Take Me Out to the Ball Game

Market participants, including myself, were thrown a few curveballs today. However, none were game changers.

The first curveball came from Bank of America. A day after stating that they would (for now) offer a preferred for equity swap to holders of private shares, the bank began proceedings to offer exchanges to holders of certain non-cumulative, publicly-traded $25-par preferred stocks. The exchange is not as straightforward as that of Citi. Bank of America is assigning different consideration prices for specific preferreds. The exchange ratio (how many common shares one receives for each preferred share) will be calculated by dividing the consideration price by the five day volume-weighted average trading price up to and including 6/22/09. BAC see is using a waterfall approach. The company will take shares voluntarily offered for exchange from the first preferred on the schedule. If BAC needs more shares converted it will take shares voluntarily exchanged from the next preferred on the schedule, etc. BAC will not suspend any dividends. Please not this is not official. BAC still has to file the exchange with the SEC (which is currently in process) and the SEC has to give BAC the go ahead. Here the the waterfall schedule and consideration prices courtesy of BAC:


1 060505815 Floating Rate Non-Cumulative BAC PrE $16.25
Preferred Stock, Series E

2 060505583 Floating Rate Non-Cumulative BML PrL $16.25 Preferred Stock, Series 5

3 060505633 Floating Rate Non-Cumulative BML PrG $15.00
Preferred Stock, Series 1

4 060505625 Floating Rate Non-Cumulative BML PrH $15.00
Preferred Stock, Series 2

5 060505617 6.375% Non-Cumulative BML PrI $17.00
Preferred Stock, Series 3

6 060505740 6.625% Non-Cumulative BAC PrI $17.50
Preferred Stock, Series I

7 060505724 7.25% Non-Cumulative BAC PrJ $18.75
Preferred Stock, Series J

8 060505765 8.20% Non-Cumulative BAC PrH $20.50
Preferred Stock, Series H

9 060505559 8.625% Non-Cumulative BML PrQ $21.00
Preferred Stock, Series 8


Other banks were in offering exchanges. Here is the info I have thus far:

KeyCorp (exchange details not known):

KEYprA 5.875% Trust
KEYprB 6.125% Trust
KEYprD 7.00% Enhanced-Trust
KEYprE 6.75% Enhanced-Trust
KEYprF 8.00% Enhanced-Trust

Regions:

Regions has announced the beginning of its plan to raise the $2.5 billion equity to satisfy the government's recent stress test. Regions Financial may target the Regions 8.875% RFprZ $25-par preferred.

Fifth Third:

Fifth Third is targeting their convertible issues to raise the necessary $1.1 billion it has committed to raise as the result of their stress test. FTB IS NOT targeting $25 par retail targeted Fifth Third issues (FTBprA, FTBprB & FTBprC) outstanding which are all enhanced trust preferreds.

The other curvball (or at least a breaking ball) came from GM bondholders. The so-called steering committee of GM bondholders have tentatively agreed to revised equity compensation WITHIN the confines of a bankruptcy filing. CNBC (the fountain of misinformation) initially reported that bondholders agreed to a revised debt for equity exchange. This is not the case. Bondholders were going to accept a minority ownership stake in GM AND give up their ability to collect on CDS contracts which would pay them par on the number of bonds which default protection was purchased.

Of course, retail investors were unable to protect themselves with CDS contracts. This is the "screwing" of retail I mentioned yesterday. The post was sweetened a bit. In addition to the original 10% equity stake in GM, bondholders will also receive warrants which enable them to purchase additional shares of GM at a later date. This could give bondholders another 15% ownership stake in GM.

If bankruptcy is inevitable, why sweeten the pot and seek bondholder approval? The government wants a quick bankruptcy similar to that of Chrysler. If the creditors are all in agreement, little more than a quick review by the courts is necessary to get GM in and out of bankruptcy. Bondholders (all bondholders) have until 5:00 PM EDT on Saturday 5/30/09 to vote yes or no.

A group pf small bondholders who own approximately 20% of the outstanding debt are threatening to vote no, but the majority of bondholders are expected to approve the deal. If the majority of bondholders approve the deal, the proposed compensation will apply to ALL bondholders regardless of how they voted.

GM creditors are crediting the government's willingness to convert more if its debt to equity as a motivator to consider the revised deal. Undoubtedly, the decision to reduce the UAW's ownership stake in GM to 17% from 38%, the extra potential 15% ownership for bondholders and the fact that it will be decided in bankruptcy, allowing many institutional bondholders to receive substantial compensation were also strong motivators.

The exercising of CDS insurance contracts causes an unusual circumstance. Since bondholders will agree on the bankruptcy terms before the filing (usually agreed upon after the filing), many current bondholders will help decide what compensation their CDS counterparties will receive.

Why is this so? When CDS contracts are settled, the seller of protection pays the buyer of protection par for the amount of bonds insured. In exchange, the seller of protection receives the bonds from the buyer and then waits to receive recovery in the bankruptcy. Current institutional GM bondholders appear to be in the catbird seat.

The GM CDS situation workout may be interesting for another reason. There may be more CDS contracts written than outstanding bonds. Traders and speculators often buy and sell CDS without having actual interests in the cash bonds. In that case CDS contacts are settled for cash. Thus, if it is agreed that bondholders will receive 10 cents on the dollar in bankruptcy, the CDS could be settled where the buyer of protection receives 90 cents on the dollar instead of par since there are no bonds to exchange. Buying CDS without owning the bonds is a common and legal way of engineering a naked short.

I am hearing GM bondholder recovery estimates in the 10 cents to 12 cents on the dollar area, in the form of new stock and warrants of course. Current GM shareholders could very well be wiped out.


Stay tuned for more on the GM Saga