The Wall Street Journal-20080128-Countrywide Bonds Stir Angst As BofA Avoids Voicing Support

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Countrywide Bonds Stir Angst As BofA Avoids Voicing Support

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Countrywide Financial Corp. bondholders saw Kenneth D. Lewis as a knight in shining armor when the Bank of America Corp. chairman and chief executive announced a takeover of the mortgage lender.

Now some are having doubts that he will ride to their rescue.

The reason: The largest U.S. bank in stock-market value has given few details about what will happen to about $25 billion in Countrywide bonds as part of the deal. As a result, some bondholders are worried that Bank of America will structure the agreement so that it doesn't fully back the mortgage lender's debt obligations. If that happens, Countrywide's debt may not rise in value to levels more in line with Bank of America bonds.

"For somebody who holds Countrywide debt, you would love to see Bank of America assume all of the obligations of Countrywide," said Sean Jones, managing director of Egan-Jones Ratings Co., an independent credit-rating firm. "But it's not clear that this is going to happen."

Terms of the deal are crystal-clear for Countrywide shareholders. They get 0.1822 Bank of America share for each Countrywide share, valuing the Calabasas, Calif., company at about $4.2 billion, or $7.19 a share, based on Bank of America's stock price of $39.48 in 4 p.m. New York Stock Exchange composite trading Friday. That, of course, is if the deal goes through, and worries about that explain why Countrywide stock closed at $6.02 a share Friday.

Bondholders are concerned about deal consummation, too. They face the additional mystery of how that debt will be treated after the merger, announced Jan. 11. In a conference call that day, Mr. Lewis deflected questions about how Countrywide's debt obligations would fit into the post-deal capital structure.

The mortgage lender is "a separate legal entity that has had their obligations and we have no incremental obligations around that," he said.

Deal documents filed Jan. 17 outlined a preliminary structure in which Bank of America would merge Countrywide Financial into a new subsidiary called Red Oak Merger Corp. Mergers often involve special vehicles such as this, but bondholders then look for companies to say they will implicitly back the debt -- something Bank of America has so far declined to do.

"It's not uncommon to create a shell company to merge with that first, but in this case it's certainly peculiar when they won't come out on a conference call and answer a question about whether they're going to assume the obligations," said Christopher Whalen, managing director at Institutional Risk Analytics, a banking research firm. "They're creating uncertainty."

Asked about its planned legal structure for the deal, a Bank of America spokesman said Friday it "is premature to discuss this because we've just begun to plan the transition." Bank of America previously said it expects the deal to close sometime early in the third quarter.

Besides worrying that the deal might not close, the fact that Countrywide shares are trading about 20% below the implied deal value also reflects jitters that the transaction price could be renegotiated. One concern is that the mortgage turmoil might have caused far more damage to Countrywide than is currently visible from the outside.

To bondholders, changes in the price of a deal typically don't matter. What counts is that it gets done -- with the new owner committing to back the target company's outstanding debt.

When the Countrywide deal was announced, the cost of insuring against a default at Countrywide plunged. Since then, though, the cost has surged to about $425,000 annually for protection on $10 million of Countrywide bonds from $342,000 the day the merger was announced, according to data provider Markit.

The increase is "abnormal," said Matthew Burnell, a bank-credit analyst at Wachovia Capital Markets. He attributes the rise to questions triggered by the Jan. 17 filing. "If there's nothing to it, why don't they say something?" he added.

Countrywide is scheduled to report fourth-quarter results tomorrow, but said last week it isn't holding a conference call with analysts and investors, citing the pending takeover.

Bank of America has said it isn't likely to begin integrating Countrywide's operations until 2009 because the Charlotte, N.C., bank first needs to digest Chicago's LaSalle Bank, which was acquired for $21 billion last year. To skeptics, this is another sign that Bank of America wants to distance itself from any lurking problems.

Other investors expect Bank of America to quickly provide new funding to Countrywide to help lower its costs and improve profits, even if the lender's operations aren't absorbed until later. Such a move might inspire enough confidence in the market to be seen as an "implicit" guarantee of Countrywide's debt.

"In my heart of hearts, I fully expect this deal to go through," said Kevin Murphy, fund manager at Putnam Investments, which holds Countrywide debt. Craig Emrick, a bank analyst at Moody's Investors Service, said the ratings firm is waiting to see the deal's final legal structure before "seeing if it raises any concern."

Mr. Emrick added that in recent days, "I've got a lot of calls about the structure of the deal." Until that is cleared up, bondholders are likely to remain on edge, and the value of Countrywide's debt could stay under pressure.