country wide paying 5.75% on cds

[davelj]

capeman, you said:

“Convertible deal with BofA- That was $2B of preferred stock at pretty much any given price at or below $18. If the stock drops to $6 that is then a “certain event” that will give BofA 3X the preferred shares at liquidation plus the ~7% interest on the convertible.”

THIS IS WRONG. HOW MANY TIMES DO I HAVE TO SAY IT? This deal is NOT a floorless convertible. If CFC’s stock goes to $6/share, BAC’s stake will still only convert into 16%-17% of the company’s common. Read the frickin’ 8-K! The “certain events” that would readjust the strike price are stock splits, stock dividends, additional issuance of options and warrants, etc. This is a STANDARD, plain vanilla convertible issue. Why can’t anyone seem to get this straight? I’m bearish on CFC too, but… wow… I’m absolutely baffled… this is public information… Why do I bother?

[File under: “I’ve Made Up My Mind – Don’t Confuse Me With The Facts”]

[TheBreeze]

According to this FAQ, the Fed will take performing subprime mortgages as collateral:

http://www.frbdiscountwindow.org/cfaq.cfm?hdrID=21&dtlID=90

So it looks like CFC can pledge their subprime mortgages so long as they are performing. Given that, does anyone have an explanation as for why they are offering such high rates on 1-year CDs when they can supposedly borrow from the Fed Discount Window at about the same rate?

[davelj]

TheBreeze, the reason relates to leverage and regulatory capital ratios. When CFC goes to the discount window it’s borrowing money, literally. When CFC pays 5.75% on a deposit, the deposit is, well… a deposit. From an income statement perspective, there’s no difference because the rates are similar (as you recognize). But one ratio that regulators look at closely is the ratio of loans to deposits. By raising more deposits – even though they are expensive deposits – CFC can keep its loan-to-deposit ratio at a lower level than if it borrows the funding. All else being equal, the regulators would prefer to see CFC using “deposit funding” – which they consider more “core” in nature – as opposed to “debt funding” – which is more “wholesale” in nature – in order to fund its assets.

[TheBreeze]

Thanks Dave. That’s kind of what I thought was happening although I wasn’t quite sure of all the details.

[capeman]

Dave,

Fact of the matter is, yes you have said that many times now, but you have not produced the documentation specifically and literally supporting your argument. There is NO legal wording in the 8-K that legally binds BofA against being allowed to hedge the investment or specifically stating what a “certain event” is. If you were a BofA shareholder and you saw the firm making that kind of investment in a near dead horse you are expecting that they hedge. If they don’t when it is perfectly legal and deters some of the risk of the convertible, they will piss off many an investor/shareholder.

I can guarantee that with the current legalize (or lack of!) in the 8-K, if CFC does go BK, BofA with preferred shares will be getting “1st” dibs to $2B in equity at the value of liquidation. Since there are not any other noted “Preferred” large shareholders the first $2B goes straight to BofA if there is $2B at all. If the liquidation value is less than that then BofA will have a legal course for recovering the CFC loan servicing unit which is the only piece of CFC of any value. Add to that the ~7% on the convertible they were collecting and the ~25% or greater hedge and it is a low-risk win big investment by BofA.

If you provide written documentation prohibiting BofA from doing any of this please present and I will eat my words. If it is not specifically prohibited and legally bound it is a loophole and you can bet your money they are exploiting it. That is what these companies do and why they have $200+Billion market cap. That is their business.

[TheBreeze]

The posts made in the comments here agree with you, capeman:

http://calculatedrisk.blogspot.com/2007/08/countrywide-8-k-sec-filing-on-bofa.html

If I’m understanding everything correctly, although this convertible is not floorless, it still allows for a risk-free short of CFC for BofA?

[capeman]

Yeah and when you just got preferred at $18 and you’re seeing $26 the next day you short the shite out of it. Sitting on your hands won’t make you any more money and investors don’t like to sit on their hands when the Benjamins are dangling in front of them.

Here is a bit of discussion on the topic…

http://www.tickerforum.org/cgi-ticker/akcs-www?post=4728&page=1

[davelj]

capeman,

I NEVER suggested that BAC could not hedge their CFC preferred investment. I merely said that I had read that Mozilo had mentioned that BAC couldn’t SHORT shares to hedge its investment. I readily acknowledged that even if BAC couldn’t short CFC’s shares there were still myriad ways to hedge its preferred position. Having said that, the 8-K filing states specifically that BAC cannot “sell or transfer” CFC common shares for 18 months after conversion. This does NOT say BAC can’t short CFC shares PRIOR to conversion (as I thought Mozilo had suggested), so I must assume that in fact there isn’t a current restriction on BAC’s shorting CFC’s stock. But, again, this is a red herring – I already acknowledged that BAC could find a way to hedge its position even if it couldn’t specifically short CFC’s stock.

