>> They probably shorted the bloody daylights out of CFC common as a hedge... This is a very common configuration for bondholders in a company.
I get the advantages of this strategy if the shorted company goes bankrupt or its common stock significantly declines in value.
But what happens if it goes the other way... if the bondholder’s investment turns the other company around? When & how do they cover the short?
7.5% interest on the investment. Countrywide is going under. Too much overhead and too little business. The CEO has been exercising his stock options and selling them a few days later more than two times per week, so he's not very confident. Look for CFC to go bankrupt and for BoA to buy the assets they want at the BK auction.
“I get the advantages of this strategy [long pfd, short common] if the shorted company goes bankrupt or its common stock significantly declines in value.
But what happens if it goes the other way... if the bondholder’s investment turns the other company around? When & how do they cover the short?
***Well, first of all, I’m of course not privy to the internal memos approving the deal. But to answer your Q to the best of my speculative understanding: they (BAC) can just buy back the short common, they don’t have to sit back and watch it rise. When they short the stock, they actually receive the proceeds from the sale in cash. (You and I would not necessarily receive the same benefit unless we were “infinitely” funded, as is BAC; BAC is not especially limited in the amount of funds they have to throw at things that make sense for them to do. Certainly BAC has a large stock trading desk (that’s a fact) with savvy traders. They know darn well that on news of the announcement, CFC will ramp. They short on that rise. If you’ll recall, the announcement (that BAC would buy the $2 bil of pfd) came out after hours. Personally, I thot it was a surprise rate cut to see CFC pump $4! Anyway, a sharp trader would realize that the ramp had occurred on very slim volume. Blam, start developing a large short position. Buy CFC puts. Sell CFC calls, go hog wild. The $2 bil pfd at nominal $25/sh is 100 MM shs of $20 common, I’m not suggesting BAC shorts 100MM shs all on one day. But their traders can flip in and out of CFC common 10 and 20 and 50K shs a day and make huge cash, all pretty much hedged.
Point being, IMO, the preferred buy is a cash infusion that pays interest. The shorting of the stock yields cash and is a hedge against a BK on CFC’s part. Should things get worse for CFC, BAC ends up owning “it” or whatever parts of it it’d like to keep...more likely, the servicing rather than the holding, but neither is a big deal for BAC since they’re already in both businesses. BAC could acquire real estate, leases on various CFC retail branches scattered about and on and on. All of which is stuff BAC already deals with, maybe they pick up the pcs of CFC, maybe they don’t, but they get paid 7% plus regardless plus $10K or $20K or $40K daily trading gains indefinitely. They don’t even have to decide any which way for now. So, how can they lose? Maybe they even get Angelo’s tanning bed!!