Bank of America Preferred CFC B Pref W
October 13, 2008 - 12:25am EST by
brook1001
2008 2009
Price: 12.20 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 104,705 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Attractive arb opportunity between two series of Bank of America preferred stock.  36% return over one year on a 100%-hedged, unlevered basis by going long a senior security and short a junior security.  The senior security is a Countrywide (CFC) preferred.  On Tuesday Bank of America (BAC) announced that it would be “assuming” all Countrywide debt and preferred, which means that the Countrywide securities will become obligations of Bank of America’s holding company.  Bank of America has held Countrywide in a merger sub since its acquisition closed on July 1, fostering speculation that it might eventually orphan the sub.  Bank of America has not offered a time frame for officially assuming the preferred.  The main risk is that Bank of America reverses this decision which I view as unlikely for reasons listed below.

 

The trade is long four shares Countrywide B preferred (7% coupon, $25 face) and short one share Bank of America 8% preferred ($100 face).  The CFC B preferred has a 15% yield to maturity at the current price of $12.20 and the BAC 8% has a 11% yield to maturity at its current price of $75.  The CFC B pref is senior to the BAC 8% because it is technically junior sub debt while the BAC 8% is regular preferred.  The CFC B preferred pays cumulative dividends while the BAC 8% dividends are non-cumulative. This means that if BAC stops dividends on the 8% preferred for a time it does not have to pay the skipped dividends.  If you assume both preferreds trade to an 11% yield to maturity over one year you make 36% (measured as a % of the long $’s invested).  If the government takes BAC over tomorrow and the prefs get wiped out, you make 54%.  I have laid out some return scenarios below. 

 

BAC is unlikely to reverse its decision to assume CFC debt/preferred because: (i) BAC is a huge debt issuer and needs credibility, (ii) CFC is making BAC money – contributing 6 cents to the 15 cent eps BAC reported in Q3 – because BAC already wrote down most of CFC loans through purchase accounting, (iii) CFC just settled lawsuits with a group of state AG’s so much of the litigation risk is gone, and (iv) under the Fed’s “doctrine of strength” rule a parent bank is responsible for supporting a subsidiary bank: CFC has a large bank subsidiary that BAC is obliged to support.

Long CFC B/Short BAC 8% Disaster Down Base Up
 Long 4 CFC B Shares           (49)            (5)           25           49
 Short 1 BAC 8% Share            75           26            (9)          (37)
 1.25% Rebate on BAC Share              -             1             1             1
 P&L            26           22           18           13
% return on CFC B Shares 54% 45% 36% 26%
CFC 7.00% Pref B          
      Disaster Down Base Up
Yield to Maturity Target 20.00% 11.00% 8.00%
Implied Price in 1 Year - 9.18 16.75 22.60
1 Year of Coupon - 1.75 1.75 1.75
Current Price (12.20) (12.20) (12.20) (12.20)
P/L $     (12.20) (1.28) 6.30 12.15
P/L %     (100%) (10%) 52% 100%
BAC 8% Preferred          
      Down Down Base Up
Yield to Maturity Target 20.00% 11.00% 8.00%
Implied Price in 1 Year - 40.86 75.50 103.72
1 Year of Coupon - 8.00 8.00 8.00
Current Price (75.00) (75.00) (75.00) (75.00)
P/L $     (75.00) (26.14) 8.50 36.72
P/L %     (100%) (35%) 11% 49%

Catalyst

The price disconnect needs to get noticed.
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    Description

    Attractive arb opportunity between two series of Bank of America preferred stock.  36% return over one year on a 100%-hedged, unlevered basis by going long a senior security and short a junior security.  The senior security is a Countrywide (CFC) preferred.  On Tuesday Bank of America (BAC) announced that it would be “assuming” all Countrywide debt and preferred, which means that the Countrywide securities will become obligations of Bank of America’s holding company.  Bank of America has held Countrywide in a merger sub since its acquisition closed on July 1, fostering speculation that it might eventually orphan the sub.  Bank of America has not offered a time frame for officially assuming the preferred.  The main risk is that Bank of America reverses this decision which I view as unlikely for reasons listed below.