Now, you seem to refuse to acknowledge that this deal is NOT a floorless convertible and you have asked me to provide you with the “certain events” language that clears this issue up. So be it, here it is (verbatim) from the 8-K:

************
(f) The Conversion Price shall be subject to adjustment as follows:

(i) If the Company shall (1) declare or pay a dividend on its outstanding Common Stock in shares of Common Stock or make a distribution to holders of its Common Stock in shares of Common Stock (other than a distribution of Rights), (2) subdivide its outstanding shares of Common Stock into a greater number of shares of Common Stock, (3) combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock or (4) issue by reclassification of its shares of Common Stock other securities of the Company, then the Conversion Price in effect immediately prior thereto shall be adjusted so that a holder of any shares of Preferred Stock thereafter converted shall be entitled to receive the number and kind of shares of Common Stock or other securities that such holder of Preferred Stock would have owned or been entitled to receive after the happening of any of the events described above had such shares of Preferred Stock been converted immediately prior to the happening of such event or any record date with respect thereto. An adjustment made pursuant to this Section 3(f)(i) shall become effective on the date of the dividend payment, subdivision, combination or issuance retroactive to the record date with respect thereto, if any, for such event. Such adjustment shall be made successively.

(ii) If the Company shall issue any shares of Common Stock, or any rights, options, warrants or convertible or exchangeable securities containing the right to subscribe for or purchase shares of Common Stock (including any distribution of Rights, whether or not currently outstanding, upon the occurrence of any Distribution Date (as defined in the Rights Agreement)), at a price per share that is lower than the then current market price per share of Common Stock (as defined in Section 3(f)(v) below), the Conversion Price shall be adjusted in accordance with the following formula:

( N x P )
AC = C x O + ( M )
O + N
where
AC = the adjusted Conversion Price
C = the current Conversion Price
O = the number of shares of Common Stock outstanding on the
record date
N = the number of additional shares of Common Stock offered
P = the offering price per share of the additional shares
M = the current market price per share of Common Stock on the
record date

(Yeah, this formula won’t paste cleanly, but you get the picture)
************

That’s the “certain events” language. Clear as day. Now, are you finally willing to admit that this is NOT a floorless convertible? Because that seems to be the real point of your entire discussion on this issue thus far.

Like you, I think CFC is in deep trouble and that its stock is going down. (Although I have no position in the stock and never will.) But I’m not going to try to convince myself of things that just aren’t true (e.g., this is a floorless convertible) in order to convince my brain that I’m right. I’d prefer to stick to the facts.

[davidt1]

Davelj,

you don’t like this stock or stocks in general? I am just curious.

[capeman]

Alright, now I am understanding you. You are emphatically stating the deal is not floorless on the basis of conversion. I think we had a miscommunication there.

My point on this and a big reason I am shorting what is the effect of never converting the preferred shares into common stock. What if there is a case of liquidation at a value of 1/4 to 1/2 of current market cap? At that point preferred shares command payment first in the event of a liquidation and without the conversion they get dibs on the first $2B in assets. At a common share price giving a market cap of $4B BAC would effectively receive 1/2 of CFCs assets in a liquidation. At $8B (optimistic in BK) they would receive 1/4 of CFCs assets. The effective ownership of the company is moot since CFC is now a carcass and BAC has preferred. The common shareholders get bent over and paid next to nothing while BAC gets the heart.

[IONEGARM]

The reason CFC cant access the borrowing window is the collateral they have is part of the mortgage company and not part of the bank (the bank has access to the borrowing window, the mortgage company has the collateral). They cant just transfer the collateral between the two entities due to various regulations.

[davelj]

davidt1… I don’t much like stocks, in general, right now. And I certainly don’t like CFC very much. But, in full disclosure, even if stocks fell 30% I probably wouldn’t pay much attention (although my interest might get piqued a little bit) as my business is private equity. I prefer to take control positions (co-investing with others) in small, illiquid, private ventures. The risk-adjusted returns on publicly-traded stocks, in aggregate, are not very attractive to me, particularly when you consider that the “control” element is largely absent.

capeman… I confess that I really don’t understand what BAC is doing with this CFC preferred investment. (Or maybe I do understand but I just think they’re nuts.) If they think the company’s going down the tubes and, as a result, are hedging their position, then why bother with the investment at all? There are a lot easier ways to make 7.5% in the lending markets – this deal was a lot of brain damage. Hell, they could make $2 billion worth of high-quality jumbo SFR loans these days and get that yield (or more). No, I think they structured this investment in the manner they did because I think they truly believe that CFC is going to survive this and its stock is going higher (again, I think they’re wrong, but that’s neither here nor there). It’s the only view that makes any sense. If you review the history of preferred shareholders in failed depositories, one thing stands out: they generally lose 100% of their investment. Unless an institution is re-capped, generally everyone – holders of common, preferred, and debt – get completely wiped out and even a few depositors don’t get made whole via the FDIC (due to deposits exceeding the FDIC’s deposit insurance limits). (FYI, where depository “liquidations” are concerned, I can count on one hand the number that have left anything for common or preferred shareholders.) BAC knows this – they’re not that stupid. They must know that if CFC hands the keys to the regulators, their investment is likely to be worthless as preferred or post-conversion common shareholders. Consequently I have to believe that BAC actually thinks CFC’s equity is going to be worth something greater in the future than it is today. Otherwise, again, why bother? I think it’s a bad bet. But, hey, that’s what makes a market. And, anyhow, it could be worse… it could be MY money.

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