Financials mixed amid uncertainty; Washington Mutual rebounds; Cheniere, Chesapeake slip on oil prices

By Kenneth Lim

Boston, July 15 - Financials and energy names continued to dominate the convertible market on Tuesday in a mixed session overall.

Fannie Mae convertible preferreds were slid further as investors remained concerned about the company's balance sheet.

National City Corp. also fell further amid speculation that the bank could be in trouble due to its large exposure to poor mortgages.

Not all was gloomy in the sector. Washington Mutual Inc. gained outright as the common stock bounced back following statements by the company aimed at reassuring jittery investors.

The energy sector came under a little pressure as oil prices declined. Cheniere Energy Inc. and Chesapeake Energy Corp. saw their convertibles retreat outright with their stocks.

Caution abounds in mixed session

Investors remained nervous on Tuesday, and a firm direction was difficult to pin down in the general market, observers said.

"By and large, I think people are still trying to digest this Fannie Mae stuff, what's going to happen on that," a West Coast convertible trader said. "I think there are sellers out there, but I think the people who are holding on to paper are waiting to see if there's going to be government support."

A buysider whose firm is underweight financials said opportunities in the market now lay outside of the financial sector.

"We favor energy and materials, that was under a little bit of pressure there today, but we'd rather be long that sort of stock," the buysider said. "But you know, things may change over time, but that's where we see opportunities."

"I think things generally overshoot," the buysider said. "There's widespread sort of panic and a lack of liquidity. People aren't making full markets like they used to...I think some of the hedge funds are hitting risk management thresholds that might cause them to sell more."

Fannie Mae falls further

Fannie Mae's 8.75% mandatory convertible preferreds dropped about 7 points outright on Tuesday as investors continued to punish the underlying common.

The convertible closed at 16.75 on Tuesday as Fannie Mae common stock (NYSE: FNM) fell $2.66 or 27.34% to close at $7.07.

Fannie Mae's convertibles have been at the mercy of the stock, a sellside convertible analyst said.

"The credit doesn't matter for the preferreds," the analyst said.

Holders of the preferreds are mainly concerned about the health of the Washington, D.C.-based mortgage financing agency and how its capital needs will be met, the analyst said.

"The problem is nobody really knows how much capital they need and how they're going to get it," the analyst said. "If their needs are too huge, what's going to happen? If the government steps in and takes over, where's that going to leave the preferreds? Because they're preferred equity, the government might not want to support them as much. Even the lending plans by the Treasury and the Fed needs to be approved by Congress, so even that is not certain."

It is difficult to know how long the issue will take to resolve, the analyst said.

"I don't even want to speculate on that," the analyst said.

Mixed session for financials

Spreads in the financial sector generally widened, but some stocks in the sector rebounded from Monday, giving outrights some respite but hurting hedge investors.

Interest in financials remained thin.

"It's toxic waste," a convertible trader said. "We've been trying to avoid them. We haven't traded them here at all...I've asked some people whether they were doing any of them, and the feedback from these people on those names is you really had to be heavy enough on those names to protect yourself on the downside."

National City, a Cleveland-based lender, saw its 4% convertible senior notes due 2011 fall about 5 points outright to trade at 60 against a stock price of $3.20. National City common stock (NYSE: NCC) closed at $3.53 on Tuesday, down by 6.3% or 24 cents.

Washington Mutual, a Seattle-based bank, did better outright. Its stock (NYSE: WM) rose 11.76% or 38 cents to close at $3.61, while its 7.75% perpetual convertible preferred gained about ½ point to be quoted at 40.25 bid, 40.75 offered.

A buysider said some of the hedged investors may have been hurt on gains like Washington Mutual's.

"I think some of them were 6 points down this morning, so you know, you'd have to be well-overhedged," the buysider sad. "When the stocks rebound, the preferreds don't necessarily follow, so it's just a tough area to be long at the moment."

Most of the financials that are suffering are facing fundamental challenges, and that makes investing in the sector difficult, the buysider said.

"You could say that it could mean there are good bargains, but these things have a lot of short interest, and they can rally 20% in a day or it can be a 20% drop," the buysider said. "The bottom line is that the fundamentals are challenged...It's going to depend on the housing market recovery and energy prices and so on, and nobody really has a crystal ball on that."

"I think when things come in so hard, it begets more selling because people are, 'I've hit my maximum loss on a single position,' or whatever," the buysider said.

Energy slips with oil prices

Cheniere Energy's 2.25% convertible senior note due 2012 fell about 6 points outright as the underlying stock retreated as part of a broader sector pullback.

The convertible was seen trading around 37 and 38. Cheniere common stock (AMEX: LNG) closed at $3.32, down by 2.35% or 8 cents.

"Some of these LNGs were on sale today, traded considerably lower," a sellside trader said, adding that the bonds were "busted. You're not really going to see versus something with this."

Cheniere is a Houston-based natural gas seller.

Chesapeake Energy, which has been active, also declined. Its 2.25% convertible senior notes due 2038 traded at 112 versus a stock price of $62, down about 2 points outright. Chesapeake common stock (NYSE: CHK) eased 5.79% or $3.65 to settle at $59.35 on Tuesday.

Chesapeake is an Oklahoma City-based natural gas production company.

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