Fannie Mae drops again, but Fifth Third, Nasdaq add; Kendle gives back some gains: GM bonds trade

By Rebecca Melvin

New York, Aug. 8 - Fannie Mae convertible preferreds and common stock were down again Friday after the mortgage financing company reported a larger-than-expected net loss of $2.3 billion, driven primarily by an increase in the firm's loan loss reserves.

Fannie Mae's convertible mandatory preferreds - which were issued exactly three months ago - have dropped about 30% since early July and are now at less than half of their original par value at $21.

Ambac Financial Group Inc.'s mandatory convertible preferreds, which priced March 6 and also have a $50 par, were lower in early trading at $29.75.

Other than the focus on Fannie's earnings report, Friday was pretty quiet in the convertible space, market players said.

But the session marked the end of an interesting week, in which players explored strategies in the aftermath of the unwinding of long energy, materials and commodities and short financials.

Health care, airlines and sundry other names were eyed instead, as well as financials like Fifth Third Bancorp and the Nasdaq Stock Market Inc., both of which were up on Friday.

Kendle International Corp., a clinical research group, was a little lower Friday but continued to show good, two-way flow after rallying Thursday in response to its higher profit and boosted outlook posted this week.

The convertible bonds of General Motors Corp. traded in heavier-than-average volume, but their gains didn't keep pace with that of the common shares, as oil prices continued to drop. Crude oil fell to below $115 per barrel for the first time since May.

A big mover to the upside for the week was Smithfield Foods Inc., which has gained 15 points in the last five sessions, against a $4 rise in its underlying shares.

Fannie falls back

Fannie Mae's 8.75% mandatory convertible preferreds due 2011 were at $20 or $21 versus a share price of $8.30 during the session.

But that didn't notch an all-time low. That happened July 15 when the mandatories dropped about 7 points outright to close at $16.75 versus a share price of $7.07, which was a 27% drop on the day.

Concern about their balance sheet and questions about how much capital it will need to raise were not allayed by Friday's earnings report.

Fannie Mae 5.375% series 2004-1 convertible perpetual preferreds were said to have "no volume" and were indicated at 39,000 bid, 43,000 offered, compared to its mid-July low of 41,000.

Shares of the Washington, D.C.-based GSO (NYSE: FNM) dropped 90 cents, or 9%, to $9.05.

The company, which provides liquidity to the mortgage market by funding mortgage lenders, said that combined loan loss reserves were raised to $8.9 billion as of June 30, up from $5.2 billion as of March 31, to reflect losses it believes will be recorded over time in charge-offs.

It raised its forecast for its credit loss ratio for the full year to 23 basis points to 26 bps, compared with its previous guidance of 13 bps to 17 bps.

The company said that going forward it will take additional action to manage capital, eliminate new Alt-A business and strengthen credit loss mitigation. It also expects 2008 will be its worst year for credit expenses.

Nevertheless, "the only way you could say there was any good news is if you were short the stock," a New York-based buyside convertibles analyst said about Fannie's quarterly results.

Challenging conditions in the housing and mortgage markets that began in 2006, deepened through 2007 and 2008," said Daniel H. Mudd, Fannie Mae's president and chief executive officer.

"Volatility and disruptions in the capital markets became even more pronounced in July. In addition, credit performance has continued to deteriorate and, based on our experience in July, we anticipate further increases in our combined loss reserves. Given this volatility and the build-up of our reserve, as well as the uncertainties inherent in the U.S. economy and the housing market, we are taking a series of additional actions that reflect our ongoing focus on conserving and enhancing our capital, as well as managing our credit risk through the balance of this cycle," Mudd said.

More than 60% of Fannie's losses have come from a small number of products, especially Alt-A loans. "We will eliminate newly originated Alt-A acquisitions by year-end," Mudd said, adding that underwriting changes have caused the volume of those products to decline by more than 80% from peak levels already.

Fannie Mae said that net revenue rose 5% to $4 billion from $3.8 billion in the first quarter, but also that due to the "unprecedented challenges" of 2008, average home prices declined by an estimated 0.6% on a national basis during the second quarter, which translates to an 8% total national decline since the beginning of the downturn in the second quarter of 2006.

Certain states, such as California, Florida, Nevada and Arizona, have experienced home price declines of 25% or more since their 2006 peaks, Fannie Mae said.

