Countrywide Trust Preferreds: A Better Way to Go

There was a piece on WSJ.com yesterday to the effect that traders believe the transaction by which Bank of America (BAC) (market cap $160 billion) issues roughly $4 billion of its newly issued stock for Countrywide Financial Corp. (CFC) will need to be reworked.

Following is a quote from the article, which can be seen here.

"The Street thinks the deal will have to be re-priced" lower, said Paul J. Miller Jr., an analyst at Friedman, Billings, Ramsey & Co. He has argued since the deal was announced that there is a high risk the price will be renegotiated if the mortgage market continues to worsen and Countrywide losses exceed Bank of America's expectations. The purchase is due to be completed in the third quarter.

I think it is entirely possible that CFC common shareholders will end up with less than the .1822 share of BAC than they are presently offered in the transaction. I do, however, think the transaction will go through. This is why I maintain that for most investors, purchase of the CFC trust preferred shares is, risk reward, a better way to go.

Reference to the CFC preferred shares is made in the merger agreement, available on EDGAR  here. Besides stipulating to the number of shares outstanding, and representing that no commitments exist binding CFC to redeem the preferreds, the shares appear to be destined to become obligations of BAC.

Countrywide Capital 7% Trust Certificates, for example, trade on the NYSE at about 17.5, or 70% of $25 par. Issued as 'trust preferreds', they represent an interest in an equivalent amount of junior, subordinated debentures of the parent company.

The prospectus for the deal is here. WSJ.COM's symbol is (CFC.B). If the deal goes through, they will become BAC securities and will probably be called. As the trust preferred is linked to actual debt of CFC, the only ways of reducing payouts to these holders would be by voluntary exchange offer or bankruptcy.

There are more elegant ways of approaching this balance sheet, long the trust preferred, short the common, hedging off the BAC volatility, but for the moment I will leave it as this:

A much better way of participating in an purchase of CFC is through their trust preferreds.

Disclosure: Author holds CFC trust preferreds

Comments

[luckikaziee:]

Certainly Mr. Eisenberg is correct about the risk being less in the pfd than the common. However, I must point out that the pfd is DEFERRABLE for up to five years w/o causing a default. This is frequently the case in the capital pfds.
IMHO, the real risk is that the deal doesn't get done. Then the pfd goes to 2. At whatever ratio the deal gets done at, the pfd is a winner. But if it doesn't get done (and BoA has lots of wiggle room), it tanks.

2008 Jan 21 12:31 PM

[Critic:]

Luckikaziee -- You are absolutely correct. My point is that if the purchase closes, there is a high degree of certainty as to what the CFC trust preferred is worth. It is possible, however, that the deal closes and either because of a change in the number of BAC shares received, or the price of BAC shares themselves, that even at this price a purchase of CFC common is a losing trade.

2008 Jan 21 03:33 PM

[Christopher...:]

CFC.B is now trading at $6.60 . . . What is going on ???

2008 Oct 01 09:10 PM