Ten days ago Zero Hedge presented the idea of applying an Asbestos-type settlement to the neverending lawsuits against Bank of America which if continue at the current rate will result in the swift and brutal end of the massively undercapitalized bank by a thousand Rep and Warranty litigation cuts. Yesterday, we were happy to see that the idea has received far broader billing, and is being taken up by non other than Reuters: "When some look at all of the litigation arising from Bank of America's big role in the U.S. mortgage mess, they start thinking of asbestos and how thousands of lawsuits arising from that cancer-causing product brought down many manufacturers more than a decade ago. The solution back then to dealing with claims filed by more than 750,000 workers exposed to asbestos was the creation of dozens of "asbestos settlement trusts," which have paid out tens of billions dollars in damages. Some of them are still going strong today. The asbestos trusts were seen as an innovative approach to deal with seemingly endless litigation and provide a measure of compensation to sick workers and their families. The system for dealing with claims also allowed some of the hobbled manufacturers to emerge from bankruptcy largely free of the crushing weight of lawsuits." In other words, the choices for Bank of America are now two: either it prepares for a slow, painful, insolvency as all of its cash is bled out in litigation fees and "one-time" lawsuit charges, or, almost just as bad, it funds a massive trust, ringfencing all past, current, and future claims, and which is funded...by nearly all of Bank of America's equity. Yes, the end result will be a near wipe out of the existing Bank of America stock, but it will not be bankruptcy! In essence, what BAC will do is a bankruptcy remote "prepackaged bankruptcy" in which it spins off its contingent liabilities, with an equity buffer of whatever the litigants choose (most likely up to about 95% of the firm's current equity value), and proceeds to grow as a simple bank (with or without Merrill) and fund itself through retained earnings, in the process shedding off the "cancer" that are $1.2 trillion in toxic mortgages. The result of this would be a BAC share price of under $1 but that is inevitable. The alternative: freefall chapter 11 and technically 7 (which will never be allowed by the administration, sorry Chris Whalen), means BAC trades to $0.00, and the status quo system of crony communism is finished.
As a reminder, from Zero Hedge:
And some more from Reuters on the theoretical underpinnings of this idea..
"We've suggested an asbestos-style settlement as a solution. It makes the most sense," says Vincent Fiorillo, a portfolio manager with DoubleLine Capital, a $15 billion bond shop that has its own pending claims against the Charlotte, North Carolina-based lender. "It is better than where we are right now."
The idea of using the asbestos litigation wars as a model for dealing with the fallout from the financial crisis is more talk than anything else. There's no indication an asbestos-style litigation trust is something Bank of America is actively considering at the moment.
But efforts to find a creative solution to Bank of America's multi-pronged exposure to Countrywide's ailing mortgage portfolio become more urgent with each downward tick in the bank's already depressed share price.
This is not the first time that some have talked about a litigation trust as a mechanism to deal with some of Wall Street's liability arising from the collapse of the U.S. housing market. In the early days of the financial crisis, regulators discussed the merits of using an asbestos-style trust to resolve potential litigation claims against the biggest U.S. banks. But regulators ultimately rejected the trust concept along with other novel ideas that were deemed either unworkable or politically untenable.
One appeal to a trust solution, according to proponents, is that it would be a way for a bank to essentially hive off its litigation liability and establish a mechanism for dealing with claims and litigation. The advocates suggest it would be a way for Bank of America to get a "fresh start" without involving a bankruptcy or a Federal Deposit Insurance Corporation-imposed receivership.
To be sure, an Asbestos resolution is not a magic bullet, and will still cost existing equity (and Buffett) virtually their entire investment:
The insurance industry continues to be plagued with new asbestos-related claims years after the trusts were created. Credit rating agency Moody's Investors Service recently said after asbestos being a "back burner" issues for years, the U.S. insurance industry is recently seeing an uptick in new asbestos claims.
And the problem with any trust is that it must be adequately capitalized. The amount of money the bank would have to commit would no doubt be contentious and costly to shareholders and potentially bondholders as well.
The easiest way to fund a litigation trust would be for Bank of America to issue new shares, something that would severely reduce the value of its existing stock. That's not the kind of plan that will sit well with stockholders, whose shares are already trading well below the bank's stated book value of $20 a share.
"You'd have to go to the market and raise capital for this and that would dilute shares," says Australian hedge fund manager John Hempton, whose Bronte Capital owns a sizable stake in the bank. "That is the last thing BofA wants to do right now."
Alas, Buffett's idiotic investment betting on yet another taxpayer funded bailout has derailed the train for the time being:
But if some momentum was building for a radical solution, Buffett's $5 billion investment changed that. Now even some early advocates of an asbestos-style litigation trust are having second thoughts.
"The dynamics have changed dramatically since Buffett entered the picture," says Sean Egan, a principal of Egan-Jones Ratings Company, an independent rating shop which has eased up on its once bearish view of Bank of America. "It's a kiss of approval," he added, even though the bank is paying a rich 6 percent dividend on the preferred stock it sold to Buffett's Berkshire Hathaway.
Egan says an asbestos-style trust seemed like a plausible solution during the summer when Bank of America seemed to have few friends in the equity markets. But now, Egan says, to set up a litigation trust would "create a total mess" and "be patently unfair to existing shareholders."
Just a few months ago, Egan discussed the merits of such a trust with several mortgage-backed securities investors now sparring with Bank of America. Those investors claim the bank is obligated to buy back the underlying home loans in those now soured bonds because the mortgages were issued to homebuyers who either obviously lacked the income to keep making monthly payments, or were duped into taking out greater loans than they could afford.
So for the time being the litigation push is delayed. Although likely not for long: BAC will soon need to access the capital markets very aggressively, which means its stock will plunge even more on daily headline risk:
Skeptics also point out that in the coming years, Bank of America will need to boost capital by $50 billion in order to comply with new international banking regulations designed to make sure banks are not taking on too much risk.
And next year, Bank of America will need to refinance at least $40 billion in corporate debt that is coming due. In a worst case scenario, the bank has more than $400 billion in liquid assets to pay off any maturing debt.
It's a lot of capital raising and skeptics worry that could hamper Bank of America's ability to generate new commercial and residential loans for the next several years. That's one reason people like Black, who want to break Bank of America apart, say something needs to be done to change the narrative because it's not healthy for one of the nation's biggest banks to exist in stasis for years to come.
One thing is certain: anyone calling for a prompt return of BAC to a $20/30/share price is certainly insane (we refer to Dick Bove's appearance on Fox News yesterday), and should never get media exposure again (just as a media desperate Dick Bove had promised months ago only to have not one but two daily showing on the ponzi channels in an attempt to get more gullible Americans to follow Buffett in throwing their money down the black hole). Also certain is that no matter what one believes, the Bank of America matter is one of cash flows: not enough (A) coming in, and more than enough (B) leaving. Regardless of how one spins it, as long as B>A, the stock price will drop ever more until bankruptcy eventually becomes an inevitability. As such any attempts to stop the bleeding should be enforced. However, pathetic attempts such as the $8.5 billion settlement only provoke and infuriate the plaintiff class (at least those who are not desperate in imposing a Res Judicata) and make any real cash retention options next to impossible.
In the meantime, two things are certain: all else equal (and with Bernanke around, they never are), the stock will continue dropping, and the CDS will continue widening until it is too late.