Well the first days are the hardest days, Don't you worry any more,
'Cause when life looks like easy Street, there is danger at your door...
- "Uncle John's Band", The Grateful Dead
We returned from the Maine woods Monday night. The fishing was tremendous as was the group led by David Kotok of Cumberland Advisers. Steve Leisman, Senior Economics correspondent for CNBC, played every Grateful Dead song he knew - a considerable list - and found time to catch some fish too.
By the way, look for The IRA on CNBC "Squawk Box" tomorrow around 8:45AM ET to talk about bank capital adequacy.
During the annual prognostication and side-wager event following dinner on day two of the trip to Leen's Lodge, a lot of bearish sentiment was expressed about the US economy. We put down some markers of our own - including a prediction about the number of US banks likely to fail by the year ended July 2009 (110) and total assets of said failed banks ($800 billion).
Now 110 bank failures may seem like too few institutions to generate such a large failed bank asset number, but throw a few large small mouth bass and a giant lake trout into the mix and reaching that amount is not hard. We'll let you guess the names of those big fish. Based on our work, four buckets seem to be visible: 1) large banks, 2) large regional banks, 3) specialized institutions and 4) community banks.
The largest portion of the assets at risk are, of course, concentrated among the top 100 banks by assets, but the largest portion of the growing angst in the public mind is focused on the smaller institutions. Over the past week, visitors to our web site have looked up nearly 1,000 institutions - but almost all of them outside the top 100 institutions. This represents a major change from patterns we've observed in previous periods when larger, publicly traded institutions predominated in search requests.
We have seen a dramatic increase in the number of retail calls from individuals and investment advisers about individual banks. Thus next week we are launching a facility to allow users to subscribe to a single bank or multiple bank profiles at $50 per name for a year at a time, allowing them to follow the progress of one or more institutions over four quarters.
We'll talk more about bank safety and soundness when we launch the IRA Bank Cart on Monday.
BNY Mellon Sues Bank America
Even though Leen's Lodge is about 200 miles Northeast of Bangor, we got the Blackberry to work well enough to receive an important missive from one of our colleagues at Bloomberg News, "BNY Mellon Sues Countrywide Over $2 Billion in Notes." As you know, we've been pondering the possibility of a bankruptcy for Countrywide Financial and now that horrific prospect seems to be in view.
"BNY Mellon is seeking a judicial declaration that Countrywide has defaulted on its obligations under the terms of the indenture. The company is also asking a judge to order Countrywide to immediately purchase the notes surrendered in cash equal to 100 percent of the principal amount plus accrued and unpaid interest," Bloomberg News reports.
It seems that BNY Mellon (NYSE:BK), acting as trustee for Countrywide bond holders, has finally taken notice of the adversarial position taken by Bank of America (NYSE:BAC) with respect to the liabilities of the company formerly known as Countrywide Financial Inc. (NYSE:CFC). It is remarkable but not surprising that it took this long for BK to recognize BAC's threatened default and to finally act in its role as fiduciary, but now that it has acted the other creditors of Countrywide, which is now a direct subsidiary of BAC, cannot remain indifferent.
As we reported earlier ("Time for Hank Paulson to Do the Right Thing and Nationalize the GSEs"), when BAC closed the Countrywide transaction, it acquired the $1.5 trillion loan servicing portfolio and other odds and ends, and overpaid for same in the view of some observers, making a claw back by a possible bankruptcy proceeding unlikely. But as of this writing, the $110 billion asset bank unit has not yet been moved out from the Countrywide Financial unit of BAC to another holding company. BAC officials did not respond to email and telephone questions regarding same.
Given the legal filing by BK, it is not impossible that another creditor of Countrywide will decide to file a claim or even an involuntary bankruptcy petition to protect their rights. As more legal claims are filed, a judge may even take notice of the diversity of claimants and suggest bankruptcy as a practical alternative. In the event, the FDIC and other regulators may be faced with the very situation they have tried to avoid via the marriage of BAC and Countrywide, namely the failure of a large depository.
The current situation is unchartered territory to put it mildly. Most of the lawyers and banking experts contacted by The IRA could never recall a situation where the parent of an insured depository institution was made subject to the authority of the bankruptcy court. Indeed, it appears that were a creditor of Countrywide to file an involuntary bankruptcy petition, the FDIC might be forced to intervene as receiver and take control of the bank unit. If a creditor, possibly even including BK, were to file an involuntary petition against Countrywide, BAC could stand to lose the book value of the investment in the bank subsidiary, roughly $7 billion at the end of March 2008.
"Typically the bond holders do not have an incentive to come together to create the demise of an issuer, but this situation is doing just that," says Joseph Mason, Professor of Finance at Louisiana State University. "The FDIC wanted to avoid a large bank resolution early in the credit crisis, but the legal lose ends in the Countrywide situation may cause precisely that result."
But another scenario suggested to The IRA by a veteran banking attorney is that the regulators (and even BAC) might be content to administer the run off of the Countrywide Bank FSB unit under the bankruptcy estate of Countrywide Financial, at least so long as the bank was profitable and contributing to the repayment of creditors. The 1989 failure of MCorp, which was forced into bankruptcy by creditors and successfully litigated against regulators for years, is suggested as a possible model for a managed Countrywide bankruptcy. While the OCC declared 14 of MCorp's subsidiary banks to be insolvent and these were taken over by the FDIC, five banks with $3.2 billion in assets remained open through the bankruptcy.
The possible issues and permutations of such scenarios are too numerous to address here, but suffice to say that the cross-guarantee provisions alone between insured depository institutions within the BAC group could create a legal nightmare if this situation does end up in a bankruptcy litigation. What will be the position of the Office of Thrift Supervision and the FDIC in the event? Just remember that we're making this up as we go along. And please do stay tuned.