Catz, the 2nd Lien RONs......
From discussions long ago with others, the 1st and 2nd lien RONs exist for a reason quite specific.
The RONs are generally first required to strip WMIH of estate assets (WMMRC) which it needed to have a real IRC 382 continuity of business. So, the WMMRC asset that WMIH was getting had to have a corresponding liability.
However, it is a hard amount to value, and when valuing the NPV of the WMMRC income streams and establishing the RONs, Blackstone (using other actuarial work product) found that the amount of the RONs was likely too large (that they might not be able to be paid off entirely, with interest).
This was a major concern to the debtors and the EC after settlement agreed to; they recognized the potential RISK OF DEBT that all of the $130M in RONs planned might be RECHARACTERIZED as EQUITY by the IRS because it might not meet all of the requirements of STRAIGHT DEBT safe harbors.
[As a negative potential consequence, to have $140M (or $130M) of debt than ran the risk of the IRS "reclassifying as equity" was too great a risk that could threaten the $6B NOL carryforward. This risk is simple once understood. If the IRS reclassified the RONs at equity for tax purposes, $140M/$340M ($200M common stock valuation and $140M of RONs) equals over 41% of WMIH. That would have created are real ownership risk as since they were ultimately almost not subscribed, WMILT ended up as the owner (a substantial holder above 5%) with risks related to further management of the IRC 382 50% limitations.]
The "reclassification" or "recharacterization" of debt to equity is in the foundation of the IRS safe harbors of "straight debt." Although recent cases and even one 2010 PLR deal with S Corporations, the same applies to C Corporations like WMIH. One of the items in the safe harbor MIGHT NOT BE MET BY THE RONS. There was a risk that the RONs would not qualify as "straight debt" because they were contingent on WMMRC being able to generate enough income to upstream dividend to WMIH to pay them; i.e., the debt was potentially conditioned on profits and other factors.
So, in order to reduce this risk, a determination was made to segregate the RONs into two tiers;
~ a 1st RON @ $110M that Blackstone could affirm was not at risk of doubt WMMRC's ability to generate revenue to pay (STRAIGHT DEBT threshold met); and
~ a 2nd RON @ $20M that could be at risk of IRS challenge for recharacterization as EQUITY. In this regard, out of caution, the 4.75% threshold was established on the ownership cap for subsequent RON owners "if ever" the IRS was to prevail down the road.
