Countrywide slides; mortgage-linked convertibles weak on credit jitters; market nervous

By Reshmi Basu

New York, Aug. 3 - Credit concerns remained the running theme for the convertible bond market Friday as sentiment was weak in the wake of more negative headlines from the mortgage sector.

Investors cut their appetite for risk across all major markets Friday as players worried about the potential contagion effect from the sub-prime mortgage market meltdown.

U.S. stocks took a beating, after Standard & Poor's downgraded its outlook for Bear Stearns Cos. Inc. to negative from stable, noting that the investment bank's reputation was damaged from the widely publicized woes of two of its hedge funds, which filed for Chapter 15 bankruptcies.

In addition, the rating agency warned that the bank would face a slew of lawsuits as investors look to recover losses.

That news coupled with mixed job numbers in the United States added more fire to Wall Street's credit story. The Dow Jones Industrial Average lost 281.42 points or 2.09% to close at 13,181.91. The Nasdaq Composite Index slipped 84.83, or 2.51%, to 2,511.25.

"Things continue to be ugly," said a portfolio manager of a blue-chip multi-strategy hedge fund in an e-mail.

"Today [Friday] saw more blocks of merchandise coming for sale, and several large prints went up 'in the hole,'" he added.

"There are rumblings of yet another large hedgie closing up that was responsible for some of these."

America Home incites more fears

Underpinning the market's jitters were additional negative headlines coming from the mortgage sector, including American Home Mortgage Corp. (NYSE: AHM), which announced that it was closing shop on nearly all its operations.

In a statement Thursday night, New York-based mortgage lender said it would slash its 7,000-strong workforce to 750, capping off a meteoric slide in the company's stock performance this week.

An analyst noted that the company's stock had closed at $10.47 on Monday but by Tuesday had slid to around $1.04.

However from Thursday to Friday's trading run, the prices were "chopped in half again."

On Friday, its stock gave up $0.76, a sharp decline of 52.41%, to close at $0.69.

One trader said he considers the firm to have zero equity value.

The company's fiscal meltdown punctuates a market already screeching in horror over the U.S. housing landscape.

"The small story there is what's going on with specific names," observed the analyst.

But the larger worry is how a decimated lender such as American Home will feed "the overall fear that is in the market," which could fan more concerns over the already weak real estate and mortgage markets, he remarked.

Countrywide slammed

The country's largest mortgage lender, Countrywide Financial Corp. (NYSE: CFC), was crushed in trading Friday.

Late Thursday. Countrywide attempted to assuage market fears about its liquidity conditions, saying that it has about $50 billion of "highly reliable short-term funding liquidity."

But those words of encouragement fell on deaf ears in Friday's session, which was unusually active for a summer Friday.

The trader noted there was selling in most names as bids were getting hit, while there were some value types buying financial names.

Flight to quality trade

Mimicking the recent trend, the convertible market continued to see a flight to quality trade as investors moved to shorter-dated securities amid a very fearful market backdrop, noted market sources.

"Folks vomiting names, shorts selling everything - to me indiscriminately," observed the trader, who predicted an imminent slew of mergers in which the weak would be bought by strong companies - "accretive, clean up excesses."

But while they have been considered a safe harbor in early sessions, on Friday short-dated names were not spared, as the selling was indiscriminate, according to the portfolio manager.

"In fact, since this was the stuff where people were hiding up until recently, this merchandise was had more to fall and this showed today [Friday].

"IG [investment grade]/vol-oriented names and those sensitive to rho were bid, with flight to quality being the theme.

"The only buyers were bottom fishers that often were run over," he said, adding that particularly held true for Countrywide.

Its bonds, which traded off dramatically Friday even from the prior session's softness, but then "rebounded to be bid ¾ point higher than where a large block seller was able to unload," he observed.

Financials broadly lower

It was not just Countrywide that was hit. During Friday's session, financials were weaker across the board.

In trading, KKR Financial Corp.'s 7% convertible senior notes due 2012 were spotted at 84 versus $20.00 on the shares.

CapitalSource Inc.'s 7¼% convertible notes dwindled in trading Friday, unable to extend the previous session's solid performance. The bonds were spotted at 87 versus a stock price of $19. On Thursday, the bonds closed at 90.5746 versus a closing stock price of $19.83.

U.S. Bancorp's three-month Libor minus 175 bps senior debentures due 2036 were last seen at 99¾ versus a $30.40 share price.

Intel Corp.'s 2.95% convertible due 2035 was quoted at 98 versus a $24.25 share price.

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