Convertibles weaken: Citigroup, other financials lower, but AIG edges up; PNC little changed

By Rebecca Melvin

New York, March 2 - The convertible bond market was weaker, but mostly quiet Monday as traders dealt with a storm that whacked markets with about as much intensity as the nor'easter that dumped more than a foot of snow on New York.

March trading picked up where February left off, only selling intensified after American International Group Inc. reported a $61.7 billion quarterly loss - the largest in history - and the U.S. government pledged an additional $30 billion to help the giant insurance company stay afloat and loosened terms of a previous bailout loan, with no promises that it will be the last aid the giant insurance company will need.

Also creating a drag on markets were downbeat comments by billionaire investor Warren Buffet related to the 2008 loss of Berkshire Hathaway, sources said.

"It was quiet. It was stormy, and it was Monday," a New York-based sellside trader said, citing not only the eye-popping AIG loss and government bailout but also Buffet's gloomy outlook to investors over the weekend.

For 2008, Berkshire lost 9.6% in book value per share.

An exception to suppressed trading was activity in financial convertible preferreds, which gave back gains notched Friday.

Trading in Citigroup Inc. convertible preferreds, which were down about 1.5 points, was activated after the ratio for which preferred shares can be exchanged into common was released. Other top-trading financial preferreds were also lower. But AIG ended higher by a nickel at $5.05.

AIG is "the epitome of what's wrong with our economy.... For smart people, they seemingly never understood the actual meaning of the word 'risk,' only how to supposedly quantify," a New York-based sellside trader said.

While one analyst brought up the market potential of airline convertibles, which are well represented in the convertible space, others said they hadn't heard trading in those names, and given the state of the economy, even lower oil prices may not be of that much benefit to the airlines given expected depressed passenger traffic.

Airline companies with convertible paper include JetBlue Airways Corp., AirTran Holdings Inc., AMR Corp., Continental Airlines Inc., US Airways Group Inc., UAL Corp. and Pinnacle Airlines Corp.

AIG edges up after further aid

AIG's 8.5% mandatory convertible equity units due 2011 closed at $5.05 compared to $5.00 on Friday. Shares of the New York-based insurance giant closed unchanged at $0.42 a share in heavier-than-average volume.

The government restructured its AIG program over the weekend and unveiled a plan that represents a fourth round of aid for AIG. The company's fourth-quarter loss ballooned to $61.7 billion, and for the year, AIG lost $99.3 billion, compared with a profit of $6.2 billion, for 2007.

In the quarter, AIG took a $21 billion charge related to taxes and wrote down $25.9 billion in assets, including mortgage-backed securities and credit default swaps.

The government, which already owns nearly 80% of the insurer's holding company, said it had no choice but to complete a restructuring of AIG because its business and trading activities are so integral to the world banking system.

If no intervention was made, the ratings downgrades would have probably caused holders of AIG derivatives contracts to have demanded cash collateral and other payments.

"The steps announced today provide tangible evidence of the U.S. government's commitment to the orderly restructuring of AIG over time in the face of continuing market dislocations and economic deterioration," the Treasury said in a statement.

Under the deal, the government will commit $30 billion in cash to AIG from the TARP, or Troubled Asset Relief Program, and also allow AIG to exchange $40 billion in preferred nonvoting shares that do not require a dividend.

To further ease AIG's debt burden, instead of paying back $38 billion in cash with interest that it has used from a federal credit line, the government will convert that into equity in two of the insurer's subsidiaries in Asia, American International Assurance and the American Life Insurance Co. The government already had direct ownership in those subsidiaries.

As part of the deal, the government would agree to lower the interest rate on all remaining AIG debt to match Libor, replacing the previous rate, which was Libor plus 300 basis points.

In September, AIG borrowed $85 billion from the Federal Reserve because it was unable to meet a round of cash calls. To secure the loan, AIG issued the government warrants for a little less than 80% of the company's shares.

In October, AIG got a new $38 billion facility from the government to shore up its securities lending business and gave the company access to a new commercial paper program, which had a much lower interest rate than the rescue loan.

In November, the government restructured its loan to AIG, raising its total commitment to $150 billion. The new arrangement reduced the rescue loan to $60 billion and stretched out its term to five years from two.

At the same time, it injected $40 billion into AIG in exchange for preferred shares, and it created two special purpose entities to take the most toxic assets.

AIG's government aid compares to $50 billion for Citigroup Inc. and $45 billion for Bank of America Corp.

'Everything down'

New York-based Citigroup's 6.5% perpetual convertible preferred, which will be exchanged for 13.0769 of common shares, closed the day at 14.64, compared with 16 on Friday. Its common stock closed down 30 cents, or 20%, at $1.20.

"Everything is down," a sellsider focused on financial issues said.

Another trader said, "It was pretty ugly."

Charlotte, N.C-based Bank of America's 7.25% convertible preferred fell to 324, down 3.25 points, from 360, while its common stock fell 8% or $0.32 to close at $3.63.

San Francisco-based Wells Fargo saw its 7.5% convertible preferreds fall about 4 points to 420 from 475. The common stock finished down 10.4%, or $1.26, to close at $10.84.

Meanwhile the 8.5% convertible preferreds of Fifth Third Bancorp closed down 2 points and those of KeyCorp were down 1.5 points, according to a sellsider.

PNC Financial Services Group Inc saw its 4% convertible bonds end little changed even after the Pittsburgh-based bank cut its dividend 85% to 10 cents. Shares of PNC lost $1.22, or 4.5%, to $26.12.

During a conference call, chief executive James Rohr cited shifting demands from government regulators together with deteriorating economic conditions as the reason behind the dividend cut.

Nevertheless, "those bonds stay in the range of 91 bid, 93 offered. They [the bank] are doing that to shore up capital, and I bet Wells Fargo will follow soon," the sellsider said.

A West Coast-based convertibles sellsider questioned the practice of paying dividends at all in the current environment. "Why any of the banks are paying any dividend whatsoever is beyond me. Right now the banking system isn't working. It makes no sense," the trader said.

Redemptions feared

The trader said that the "gating factor" will likely lead to an increase of convertibles for sale.

There will be more redemptions and more people going out of business, he said.

Another wave of redemptions is expected to hit, he said, citing an article in Monday's Wall Street Journal.

The Journal article said hedge funds expecting withdrawals were New York-based D.E. Shaw & Co. and Och-Ziff Capital Management Group LLC.

The article also cited Huw van Steenis, an analyst at Morgan Stanley in London, who says he has seen "no deceleration" in investors' requests to pull money out of hedge funds. Thus he estimates that assets under management in the global hedge-fund industry will shrink by as much as 30% this year due to withdrawals, following a 20% decrease in the second half of last year. That will leave total assets at less than $1 trillion, down from a peak of more than $1.9 trillion in mid-2008.

Sources still saw opportunities in convertibles, nevertheless, and "convertibles should do all right," a Connecticut-based sellsider said, "when this is over."

Mentioned in this article:

American International Group Inc. NYSE: AIG

Citigroup Inc. NYSE: C

PNC Financial Services Group Inc. NYSE: PNC

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