May 2 (Bloomberg) — Countrywide Financial Corp.’s credit rating was unexpectedly cut to junk by Standard & Poor’s Corp., which cited doubt about whether Bank of America Corp. will back the home lender’s debt after a pending takeover is completed.
The revision reflects “the new level of uncertainty as to the ultimate legal status of Countrywide’s creditors” after the lender’s sale to Bank of America, Standard & Poor’s said in a statement today. Prices on some of Countrywide’s $97.2 billion in debt tumbled and instruments that protect investors from default posted their biggest jump in almost four months.
S&P made the cut just two days after saying it might raise Countrywide’s ratings. The reversal squelched expectations among bond owners that their holdings would become more secure after Bank of America buys Countrywide, and renewed doubts among analysts about whether the $4 billion stock-swap will be completed at all.
“There’s no way that bondholders come out of this with anything but a severe haircut,” said Christopher Whalen, managing director at Institutional Risk Analytics, a banking research firm in Torrance, California. Bank of America may be trying to compensate for the anticipated cost of lawsuits tied to Countrywide mortgages that have gone sour, he said.
Raising Doubt
Bank of America, the second-largest U.S. bank by assets, agreed in January to buy Countrywide, the largest U.S. mortgage lender. The bank, based in Charlotte, North Carolina, rose 1 percent to $39.79 at 4:15 p.m. in New York Stock Exchange composite trading. Countrywide, based in Calabasas, California, dropped 1.1 percent to $5.98.
Countrywide had run short on cash when the deal was announced and continued to lose money since then, posting an $893 million deficit for the first quarter. That means bondholders may have to go to court if Bank of America refuses to stand behind all of the lender’s debt.
S&P said doubts about Countrywide’s debt were raised by Bank of America in an April 30 regulatory filing that included a passage on whether the bank will honor debt issued by Countrywide. The documents said “there is no assurance that any such debt would be redeemed, assumed or guaranteed,” adding that no decision had been reached.
“Until this filing, it was our understanding that Bank of America would acquire all of Countrywide,” Standard & Poor’s analyst Victoria Wagner wrote today. “This new filing raises the possibility that this assumption is no longer true.”
Debt Prices
Countrywide’s $1 billion of 6.25 percent notes due in 2016 fell 10 cents to 82 cents on the dollar today, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt yields 9.5 percent, or 5.6 percentage points more than similar-maturity Treasuries, Trace data show.
Credit-default swaps tied to Countrywide’s home-lending unit climbed 135 basis points to 290 during the day, according to London-based CMA Datavision. The instruments pay buyers if a company breaks its debt agreements, and a rising price shows investors are more concerned about default.
Countrywide Financial and its home lending unit had their ratings cut to BB+/B from BBB+/A-2. Standard & Poor’s also cut the rating on Countrywide Bank FSB to BBB/A-2 from A-/A2.
Investors have been asking Bank of America about plans to back Countrywide’s debt since January, when the issue was discussed in a conference call to explain the merger. The bank has demurred ever since.
Stock Deal
For equity holders, “the deal will get priced down,” said Paul Miller, an analyst at Friedman Billings Ramsey & Co., said today. He has a “market perform” rating on Countrywide. “A lot of things have changed in the last 30 days. Home prices are still falling very rapidly and Countrywide’s credit costs are getting worse from what we hear.”
Bank of America spokesman Scott Silvestri said earlier today, before the S&P downgrade, that the filing “just means we haven’t made a decision.” He declined to comment on S&P’s action. “We expect the merger to close in the third quarter,” he said. Countrywide officials couldn’t be reached immediately for comment.
Whalen expects a transaction in which Bank of America will absorb the best assets, including Countrywide Bank, while the debt remains with a new company created by the merger, Red Oak Merger Corp. Red Oak may then file for bankruptcy, shielding Bank of America from liability, Whalen said.
Bank of America Chief Executive Officer Kenneth Lewis is a “tough guy and he’s got to protect his shareholders,” Whalen said.
Debt Breakdown
Countrywide debt included $11.5 billion in credit lines at the end of 2007 and $47.7 billion in advances from the Federal Home Loan Bank Board, according to the bank. Bank of America said the credit lines will be paid when the merger is completed, while the advances will remain outstanding.
The remaining debt, about $38.1 billion, would equal about 2.4 percent of the bank’s total liabilities at the end of last year, according to the filing.
To contact the reporter on this story: David Mildenberg in Charlotte at dmildenberg@bloomberg.net
