Fannie seesaws up, closes lower; UnumProvident mandatory slides; Conexant 4% due 2007 drops

By Ronda Fears

Nashville, Jan.13 - Fannie Mae was seeing some good-two-way action Thursday and the convertibles held up against a sharp drop in the stock as the fate of its government subsidies continues to stir concern. Otherwise, it was an excruciatingly slow session as player digested earnings and economic data.

Again Thursday, Advanced Micro Devices Inc.'s convertibles improved a bit, following the slide taken earlier this week on the chipmaker's warnings about results due next Tuesday. But one fund manager remarked: "We will see for how long!"

Conexant Systems Inc.'s converts due 2007 dropped following remarks by company executives that the redemption was in question. The Newport Beach., Calif.-based maker of semiconductor devices for broadband applications made a presentation at the Needham & Co. growth conference on Wednesday.

A buyside trader at an outright shop noted shifts out of Conexant into some other chip names that got easier on the AMD warning and on news of their own, mentioning Triquint Semiconductor Inc. and RF Micro Devices Inc.

Moreover, players continue to debate volatility plays, which are said to be on the upswing because of some earnings surprises. Yet, one buyside trader at a hedge fund in New Jersey said it was "making the market feel like Las Vegas, not an investment vehicle."

"It is eerily calm," commented a New York fund manager. "I'm a sailor. It's the calm before the storm. There are plenty of reasons to expect volatility to recover. We know it will, we just don't know when! I'm a storm sailor. I like rough water and high winds.

"In investing, vol creates opportunities, and it sure is a plus for option values, whether we're using options as hedging overlays or we're using convertibles with embedded option value. Storms at sea are thrilling. A return to high vol will also be thrilling, and will be rewarding to those who keep a proper watch!"

Fannie swings up, ends lower

Federal Reserve studies show that government backing for Fannie Mae does little to improve mortgage rates for homebuyers, while it does prop up values for the company's stockholders and debtholders. Thus, the subsidy has come into question as a worthy government expenditure, which brought out lots of sellers of Fannie Mae paper. But amid the fray traders said plenty of willing buyers showed up, too.

"Fannie has been irresistible," one convertible fund manager in New York, an avid buyer, said.

There was a good two-sided market for the new Fannie Mae 5.375% perpetual convertible preferred, dealers said, and it swung as much as a half-point higher before dipping to close off a quarter-point at 104.375 bid, 104.875 offered. Fannie Mae shares lost 53 cents on the day, or 0.75%, to end at $69.80 but the stock was lower still in after-hours trading.

Fed economists suggest that the relationship of the U.S. government with Fannie Mae and Freddie Mac generates a subsidy worth $122 billion to $182 billion, of which their stockholders retain the lion's share - an estimated $53 billion to $106 billion. In one of three studies so far made by the Fed on the situation, economists also estimated as much as 44% to 89% of the market value for Fannie and Freddie stock is due to the perceived government support.

"These results suggest that Fannie Mae may indeed price mortgages as a spread to swaps," one of the Fed papers said. "However, this spread does not capture the debt advantage resulting from the implicit subsidy and therefore is not the proper comparison to make. When we do draw the proper comparison, we find that little or none of the debt advantage is passed through to homeowners in the form of lower mortgage rates."

Fannie holders see debt support

Given the potential of the suggestion that government subsidies to Fannie Mae could send the stock reeling, convertible holders shorting the stock are delighted. In addition, one outright convert holder is confident that the government would somehow support Fannie debt even if matters came to the worst possibilities.

A Phoenix-based fund manager, with a long position, said the ultimate threat is that if the subsidy is yanked Fannie would collapse, but that seems "a pretty far-fetched idea."

"In other words, [the Fed study shows] a subsidy makes Fannie shareholders big money but doesn't help homeowners. If this is true, then Fannie as it is presently comprised doesn't need to exist," he said. If Fannie failed altogether, "the Fed would step in to save the bond market part - all of those MBS [mortgage-backed securities] and the debt issued to buy them, and let the rest swing."

By the sheer magnitude of Fannie's, and Freddie's, presence in the bond markets, he said, some government support of the debt seems likely in the event of a default, which does not seem probable.

