Countrywide fears spike
Standard & Poor's downgrade of Countrywide's debt rating has creditors wondering if they'll get paid when Bank of America seals its $4 billion deal with the troubled lender.
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| Bank of America warned in a filing that it is evaluating how to handle Countrywide's debt. |
(Fortune) -- Countrywide's creditors are getting nervous.
The price of insuring against a default on Countrywide (CFC, Fortune 500) debt soared by more than half Friday after Standard & Poor's cut Countrywide's debt ratings to junk.
The spreads on Countrywide's credit default swaps surged as wide as 250 basis points Friday afternoon - reflecting a $250,000 annual premium on $10 million of insurance - from 165 Friday morning, traders said. The blowout came after S&P warned of "the new level of uncertainty as to the ultimate legal status of Countrywide's creditors after the merger" with Bank of America (BAC, Fortune 500).
S&P's decision was prompted by language in a Thursday filing by Bank of America, which agreed in January to buy Countrywide in a stock swap then valued at $4 billion. While corporate acquirers routinely take on the debt obligations of their partners, Bank of America warned in its filing that it is "currently evaluating alternatives for the disposition of the remaining Countrywide indebtedness." There is no assurance, BofA warned ominously, that "any of such debt would be redeemed, assumed or guaranteed."
A BofA spokesman didn't return two calls seeking comment. But if BofA walks away from the debt, bondholders - including state pension funds - could suffer catastrophic losses. Institutional Risk Analytics principal Christopher Whalen, who noted BofA's ambiguous stance on Countrywide debt in previous filings, wrote this week that should BofA decide not to guarantee the Countrywide debt, investors could resume their flight from the debt markets.
"What investor in their right mind would want to hold the debt of any bank holding company were BAC to elect the nuclear option," he wrote, referring to a possible decision to walk away from Countrywide debt.
Whalen envisions a situation in which Bank of America would purchase Countrywide, then put Countrywide into a shell company called Red Oak Merger Corp. He says BofA could then move Countrywide's banking subsidiary out of Red Oak and into another part of BofA, while compensating Red Oak for the transfer. After assessing the remaining assets and liabilities at Red Oak, BofA could put Red Oak into Chapter 11. Doing so could enable BofA to escape, among other things, "liabilities from litigation and regulatory inquiries, which could be substantial." Countrywide has come under fire since the housing boom collapsed for its aggressive lending practices.
In fairness, BofA is facing no small amount of financial risk with the Countrywide purchase. Countrywide was widely seen as mere days away from collapse in January prior to BofA's merger offer - which is why Bank of America was able to get Countrywide to agree to a deal that valued Countrywide at a mere fraction of its book value.
Confirming that assessment, the Calabasas, Calif., lender reported dismal first-quarter results this week. Countrywide's $893 million loss included a $1.5 billion provision for loan losses. More important, delinquencies grew across all mortgage product lines, including adjustable rate mortgages, which saw 9.4% of the portfolio go 90 days past due. That means BofA could face substantial losses on Countrywide's portfolio. 
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