Thursday, December 13, 2012

Is Bank of America Too Big To Think?

We know that Bank of America (BAC) is Too Big To Fail (TBTF).  Is BAC also Too Big To Think (TBTT)?

BAC stated this evening that it purchased $136 million worth of MBIA 5.70% notes in the tender offer that it had extended without conditions, and that it had issued a notice of default to MBIA and the trustee for the notes. BAC said it issued the default notice because the adoption of a proposed amendment to remove the cross default provision to MBIA Insurance was in violation of the terms of the indenture. By owning at least 25% of the notes, BAC is entitled to send MBIA its own default notice rather than ask the trustee to do it under the indenture, although of course its ownership position doesn't somehow convert a claim that there is an event of default into an actual event of default.

I posted earlier  here that when BAC extended its tender offer without conditions, BAC might wish to pursue some litigation theory that required it to own notes, or it was rounding up MBIA wampum in anticipation of a possible settlement with MBIA. But if you take at face value that BAC just spent $136 million to buy MBIA notes at a 20% premium to pursue a doomed litigation and corporate strategy, then you definitely think that BAC is TBTT.

While I have not seen BAC's complaint, it is clear to me what BAC's litigation theory is.  BAC is certain to allege that the consents that noteholders issued to MBIA before selling their notes to MBIA are, in substance, consents expressed by MBIA, and MBIA cannot express a consent with respect to notes they have issued that they beneficially own.

Like all indentures, the MBIA 5.7% note indenture states that notes beneficially owned by MBIA and its affiliates are not "outstanding" for purposes of the indenture.  If they are not outstanding, no consent expressed with respect to such notes can be counted towards meeting the majority approval for an amendment.  In essence, an issuer can't oppress its noteholders by buying up notes and then forcing upon them a disadvantageous amendment by virtue of its noteholdings.  I am certain that BAC is alleging that by purchasing notes soon after noteholders expressed a consent to approve the change in the cross default provision, MBIA should be treated as having beneficially owned such notes at the time the consent was expressed, thereby invalidating the consent.

First off, this is a losing litigation strategy.  

These transactions can certainly be orchestrated to conform to these rules of beneficial ownership with respect to "outstanding" notes.  I expect  that MBIA was advised capably to structure the transactions so that MBIA did not acquire notes from consenting noteholders until after consents were expressed.  And while I was not there when MBIA orchestrated these consent-then-sale transactions to see if there were any winks or nods, neither was BAC.  Moreover, we are talking about institutional investors and debt securities, with respect to which an issuer owes the noteholder no fiduciary duty. So this is as close to the wild, wild west as you are likely to see in the securities markets. Whine and go home, and winks and nods, if any, be damned.

But, even if it was a winning litigation strategy, it is a losing corporate strategy.  

So what if BAC invalidates the amendment? The notes that MBIA bought still exist.  Remember that they constitute a majority of the 5.7% notes. Even if BAC wins in court MBIA can simply resell the notes to a friend of the family (maybe even at a discount, if it is a friendly friend), and the friend of the family noteholder can then promptly provide MBIA a new consent with respect to its majority of notes, and ...presto...the amendment has been re-approved.  What can BAC do about this?  It is the proud owner of a minority amount of, BAC can do nothing about this little fix-it maneuver, assuming that BAC could even win on the merits of its litigation theory (which I repeat is weak).

So, go big BAC, no guts no glory, go buy $136 million of notes to make a claim that you need only a single $1,000 note to make, and spend as much as you can knowing that you can't spend enough to own a blocking position to a new amendment once MBIA de-sterilizes the notes that it owns.  One might think there is some advantage to BAC under the indenture in buying 25% of the notes (approximately $$85 million), so that BAC can send an event of default notice to MBIA, rather than ask the trustee to do it, but (i) owning 25% of the notes does not, ipso facto, convert a claim that there is an event of default into proof of an actual event of default, as BAC must still prove its case, and (ii) why would BAC buy an additional $51 million of the notes beyond reaching the 25% threshold, even if it thought reaching the 25% threshold offered some advantage?

I prefer to think that BAC is really buying some MBIA wampum in preparation of an eventual settlement and just giving MBIA a little tsouris (heartache) in the process for good measure, because I don't think BAC is so stupid as to spend $136 million to pursue a doomed strategy.  But perhaps I am wrong and BAC is really TBTT.

NB:  this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice.  Investing is a tough game, and everyone must do and "own" their own work, because you will certainly own your investments.

Disclosure: long MBI.  Follow me on twitter.

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