     

    The trade is long four shares Countrywide B preferred (7% coupon, $25 face) and short one share Bank of America 8% preferred ($100 face).  The CFC B preferred has a 15% yield to maturity at the current price of $12.20 and the BAC 8% has a 11% yield to maturity at its current price of $75.  The CFC B pref is senior to the BAC 8% because it is technically junior sub debt while the BAC 8% is regular preferred.  The CFC B preferred pays cumulative dividends while the BAC 8% dividends are non-cumulative. This means that if BAC stops dividends on the 8% preferred for a time it does not have to pay the skipped dividends.  If you assume both preferreds trade to an 11% yield to maturity over one year you make 36% (measured as a % of the long $’s invested).  If the government takes BAC over tomorrow and the prefs get wiped out, you make 54%.  I have laid out some return scenarios below. 

     

    BAC is unlikely to reverse its decision to assume CFC debt/preferred because: (i) BAC is a huge debt issuer and needs credibility, (ii) CFC is making BAC money – contributing 6 cents to the 15 cent eps BAC reported in Q3 – because BAC already wrote down most of CFC loans through purchase accounting, (iii) CFC just settled lawsuits with a group of state AG’s so much of the litigation risk is gone, and (iv) under the Fed’s “doctrine of strength” rule a parent bank is responsible for supporting a subsidiary bank: CFC has a large bank subsidiary that BAC is obliged to support.

    Long CFC B/Short BAC 8% Disaster Down Base Up
     Long 4 CFC B Shares           (49)            (5)           25           49
     Short 1 BAC 8% Share            75           26            (9)          (37)
     1.25% Rebate on BAC Share              -             1             1             1
     P&L            26           22           18           13
    % return on CFC B Shares 54% 45% 36% 26%
    CFC 7.00% Pref B          
          Disaster Down Base Up
    Yield to Maturity Target 20.00% 11.00% 8.00%
    Implied Price in 1 Year - 9.18 16.75 22.60
    1 Year of Coupon - 1.75 1.75 1.75
    Current Price (12.20) (12.20) (12.20) (12.20)
    P/L $     (12.20) (1.28) 6.30 12.15
    P/L %     (100%) (10%) 52% 100%
    BAC 8% Preferred          
          Down Down Base Up
    Yield to Maturity Target 20.00% 11.00% 8.00%
    Implied Price in 1 Year - 40.86 75.50 103.72
    1 Year of Coupon - 8.00 8.00 8.00
    Current Price (75.00) (75.00) (75.00) (75.00)
    P/L $     (75.00) (26.14) 8.50 36.72
    P/L %     (100%) (35%) 11% 49%

    Catalyst

    The price disconnect needs to get noticed.

    Messages


    SubjectNew Writeup
    Entry10/13/2008 12:26 AM
    Memberbrook1001
    Description:

    Attractive arb opportunity between two series of Bank of America preferred stock.  36% return over one year on a 100%-hedged, unlevered basis by going long a senior security and short a junior security.  The senior security is a Countrywide (CFC) preferred.  On Tuesday Bank of America (BAC) announced that it would be “assuming” all Countrywide debt and preferred, which means that the Countrywide securities will become obligations of Bank of America’s holding company.  Bank of America has held Countrywide in a merger sub since its acquisition closed on July 1, fostering speculation that it might eventually orphan the sub.  Bank of America has not offered a time frame for officially assuming the preferred.  The main risk is that Bank of America reverses this decision which I view as unlikely for reasons listed below.

     

    The trade is long four shares Countrywide B preferred (7% coupon, $25 face) and short one share Bank of America 8% preferred ($100 face).  The CFC B preferred has a 15% yield to maturity at the current price of $12.20 and the BAC 8% has a 11% yield to maturity at its current price of $75.  The CFC B pref is senior to the BAC 8% because it is technically junior sub debt while the BAC 8% is regular preferred.  The CFC B preferred pays cumulative dividends while the BAC 8% dividends are non-cumulative. This means that if BAC stops dividends on the 8% preferred for a time it does not have to pay the skipped dividends.  If you assume both preferreds trade to an 11% yield to maturity over one year you make 36% (measured as a % of the long $’s invested).  If the government takes BAC over tomorrow and the prefs get wiped out, you make 54%.  I have laid out some return scenarios below. 

