Countrywide May Be Going Bankrupt

Story first appeared in Bloomberg Law.
Bank of America Corp. (BAC), the lender burdened by its Countrywide Financial Corp. takeover, would consider putting the unit into bankruptcy if litigation losses threaten to cripple the parent, said a Boston Bankruptcy Lawyer.
The option of seeking court protection exists because the Charlotte, North Carolina-based bank maintained a separate legal identity for the subprime lender after the 2008 acquisition, said the people, who declined to be identified because the plans are private. A filing isn’t imminent and executives recognize the danger that it could backfire by casting doubt on the financial strength of the largest U.S. bank, the people said.
The threat of a Countrywide bankruptcy is a nuclear option that Chief Executive Officer Brian T. Moynihan could use as leverage against plaintiffs seeking refunds on bad mortgages. Moynihan has booked at least $30 billion of costs for faulty home loans, most sold by Countrywide during the housing boom, and analysts estimate the total could double in coming years.
If the losses become so great, how can Bank of America at least not discuss internally the relative tradeoff of a Countrywide bankruptcy? And if you pull out the bazooka, you’d better be prepared to use it.
Countrywide Practices
Just before former CEO Kenneth D. Lewis bought Countrywide, it was the biggest mortgage lender in the U.S. with 17 percent of the market and $408 billion of loans originated in 2007, according to industry newsletter Inside Mortgage Finance. Regulators later found its growth was fueled by lax lending standards, with loans marred by false or missing data about borrowers and properties.
Bankruptcy for Countrywide has gained credence with some investors and analysts after Bank of America lost almost half its market value this year. The shares have been whipsawed as the caseload of lawsuits by mortgage bond investors expanded, along with doubts about whether the bank has enough reserves to handle claims.
A Countrywide bankruptcy could halt legal proceedings and consolidate litigation into one court that would split up the subsidiary’s remaining assets for creditors. In effect, this would trade one type of litigation for another. The decision would turn on whether the potential savings of a filing outweigh the risks involved in disavowing some of the firm’s obligations.
What Could Go Wrong
Pitfalls include the possibility that a bankruptcy filing would cast doubt on the entire company’s willingness to support its other subsidiaries and damage Bank of America’s standing in the credit markets or with rating firms, hurting its ability to borrow, according to a Houston Bankruptcy Lawyer.
Moynihan, 51, has been asked publicly about a potential Countrywide bankruptcy at least three times in the past year, most recently this week at a conference in New York. The bank’s mortgage division is his only unprofitable business, reporting a $25.3 billion pretax loss in the first half of this year.
Larry DiRita, a Bank of America spokesman, said he couldn’t comment on whether the company planned to file a Countrywide bankruptcy. The bank took great pains to preserve the separate identity of Countrywide.
Separate Accounting
Those steps include using separate accounting systems and profit-and-loss statements for Countrywide units, according to a report prepared for Bank of New York Mellon Corp. (BK), the trustee for a group of investors who agreed to an $8.5 billion settlement in June with Bank of America over faulty loans.
Bankruptcy makes absolute good sense if they can do that, said an Indianapolis Bankruptcy Lawyer. FHFA sued Bank of America and 16 other banks this month to recover losses on about $200 billion in mortgage-backed securities sold to Fannie Mae and Freddie Mae, the government- backed mortgage firms. Bank of America and its subsidiaries created more than a quarter of those bonds.
Given the size of these lawsuits, the potential liability could exceed the net worth of the subsidiary. They could say the claims far exceed the amount that we have and therefore we need a bankruptcy court to pick and choose between those creditors.
Assets Available
Countrywide has $11 billion in assets that could be depleted through demands to repurchase defective mortgages. After that, Bank of America may not have any obligation to pay claims from Countrywide’s creditors.
Typically, a corporation that acquires another firm’s assets isn’t liable for the seller’s debts, unless the transaction is considered a de facto merger or there was fraud in the takeover.
American International Group Inc. (AIG), the insurer that sued Bank of America last month to recoup more than $10 billion in losses on Countrywide mortgage bonds, argued that the bank is a legal successor to the unit. New York-based AIG cited a series of transactions by Bank of America in 2008 that were structured in such a way as to leave Countrywide unable to satisfy its massive contingent liabilities, according to a Paris Bankruptcy Lawyer.
Just in Case
Plaintiffs in the $8.5 billion settlement handled by BNY Mellon didn’t take any chances. Their agreement specified that Bank of America was responsible for making good on the payment because they were concerned that Countrywide might be thrown into bankruptcy, said Bob Madden, a Gibbs & Bruns LLP partner representing institutional investors that sued the bank.
The chances of a bankruptcy filing rise every time another suit gets put on the pile.
Bankruptcy’s Backlash
Bankruptcy would be a last-ditch option, and possibly a costly one, because counterparties might become hesitant to buy the parent company’s debt or open trading lines with its Merrill Lynch unit. Credit-rating firms could downgrade Bank of America subsidiaries, which benefit from the implicit support of their corporate parent. That would drive up the bank’s cost of borrowing.
Most counterparties think this would be a very difficult option for Bank of America and unlikely to be sanctioned by regulators. The whole reason they would pursue the nuclear option of a Countrywide bankruptcy would be to put this behind them, but all you would be doing is opening up a Pandora’s box.
Outstanding Debt
Countrywide has $6.53 billion of debt outstanding, including $2.81 billion of senior unsecured notes, $2.2 billion of preferred securities and $529 million of mortgage-backed bonds, Bloomberg data and Bank of America figures show. The unit’s $1 billion in 6.25 percent notes have plunged 9.2 cents since Aug. 1 to 97.1 cents on the dollar as of Sept. 13, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority.
Management’s public stance on a potential Countrywide bankruptcy has evolved. In November, responding to a question from Mayo — who had written a report that month entitled “Is a Countrywide Bankruptcy Possible?” — Moynihan said he didn’t see any liability that would make us think differently about working through it in the way we’re working.
Since then, damage from Countrywide has steadily mounted as U.S.-owned Fannie Mae and Freddie Mac step up demands that the bank repurchase soured loans and new suits emerge, including from AIG and the FHFA. Further, New York Attorney General Eric Schneiderman is seeking to scuttle the $8.5 billion deal, which may result in greater mortgage costs, according to a Wilmington Bankruptcy Lawyer.
Last month, when Moynihan was asked during a conference call held by fund manager and bank shareholder Bruce Berkowitz if a Chapter 11 restructuring would be a viable solution for Countrywide, the CEO declined to say what he’d do.