The Wall Street Journal published an article today discussing invstors' concerns that Bank of America may not back Countrywide bonds as they do there own when and if the deal closes in the third quarter of 2008. To those concerns I say, duh!!!
Investors should never assume that an acquiring company will guarantee the debt of what is now a new subsidiary or business unit. It is not uncommon for different units of a conglomerate to be responsible for their own debt without cross default protection with the parent or other divisions. This is how most utilties are arranged. The local operating subsidiary issues bonds and is only responsible for its own bonds. It does not back the parent's or other subs' bonds. Also, the parent is only responsible for its own bonds.
Here is a shocker for some of you. Bonds issued by local operating subs are, in most cases, more secure than those issued by the parents. Local operating subs of utioities actually generate cashflow and own the equipment. Utility parents are merely shells which earn money from internal dividends paid to the parent by the operating subs. The subs pay their own exenses before giving a dime to the parent.
Similar situations exist on financials. Ford does not guarantee Ford Motor Credit bonds and vice versa. GM and GMAC had a similar arrangement before the 51% sale to Cerberus. The situation between GMAC and Rescap does not involve any cross default protections. If Rescap's situation worsens, GMAC is not responsible for Rescap bonds.
I say all of this not to frighten CFC bondholders, but to manage their expectations. CFC will be in much better shape when the deal with BAC closes. CFC bonds will be more secure. However, though more secure, they may not be obligations of BAC. Investors should decide for themselves if they need BAC to guarantee CFC bonds and preferreds or is an improved CFC provides enough comfort for their needs.
3 comments:
"It is not uncommon for different units of a conglomerate to be responsible for their own debt without cross default protection with the parent or other divisions.... If Rescap's situation worsens, GMAC is not responsible for Rescap bonds."
Strange and interesting. Do such arrangements hold up in court? That is, when a parent protects itself from default of its subsidiaries' bonds, can the bondholders typically succeed if they sue the parent? And why wouldn't ResCap have protected itself this way against the debt of its subprime subsidiary, RFC?
Yes, they do hold up in court. Not so strange. Each division is an independent subsidiary. Think of it as being like the U.S. itself. If New York defaulted on its debt, the U.S. Government is not ob;igated to make good, neither are the other states.
There is a recent example of this. Following Hurricane Katrina, Entergy New Orleans filed for Chapter XI protection. Mo other parts of Entergy were affected.
As for Rescap, this was a case of bad risk management Rescap and Wamu jumped into subprime heavily in 2006, a time when many subprime players were jumping out. RFC is not a subsidiary, but a program within Rescap.
Can bondholders sue? Sure. Will theywin? depends on teh judge, but there must be something to this or companies wouldn't structure this way. GM was concerned that, if it filed for Ch. XI GM bondholders would file lawsuits to go after GMAC assets. Since GM was in no position to engage in such a battle and needed cash, it sold 51% of GMAC Cerberus.
Let all the uncertainty around this continue. I'm no merger arb guy, but I'm paying a lot of bills day trading CFC. Back to your point, the bondholders can sue, but they won't because they know that whatever they get out of BAC, it's more than they will get from a stand alone CFC. After all, this isn't Indonesia and CFC isn't Asia Pulp and Paper, which is still going on.
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