Why S&P Cut Countrywide's Debt to Junk

The rating agency says an SEC filing by BofA creates uncertainty as to the ultimate legal status of Countrywide's creditors after the merger

On May 2, Standard & Poor's Ratings Services lowered its ratings on Countrywide Financial Corp. (CFC) and Countrywide Home Loans Inc. to BB+ from BBB+. The move puts Countrywide's coprporate credit rating below investment grade.

We also lowered our rating on Countrywide Bank fsb to BBB from A-.

The rating actions were due to the disclosure in Bank of America Corp.'s (BAC) May 1 Form S-4/A filing with the Securities and Exchnage Commission relating to the terms of the merger between BofA and Countrywide and a new reference regarding the treatment of Countrywide's indebtedness.

All of our ratings on Countrywide are now on CreditWatch Developing, a revision from CreditWatch Positive (where they were placed Jan. 11, 2008) due to the new level of uncertainty as to the ultimate legal status of Countrywide's creditors after the merger. As recently as April 30, 2008, we issued a CreditWatch update on Countrywide indicating that our sensing a change in the status of this merger agreement would result our downgrading Countrywide several notches.

Specifically, our rating actions follow BofA's May 1 filing, which states that "As part of its integration planning in connection with the merger, Bank of America is currently evaluating alternatives for the disposition of the remaining Countrywide indebtedness, including the possibility of redeeming, assuming, or guaranteeing some or all of this debt, or allowing it to remain outstanding as obligations of Countrywide (and not Bank of America). Bank of America has made no determination in this regard, and there is no assurance that any of such debt would be redeemed, assumed, or guaranteed."

The filing indicates that it is now possible that BofA would not support some of Countrywide's debt, including the approximately $17 billion of medium-term notes, $4 billion of convertible debt, $2.2 billion junior subordinated debt, and $1 billion of subordinated debt currently outstanding.

There is also language in the filing indicating that Countrywide will be merged with and into a merger subsidiary that will remain wholly owned by BofA, and assurances from BofA to Countrywide's common shareholders that they will receive common dividends. Until this filing it was our understanding that BofA would acquire all of Countrywide as stated in the January 2008 merger agreement. This new filing raises the possibility that this assumption is no longer true.

The CreditWatch Developing indicates that after the merger, the ratings on Countrywide could either be raised, lowered, or affirmed depending on the ultimate legal status of and support for Countrywide creditors and final clarification by BofA regarding the merger terms, according to Standard & Poor's credit analyst Victoria Wagner. "If Countrywide is to be a wholly owned, core subsidiary of BAC after the acquisition, then we expect to equalize our ratings on Countrywide with those on BAC," says Wagner. If selective debt of Countrywide is not fully supported under the merger terms or its legal status as a wholly owned subsidiary post-acquisition is not considered to be core under our criteria, then ratings could either be affirmed or lowered.

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