Oil softens Fannie's blow

The reason "you're seeing green on the screen today is a drop in the price of oil," the convertibles analyst said. "Maybe with oil at 116, there's that silly switch out of energy into financials. I call it silly because the two biggest buyers of mortgages are telling us that they are balance sheet constrained, which is a signal to lighten up on financials."

Fannie is slightly better capitalized then Freddie Mac, its sister mortgage lending GSO, but not reassuringly so. Freddie, for its part, seemed to say in its earnings call transcript that it has visibility on capital though 2008, but 2009 is in question, and it will probably be returning to the market and that $5.5 billion is adequate, the convertibles analyst said.

"Against a market capitalization of $3.6 billion, it has me wondering about the mechanics of that," the analyst said, adding that Goldman Sachs and JPMorgan are currently circulating around Boston, trying to get indications of interest for some kind of capital raise.

"The bankers still think that people on the buyside will pony up for this deal, and Fannie Mae is still under the same illusion," the analyst said.

Looking on the positive side, if this is a turning point and "if Freddie can raise $5.5 billion and if $5 billion is enough for Fannie, and that's all we need to get through this and we could go on with our lives and these guys could continue to provide liquidity, then from the standpoint of owning the convertible in Fannie and Freddie it's unlikely that they would cut their dividend. But I feel like there are more attractive places to play."

They're not really best as public companies given their balance sheet, and that they have so little equity and that they are quasi governmental entities, the analyst said.

Fifth Third adds more

Fifth Third's 8.5% series G perpetual convertible preferreds gained 3 points in early trade to change hands at 145 versus a share price of about $15.50.

Shares of the Cincinnati-based regional bank (Nasdaq: FITB) ended up 68 cents, or 4.5%, at $15.68.

There was no clear driver of Friday's move, other than the overall financial index was higher. The paper has moved up pretty consistently since it was priced in June.

Investors say they are starting to get longer on the traditional banks like Fifth Third, National City Corp. and Wachovia Corp.

On Friday, National City's 4% convertibles were standing pat at 73.5 bid, 74 offered.

Bankunited Financial Corp., around which rumors of private investors bailing them out have circulated, saw its bonds for sale at 35, but there were no takers ahead of earnings seen out after the close.

After the close it posted a wider-than-expected third-quarter loss of $118 million.

Nasdaq continues to climb

The Nasdaq 2.5% convertible senior notes due 2013 closed at 91 versus a closing share price of $33.73 on Friday, compared with about 89 versus a share price of $31.40 on Thursday.

Shares of the New York-based stock exchange (Nasdaq: NDAQ) gained $2.33, or 7.4%.

After posting an 81% jump in second-quarter profit on Wednesday, Jefferies & Co.'s analyst Daniel Fannon praised its cost-cutting efforts in a research note.

It was the first full quarter in which Nasdaq operations were combined with those of Sweden's OMX stock exchange; acquired in February. And last month, Nasdaq OMX completed its buyout of the Philadelphia Stock Exchange. It plans to complete its acquisition of the Boston Stock Exchange in the third quarter.

Kendle drops back some

Kendle International's' 3.375% convertible senior notes due 2012 were little changed on Friday while its shares gained 1.3%.

The Cincinnati-based clinical research organization said earlier this week that continued demand for drug development services helped propel its second-quarter net income to $7.8 million, which was better than expected. Revenue rose 27% to $177.4 million.

It also said that it now expects full-year profit to be between $2.00 and $2.15, up from prior guidance of $1.90 to $2.07 a share.

Kendle's 3.375% convertibles were indicated at 118.8, compared to 118.7 on Thursday.

GM convertibles move shy of common

GM's 6.25% convertibles due 2033 (NYSE: GPM) closed up by 2.4% to 11.01 in heavy volume, versus a closing share price of $10.03, which was up 2.9% on the day.

The GM 5.25% convertibles due 2032 (NYSE: GBM), with its 10-year put, were up just 1% at 12.09, also in heavy volume, while the GM 1.5% convertibles due June 2009 (NYSE: GRM) added by less than a full percentage point at 20.20 in lower-than-average volume.

Since oil prices began to spike this spring, the Detroit-based automaker has seen its lowest share prices since the 1950s. Its shares tend to move higher with lower oil.

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