WaMu drops on capital concerns; UAL, JetBlue gain, Chesapeake slides on oil prices; Alliance plans deal

By Kenneth Lim

Boston, July 23 - Washington Mutual, