debt of the latter and agrees to make timely payments of interest and principal as previously contracted. In the case of BAC’s purchase of CFC, however, BAC seems to view the transaction as an option.

Bankers who’ve been briefed by BAC officials tell The IRA that CEO Ken Lewis intends to keep the crippled thrift holding company “bankruptcy remote” by merging CFC with a new vehicle, called Red Oak Merger Corp in the merger plan, and that BAC does not intend to consolidate the entity or take full responsibility for the CFC debt.

According to the plan: “…at the Effective Time, [CFC] shall merge with and into Merger Sub. Merger Sub shall be the Surviving Company in the Merger and shall continue its existence as a limited liability company under the laws of the State of Delaware.” (BAC public affairs officials Kevin Stitt and Pamela Black did not respond to written questions sent by The IRA via email on Thursday.)

The implication is that BAC eventually will take direct ownership of the FDIC insured Countrywide Bank FSB, which now has assets of some $130 billion, leaving the remaining assets of the formerly public CFC and a good chunk of its $105 billion in parent level debt at risk of an eventual default. BAC officials are reported to have said that BAC’s deposit base and debt issuing power offer significant funding advantages to CFC, but also said that BAC will keep the target separate for an “interim period” of indeterminate duration.

FDIC insured banks, you see, cannot file bankruptcy. Were BAC to even contemplate putting the company formerly known as CFC into Chapter 11, it would first need to move Countrywide Bank FSB to a different part of the BAC group. Otherwise, when BAC was about to file the Chapter 11 petition, the Office of Thrift Supervision would intervene and invoke its statutory authority as the bank’s primary regulator to appoint the FDIC as receiver of the bank, potentially stripping BAC of its entire equity investment.

Readers of The IRA will recall our fascination with the televised interview between the money honey, Maria Bartiromo, and CFC co-founder and honcho Angelo Mozillo, the bronze god of affordable housing. Last September, we described (“When Flying to Quality, Be ‘In the Bank'”, September 10, 2007) why the phrase “in the bank” was so significant to investors holding CFC debt and equity.

According to statements allegedly made by BAC officials during private conference calls held over the past two weeks, statements which are nowhere to be found in BAC’s public disclosure filed with the SEC, the CFC debt is expected to be “assumed not guaranteed,” this under the theory that “the biggest risk at CFC was liquidity and that when the deal closes, that risk goes away,” according to a banker involved in the conversations.

The BAC strategy is reportedly to manage the orderly liquidation of CFC, excluding Countrywide Bank FSB, and to guarantee payments of interest and principal so long as the remaining non-bank assets and liabilities of CFC support same. The BAC officials reportedly expressed the view that keeping CFC is a separate subsidiary of BAC insulates the rest of the group from legal liabilities and “arguably prevents them from ballooning out of control,” says the banker.

If BAC officials are keeping CFC “bankruptcy remote” to protect the large organization from legal and financial losses from the ex-bank portion of CFC, which includes the bank’s conduit and non-bank assets, the implications for CFC debt holders – and holders of bank debt generally – are quite grim. If the same fire sale valuations seen in the market for subprime assets are applied to the ex-bank assets of CFC, then the Friday close of 79 cents per dollar of face value of CFC bonds may be a tad on the high side.

More to the point, if the Fed, OCC and OTS are willing to countenance a bank merger transaction where BAC does not explicitly stand behind the parent company debt of CFC, what does this say about the debt of other relatively small bank holding entities such as Washington Mutual (NYSE:WM) and Capital One (NYSE:COF)?

If CFC is to be allowed by regulators to fall into bankruptcy once the insured bank subsidiary is secured, then how about WM and COF? Are the Fed and other regulators indifferent to the systemic implications of such a transaction? More important, don’t investors in BAC and CFC securities have a right to an unambiguous statement from BAC CEO Ken Lewis regarding his intentions with respect to CFC debt?

Unfortunately we cannot participate in the BAC conference call on Tuesday due to a previously scheduled client meeting, but perhaps one of our colleagues in the analyst rat pack will ask BAC to elaborate on the following:

1) Were the statements we describe regarding the acquisition of CFC, in fact, made by officials of BAC?; and

2) If so, why were these statements not immediately made available to all BAC and CFC investors?

We again put those questions to BAC.

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  1. Anonymous

    Being Dutch, I’m not conversant with US bankruptcy law. But do I understand correctly that Bank of America is trying to get hold of the profitable bits of Countrywide, and leave the rest to the creditors? That will keep some lawyers busy… As a contributor to (the Dutch) Wikipedia, thank you for saying the article gives “a very good explanation”!

  2. Abe Froman

    That looks legal to me. Its a reverse triangle merger. They are used all the time.

    Rather than do a straight merger of CFC into BAC, BAC merges CFC into a wholly owned subsidiary. This isolates the liabilities to sub while keeping itself free from the sub’s obligations.

    This is very common. I does not constitute a fraudulent conveyance.

  3. Anonymous

    This will be taken to the International Court. Under blacks Law Dictionary 1912.
    If you look at the major share holder of both Corporations it would be Barclay Global investment.
    The only Problem with putting this deal in court, Would make 90% of the World Corporations Bankrupt,they are all connected in one way. By how the Global economics Became so open. Just look what Barclay owns and where it is on Major share holdings even look at the other major share holders of each corp And Barclay will have a major stake in this.
    The World governing body will want this swept under the covers.
    Lets face it who can pay this massive debt off. The US is Bankrupt, There cannot even make payment on their Municipals Bonds. Just look at the rate cut today there need to get all those overseas Promissory notes back. So lower the rate what will decrease the value of the Dollar, and then the Countries holding all that Debt comes back and buy,s everything cheap. We have to face the fact that The US did exactly what the sec was set out to regulate the amount of Margin what could be given to the actual reserve of the entity had. Taking from Paul to pay Steve and then Steve Has to Pay Paul, Has finally has caught up with all that false money.
    Know one knows how far this will go. Maybe the world needs to completely excuse all debt, work with one Monetary form, and learn from this stupid and greedy economic society. Every County works on the same tariff’s, and the same principle’s. Capitalism and socialism at it best. I will stop writing now I could go on for year’s. From a commoner who has not been educated, just listen, read and wittiness. Now I am speaking out because someone has to. I hope others will hear, and start reorganizing the shambles we are in. Start speaking the truth and tighten are belts. So the next generation will have something left.

  4. Anonymous

    This story should be bookmarked for future study. I think the market turmoil will make this an overlooked story, which is worth digging deeper into! Im very interested but this is an intense area of study where false and misleading information may be connected with fraudulent conveyance; however, the intent to make this a public deal and disclose details is the issue here.

    This reminds me of the story yesterday about Northern Rock and the stupidity of disclosure being blocked by the courts;

    here is what they dont want released for some dumb reason: The following is excerpt of Project Wing – the executive summary of a plan, put together by
    Merrill Lynch, Citi and The Blackstone Group, to sell stricken mortgage lender Northern Rock,
    code-named Blackbird. This “Briefing Memorandum” has been sent to all potential acquirers

    Blackbird is currently pursuing a sale of its business as a whole (”WholeCo” or the “Whole
    Company”). This is Blackbird’s preferred outcome. As an alternative to the sale of WholeCo and to
    assist interested parties, Blackbird has defined two discrete preferred asset sale structures, namely
    the acquisition of either (i) the Company’s existing infrastructure/operational platform and/or
    Blackbird’s retail deposits and matching assets (”PlatformsCo” of the “Platforms Company”) or (ii)
    PlatformsCo plus further selected assets and liabilities, including the securitisation and covered
    bond funding programmes (”PrimeCo” or “Prime Mortgage Company”). Blackbird and its advisers
    encourage offers for assets and liabilities of the business which are different from those
    contemplated under the preferred structures. For example, this Memorandum also gives separate
    financial information on the retail deposits platform.
    Any assets and liabilities not transferred to the purchaser will be retained within an entity called
    FinCo is expected to remain listed and to be placed into a solvent run-off with the objectives of (i)
    orderly run down of the balance sheet; (ii) repayment of creditors; and, if appropriate, (iii) the return
    of residual value to Blackbird shareholders.

    Go look at stories on Blackbird & Northern Rock!

    The point here related to fraudulent conveyance or false and misleading information is that a corporation should be held liable for a lack of disclosure.

    More later!

  5. Anonymous

    Today the transparency group Wikileaks released censorship demands it has received over a confidential briefing memo relating to the dramatic financial collapse of the UK’s Northern Rock bank.

    The bank collapsed late last year under the weight of the US sub-prime lending crisis and was re-floated by Bank of England at a cost of 400 pounds for each person in the United Kingdom (24 billion pounds).

    The memo led to stories in the Financial Times, the Telegraph and many others. Despite being of clear public interest, the document and even the some of the stories arising from it fell to censorship injunctions. Only Wikileaks continues to withstand the attack.

    Northern Rock hired Schillings, an expensive London firm of Lawyers and public relations consultants. Schillings state in their legal threats to Wikileaks:

    “Pursuant to an Order of the Royal Courts of Justice dated 13th November 2007 (‘the Order’) no person shall publish or communicate or disclose to any other person (other than by way of disclosure to legal advisers instructed in relation to the proceedings for the purpose of obtaining legal advice), inter alia, the information contained within the ‘Northern Rock Executive Summary’

  6. Yves Smith

    abe froman,

    I was probably not sufficiently clear in my intro to the two long extracts, and am not certain that you read through the entire IRA piece.

    I’ll admit to being remiss in not reading the underlying SEC docs (there are only so many hours in the day) but as IRA tells it, this is not a normal transfer of all assets and liabilities to a merger sub. The FDIC regulated depositary institution will somehow be conveyed separately. This is the extraction of a material entity from the deal and to me does raise questions of fraudulent conveyance.

  7. russell120

    I poked around with some bk’s recently and it seems like fraudulent conveyance gets talked about a lot,but is reasonably uncommon. The (relatively) new US bk laws actually brought the look back period to 2 years.

    What constrains most of the really fun scenarios is the covenants on all the various levels of lending. It seems like management cannot sneeze without tripping over some sort of covenant that puts them in technical default. But of course much of the recent lending has been continually referred to as “covenant lite.” So if the covenant-light bondholders, are going to get screwed, it is their own darned fault.

  8. Lead Zeppelin

    Hella, this whole Merger Agreement between CFC and BofA, through Red Oak Merger Corp is at yahoo finance at the following link.

    It’s OK, we are redistributing debt with countries that refuse to balance their currencies with ours.

    check out the New York Fed statement from 3 years ago @

    It allows foreign countries to own (Your) assets with an equalibrium of lower interest rates.

    In other words, the dollar is being “Crashed” by lower interest rates.

    It is not the end of the world, just a return to double digit inflation at the American Consumers expense…

    Shocked, I doubt it… We have become acclimated to getting it up the wazoo!

  9. Yves Smith


    As I said, I am not current on the state of play, but this deal looks awfully transparent as to its effects. And remember, there has been a dearth of corporate bankruptcies in recent years.

    I don’t know the terms of these bonds, but my impression is that cov lite took place preponderantly in LBO deals that got sold via collateralized loan obligations. Given the dearth of good old fashioned investment grade (at the time of issue) deal, the Countrywide bonds may have had more conventional terms.

  10. Anonymous

    A “creditor” does not need to resort to a BK judge to protect its interest from a fraudulent conveyance. I’ve dealt with both sides of such lawsuits under CA law.

    I’m sure BofA would like to avoid the debt but, assuming that the bondholders have a right to those assets in the first place, any attempt to transfer them out of the entity subject to the bonds without fair consideration can be enjoined and reversed under garden-variety state law.

    If CFC were in BK then the BK laws with similar rights are also available.

    The only way BofA will get away with stiffing bondholders is if the bond agreements themselves never provided recourse against the servicing business.

    I don’t know the capital structure of the group of entities that are traded under CFC. And apparently part of the assets are held under the bank entity and some are not.

    My understanding is that CFC owes a ton of money to the FHLB. It might be easier to bulldoze another quasi-public entity than savvy wall street bondholders.

    BofA may want to try this and use any lawsuit as a way out of the deal if they can’t get away with it.

    Purportedly, there are some huge tax benefits to B of A in addition to the servicing business.

    The nice thing about being a bondholder is that you typically can protect your interests fairly easily. The contract determines your rights and nobody can transfer a valuable asset out from under you to a related entity or without fair value, so long as you are willing to sue.

  11. Anonymous

    Bottom line… not only is the purchase going to be a great opportunity for Bank of America, there is a lot of outside pressure for a large institution to step in and take over. Do you really think BofA would even consider acquiring Countrywide if it would also have to inherit all of the lawsuits and risk?

  12. Anonymous

    the issue resolving cfc was with its corporate structure. the most valuable asset is the servicing book which was held at the parent and not at the insured thrift. the thrift has little franchise value as it is nothing but bad mortgages funded by fhlb advances and non-core deposits. hence, if they would have allowed the thrift to fail, its cost to fdic would have been significant as it could not get its hands on the mortgage servicing book.

    bac acquires the parent, which has 2 main assets — the servicing book and the thrift charter. now bac has bought (stripped) these 2 assets and left the parent debt behind. the question will center around did bac pay a fair value price for these 2 assets. if not, they will have to pony up more money if the bk trustee is successful when it litigates (this litigation is certain).

    the other question surrounds the piles of litigation that cfc is under. does this structure allow bac to ideminfy themselves from it? the purchase by bac never made sense as they should have allowed cfc to fail which would provide ideminification. as such, the current transaction does not make economic sense; when this happens usually there is something below the surface to make it work. perhaps bac has assurances from its regulators or politicans friends that they will support or shield bac from these lawsuits.

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