Washington Mutual considered 'worthless'; Wachovia, National City slammed as financials melt down

By Rebecca Melvin

New York, Sept. 26 - Convertible players watched financials continue to melt down for most of Friday, a day after Washington Mutual Inc. was seized by federal regulators, marking the largest bank failure in U.S. history. The events came as political haranguing continued in Washington as lawmakers stalled a rescue plan for the ailing financial system.

"The key word of the day is 'Washington:' for D.C. and Mutual," a West Coast-based sellsider said. "Without the former coming together, the latter's coming apart significantly worsened the credit crisis. I think everyone expected [Washington Mutual] to fail, but what they didn't expect was Washington, D.C., politics to be so apart."

Washington Mutual, which priced $3 billion of convertible preferred stock last December, saw the value of its convertible paper and shares slide to virtually nil. Sources said that although they traded some, they are likely to be worthless going forward.

Wachovia Corp. also fell under significant selling pressure as investors worried about its hopes of survival. Late in the day, the New York Times reported that the ailing Charlotte, N.C.-based commercial bank was in early merger talks with Citigroup Inc. Its shares continued to decline in after-hours trading.

National City Corp. was clobbered as well, although some buyers stepped in when the 4% convertible notes hit 50, which was down from 69 bid, 70 offered on Thursday.

By the end of the session, some of the pressure eased, and many financials bounced back on hopes that a plan from Washington will be forthcoming.

At the same time, some players waxed philosophical. Citing JPMorgan Chase & Co., which bought WaMu's assets for $1.9 billion and then sold $10 billion of stock to facilitate the deal, an East Coast-based sellsider said, "Not everything's down...You're going to see the strong get stronger, and the weak will fade away. It's a natural thinning process."

WaMu will fade away

The WaMu 7.75% perpetual convertible preferreds, which had a par of $1,000, traded at $0.50 bid, $3 offered.

The 5.375% PIES due 2041 traded at $0.05 bid, $0.35 offered. Shares of the Seattle-based savings and loan (NYSE: WM) fell $1.53, or 90.5%, to $0.16.

"[WaMu preferreds] are worthless. Bids are either lottery tickets or short covering," a New York-based sellside trader said.

WaMu priced the upsized $3 billion in mandatory convertibles via Morgan Stanley and now-bankrupt Lehman Brothers last December. They have a conversion price of $21.25.

In January, Bank of America Corp. brought to market an issue double the size of 7.25% perpetual convertible preferred stock. That paper traded Friday at 84 versus a share price of $35, compared to a price of 85 on Thursday. Shares of the Charlotte, N.C.-based bank (NYSE: BAC) ended up $2.44, or 7%, at $36.70.

The WaMu collapse was triggered by the slow but steady withdrawal of deposits. And while depositors were saved, holders of debt and preferred stock will likely see little recovery, sources said. That's a situation that, say convertible players, isn't good for their own market or others.

Michael Kao of hedge fund Akanthos Capital Management wrote in a column Friday that in the days following the Fannie Mae and Freddie Mac conservatorship move, or rescue, "the market for financial preferreds was essentially eviscerated, virtually eliminating any hope of recapitalization through public markets."

"Why is this relevant? Aside from the direct consequences of many regional banks having to write their agency preferred investments to nearly zero and further eroding already-thin capital ratios, the overall market for preferreds is significantly larger than the amount of agency preferred outstanding. In fact, this market was one of the only capital markets that remained open to financial institutions in the last eight to nine months, and it raised nearly $80 billon during this period from straight and convertible preferred issuance," Kao wrote in his column.

"It's one thing to 'punish' common equity holders who arguably have lived off the 'fat of the land' when Fannie and Freddie reaped abnormal profits, but it's entirely another thing to pull the rug out from under a class of investors (senior to the common) who stuck their neck out to recapitalize financial firms in need less than one year ago! This has caused preferred holders to hedge their exposure by heavily shorting the underlying stocks, further blowing out their cost of capital for the underlying companies," the hedge fund chief executive and portfolio manager wrote.

Wachovia, National City slammed

Wachovia's 7.5% perpetual preferreds traded at 370 versus a share price of $10.00, compared to 600 versus a share price of $13.70 on Thursday.

Shares of Wachovia (NYSE:WB) closed down $3.70, or 27%.

National City 4% convertibles due 2011 closed at 50.6 versus a share price of $3.71, compared to about 69 versus a share price of $4.99 on Thursday.

Shares of the Cleveland-based regional bank (NYSE: NCC) lost $1.28, or 26%, $3.70 on Friday.

National City has been known as a commercial and mortgage lender and has significant exposure to the weak Michigan, California and Florida real estate markets.

There was other news late in the day that "a third of Morgan Stanley's prime assets have left, and people think another third will," a sellside trader said.

Convertible players say a government bailout plan is needed to help loosen up frozen credit markets and stabilize credit spreads that have widened.

The credit markets were in sad shape Friday, even though the Dow turned green, one source pointed out.

"What we've learned the past several days is that after 2,000 years, politicians still fiddle while the city burns around them," a New York-based sellsider trader said.

A West Coast-based buysider said, "Subsidized housing is the largest of all political troughs. The political classes are actually stupid enough to be toying with the Goose. I despise them all."

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