"You should be concerned if you are long - the traditional prop to Fannie stock has been the implicit government guarantee. Now that the Fed is kicking out the prop, you should be concerned because the stock will fall like a rock," the manager said. "Everybody short, though, is sitting pretty."

Conexant 2007 converts slide

Conexant's 4% convertible due 2007 dropped at least 1 point on Thursday with some selling on the heels of remarks by company executives that the payoff on those bonds was tenuous, although they are confident about having the ability to pay off the other two convertible issues that mature in 2006.

The 2007 converts were "a point lower - these are way overvalued, by at least 15 points," said one sellside dealer.

On Wednesday, Conexant executives - speaking at the Needham conference and to Prospect News - said they are confident the company has "more than sufficient assets on hand" to retire the $197 million face value 5.25% convertible due May 2006 as well as the $67 million 4.25% convertibles also due May 2006. Cashing in stock holdings in several growth names such as Skyworks Solutions Inc., Mindspeed Technologies Inc. and Jazz Semiconductor Inc. would provide the cash.

However, they both were less sanguine about the prospects for easy repayment of the $515 million of 4% convertibles due February 2007.

Triquint, RF Micro, JDS eyed

A buyside trader said he was noting interest in other chip names, which he attributed in part to the Conexant exodus along with the sell-off in AMD.

Triquint and RF Micro Devices were two stand-outs, although "dicey," he said.

RF Micro Devices' 1.5% convert due 2010 was quoted at 102.5 bid, down from 104.5 on Wednesday, while the stock dropped 20 cents Thursday, or 3.38%, to close at $5.71. Triquint's 4% convert due 2007 was pegged at 97.5 with the stock down 18 cents, or 5.17%, to $3.30.

"I think TQNT and RFMD will be something worth owning in six to nine months, so now would be a good entry point, on the dip," the trader said. "Handset orders are key and it seems with the constant upgrades in those that it will be steady. RFMD is a pure play on handsets while TQNT is more diversified and has an optics business that's on the downswing but stabilizing."

JDS Uniphase Corp. is another, he added, but he was more hesitant to look to buy in that name until "around November." At that point, he said it might be time to take what profits, if any, are available in Triquint and buy JDS Uniphase.

The JDS Uniphase 0% convert due 2010 was quoted off 0.75 point to 91.5 bid, 91.615 offered, with the stock down 9 cents on the day, or 3.2%, at $2.72.

UnumProvident convert falls

With earnings yet to provide an upbeat tone to the market, a sellside dealer noted some selling in insurance paper - an area of trepidation following a year of accounting probes, investigations into mutual fund trading and other controversies.

"We were seeing sellers in UNM today," the trader said. "There had been a buying spree before the holidays, but that has all died out. Hopes for 2005 holding a big recovery have faded away."

UnumProvident Corp. was particularly noteworthy, he said, with its 8.25% mandatory due 2006 sliding 0.5 point to 34.25 bid, 34.5 offered; on the New York Stock Exchange the convert ended down 0.61 point to 34.4.

UnumProvident shares dropped 36 cents on the day, or 2.08%, at $16.93.

The trader said spreads on the UnumProvident credit widened "a tad" on Thursday, although the trend has been for a tightening bias on insurance paper in recent weeks.

"A handful of credits - notably UnumProvident - may face negative ratings actions as a fall-out of regulatory investigations and civil lawsuits," said Kathleen Shanley, analyst at GimmeCredit, in a report Thursday.

"But overall, credit fundamentals are stable for the life insurance sector heading into 2005.And the rebound in credit spreads and drop in default rates has been a particular boon to an industry that depends heavily on investment returns."

Sell-offs in insurance paper

Yet, Shanley said, there could be further pressure in insurance paper, along with more consolidation in the industry. In addition to the various legal matters overshadowing the group, she said there is risk that insurers will price and structure their products too aggressively in an attempt to gain market share.

"Default rates can't go much lower, whereas margin compression is likely to increase over time if interest rates remain low," the analyst said. "Conversely, insurers risk disintermediation if rates spike abruptly and customers pull funds to invest in more attractive options elsewhere."

However the analyst is upbeat about insurance credits in 2005, expecting the possibility for some ratings upgrades if portfolio rationalization turns out to be a prelude to further consolidation.

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