How far have banks been willing to go to offload toxic loans left on their books? Pretty far, if the facts revealed in a lawsuit by Mexican telecom Empresas Cablevision SAB de CV against J.P. Morgan Chase & Co. are any indication.
According to U.S. District Court Judge Jed Rakoff, who recently forced a renegotiation of a settlement between Bank of America Corp. and the Securities and Exchange Commission over the Merrill Lynch & Co. acquisition, J.P. Morgan tried an "end run" around its credit agreement with Cablevision (which is not affiliated with U.S. cable operator Cablevision Systems Corp. but is a unit of Mexico's Grupo Televisa SAB).
"J.P. Morgan thereby violated, at a minimum, the covenant of good faith and fair dealing automatically implied by law in the credit agreement," wrote Rakoff in a January preliminary injunction, which he affirmed last week. The ruling stops the New York bank from transferring to Banco Inbursa SA, a Mexican bank controlled by billionaire Carlos Slim Helú, a $225 million loan it made to Cablevision.
The ruling has drawn interest among lenders because of the light it casts on one of the largest and most powerful global banks. It also raises questions about banks' motivations as they try to balance their own interests with that of their clients.
Cablevision borrowed the money to finance its $325 million acquisition of Bestel SA de CV, which operated Mexico's third-largest fiber-optic network. J.P. Morgan had planned on syndicating the loan, but it waited until early 2009, after the worst of the financial crisis. Although the bank approached HSBC Holdings plc, BNP Paribas SA and Bank of Nova Scotia to take its 90% stake in the loan, it couldn't get attractive enough terms from them and turned to Slim's Banco Inbursa.
So far, this isn't unusual, but what makes the case special is the fact that Slim also holds a controlling interest in Teléfonos de México SAB de CV, which competes with Cablevision in Mexico. J.P. Morgan was trying to "assign" the loan to Inbursa, meaning Slim's bank would have full voting rights over loan amendments and gain access to Cablevision's confidential information. Once Cablevision realized all this, it exercised its right to veto any planned assignments. J.P. Morgan, undeterred, then decided to sell a "participation" to Inbursa, meaning it would have only limited voting rights.
Under standard credit agreements, lenders don't need to seek approval from borrowers to sell participations. One banker says this is common practice among banks that need to get loans off their books and are hampered from doing so by borrower vetoes. "It's absolutely commonplace," the banker says, noting that banks have done what they've needed to do to remove loans from their books, even ones as relatively small as the $225 million Cablevision loan. "They all make a difference."
However, there seems to be more at work here. According to Rakoff, J.P. Morgan's participation agreement with Inbursa allowed for several unusual powers. Inbursa negotiated for the right to ask J.P. Morgan to pass along information it obtained from Cablevision under their credit agreement. According to Rakoff, that amounted to "almost anything." It also provided for the participation agreement to morph into an assignment with full voting rights if Cablevision defaulted on terms of the credit agreement, and it allowed Inbursa the right of first refusal if J.P. Morgan wanted to transfer the remaining amount of the loan. All of these provisions seemed aimed at allowing Inbursa full access to Cablevision's books, giving them an effective assignment but keeping the veneer of a participation intact.
Telling is the fact that Rakoff, as part of his final judgment, barred 10 J.P. Morgan bankers from having any further dealings with the loan. The list includes Steven Black, J.P. Morgan vice chairman and former co-head of investment banking, Daniel Pinto, co-head of global fixed-income trading, and Eduardo Cepeda, senior country officer of Mexico. The banker ban was negotiated in court after Cablevision argued it could no longer trust those bankers to act toward it in good faith, one source says.
"What sets this apart is the egregiousness of how this was handled by J.P. Morgan," says a source. "It seems J.P. Morgan made a decision at the highest levels to prioritize their relationship with Slim's group." J.P. Morgan declined to comment.