     

    BAC is unlikely to reverse its decision to assume CFC debt/preferred because: (i) BAC is a huge debt issuer and needs credibility, (ii) CFC is making BAC money – contributing 6 cents to the 15 cent eps BAC reported in Q3 – because BAC already wrote down most of CFC loans through purchase accounting, (iii) CFC just settled lawsuits with a group of state AG’s so much of the litigation risk is gone, and (iv) under the Fed’s “doctrine of strength” rule a parent bank is responsible for supporting a subsidiary bank: CFC has a large bank subsidiary that BAC is obliged to support.

    Long CFC B/Short BAC 8% Disaster Down Base Up
     Long 4 CFC B Shares           (49)            (5)           25           49

    SubjectBAC Preferred
    Entry10/13/2008 06:43 PM
    Memberdavid101
    Brook,

    What is the symbol on the BAC preferred? I am not finding anything matching your 8% coupon and $100 par.

    Thanks in advance.

    David

    SubjectRE: BAC Preferred
    Entry10/13/2008 06:56 PM
    Memberbrook1001
    Not listed on an exchange. Cusip is 060505DR2. On Bloomberg: BAC 8%

    SubjectRE: RE: BAC Preferred
    Entry10/13/2008 06:57 PM
    Memberbrook1001
    that got cut off... on Bloomberg it is BAC 8% Corp Go.

    SubjectRE: RE: RE: BAC Preferred
    Entry10/14/2008 12:49 PM
    Membervarna10
    Thank you Brook - does the trade work with another security say the BAC 8.2% preferred security with 25 par - anything specific about the 8% preferred. Also it appears that the issuer may defer payments on the CFC preferred for up to 5 years - what are the conditions for that?

    SubjectRE: RE: RE: RE: BAC Preferred
    Entry10/14/2008 02:23 PM
    Memberbrook1001
    It does work with the BAC 8.2% which, like the 8%, is non cumulative and is regular preferred meaning it is junior to the CFC B. If they stop dividends on the CFC B they have to stop dividends on everything junior to it. And, if they stop dividends they have to pay you the accrued, but unpaid, dividends on the CFC B while they do not have to pay the same for the BAC 8% or 8.2%. So the arb works if the stop dividends. I think they can just stop dividends if they want, but they would have to stop dividends on the common too which they don't want to do.

    Subjectcatalyst
    Entry10/15/2008 04:49 PM
    Membervarna10
    thank you for your response. are there any other catalysts to closing this gap other than market becoming rational

    SubjectRE: catalyst
    Entry10/15/2008 06:38 PM
    Memberbrook1001
    It should help when BAC officially assumes the debt, for which there is no specific time frame. Other than that unfortunately there are no catalysts.

    SubjectRE: RE: catalyst
    Entry10/16/2008 03:50 PM
    Membersparky371
    There's a time frame now..... : )

    Countrywide to Voluntarily Delist, Deregister Securities
    2008-10-16 19:11:51.550 GMT

    Countrywide to Voluntarily Delist, Deregister Securities

    Bank of America to Relist Securities

    PR Newswire

    CHARLOTTE, N.C., Oct. 16

    CHARLOTTE, N.C., Oct. 16 /PRNewswire/ -- Bank of America announced today
    its wholly-owned subsidiaries, Countrywide Financial Corporation and
    Countrywide Home Loans, Inc., together with Countrywide Capital IV and
    Countrywide Capital V, have notified the New York Stock Exchange of their
    intention to voluntarily delist certain securities.

    (Logo: http://www.newscom.com/cgi-bin/prnh/20050720/CLW086LOGO-b )

    Those securities are the Countrywide Capital IV 6.75 percent Trust
    Preferred Securities (NYSE: CFCPRA) and the related guarantees of
    Countrywide Financial Corporation and Countrywide Home Loans, Inc., and
    the Countrywide Capital V 7 percent Capital Securities (NYSE: CFCPRB) and
    the related guarantees of Countrywide Financial Corporation.

    Following the delisting, the Countrywide issuers intend to withdraw the
    securities from registration with the Securities and Exchange Commission
    and Countrywide intends to suspend its reporting obligations under the
    Securities Exchange Act of 1934.

    The Countrywide issuers intend to withdraw the trust preferred securities
    and related Countrywide guarantees from listing and deregistration in
    connection with the previously announced intention of Bank of America to
    assume the obligations of Countrywide Financial Corporation and
    Countrywide Home Loans, Inc. under their debt securities and related
    guarantees, including these Countrywide guarantees, as part of the
    consideration for the transfer of substantially all of the assets and
    operations of Countrywide Financial Corporation and Countrywide Home
    Loans, Inc. to other subsidiaries of Bank of America.

    Separately, Bank of America intends to apply to the New York Stock
    Exchange for the listing of the trust preferred securities and related
    Bank of America guarantees following the assumption once in effect.

    The Countrywide issuers will file Form(s) 25 with the SEC on or about
    October 27, 2008 and expect the delisting to become effective and
    Countrywide's reporting obligations to be suspended 10 days after the
    filing. Bank of America expects the sale of Countrywide assets and the
    related assumption of Countrywide debt securities and related guarantees
    to occur around November 7, 2008, subject to receipt of necessary
    approvals and negotiation of appropriate agreements.

    SubjectRE: RE: catalyst
    Entry10/16/2008 03:50 PM
    Membersparky371
    There's a time frame now..... : )

    Countrywide to Voluntarily Delist, Deregister Securities
    2008-10-16 19:11:51.550 GMT

    Countrywide to Voluntarily Delist, Deregister Securities

    Bank of America to Relist Securities

    PR Newswire

    CHARLOTTE, N.C., Oct. 16

    CHARLOTTE, N.C., Oct. 16 /PRNewswire/ -- Bank of America announced today
    its wholly-owned subsidiaries, Countrywide Financial Corporation and
    Countrywide Home Loans, Inc., together with Countrywide Capital IV and
    Countrywide Capital V, have notified the New York Stock Exchange of their
    intention to voluntarily delist certain securities.

    (Logo: http://www.newscom.com/cgi-bin/prnh/20050720/CLW086LOGO-b )

    Those securities are the Countrywide Capital IV 6.75 percent Trust
    Preferred Securities (NYSE: CFCPRA) and the related guarantees of
    Countrywide Financial Corporation and Countrywide Home Loans, Inc., and
    the Countrywide Capital V 7 percent Capital Securities (NYSE: CFCPRB) and
    the related guarantees of Countrywide Financial Corporation.

    Following the delisting, the Countrywide issuers intend to withdraw the
    securities from registration with the Securities and Exchange Commission
    and Countrywide intends to suspend its reporting obligations under the
    Securities Exchange Act of 1934.

    The Countrywide issuers intend to withdraw the trust preferred securities
    and related Countrywide guarantees from listing and deregistration in
    connection with the previously announced intention of Bank of America to
    assume the obligations of Countrywide Financial Corporation and
    Countrywide Home Loans, Inc. under their debt securities and related
    guarantees, including these Countrywide guarantees, as part of the
    consideration for the transfer of substantially all of the assets and
    operations of Countrywide Financial Corporation and Countrywide Home
    Loans, Inc. to other subsidiaries of Bank of America.

    Separately, Bank of America intends to apply to the New York Stock
    Exchange for the listing of the trust preferred securities and related
    Bank of America guarantees following the assumption once in effect.

    The Countrywide issuers will file Form(s) 25 with the SEC on or about
    October 27, 2008 and expect the delisting to become effective and
    Countrywide's reporting obligations to be suspended 10 days after the
    filing. Bank of America expects the sale of Countrywide assets and the
    related assumption of Countrywide debt securities and related guarantees
    to occur around November 7, 2008, subject to receipt of necessary
    approvals and negotiation of appropriate agreements.

    SubjectRE: capital structure
    Entry10/21/2008 04:52 PM
    Memberbrook1001
    I don't think I have a satisfactory answer. They are obviously junior sub per their indenture but it is not totally where they rank within the BAC complex. They are senior to the BAC pref I wrote up and they are senior to the government pref. I tried to figure out where they rank relative to the MBNA preferred but could not do it. Are you trying to figure out where they rank relative to a particular security?
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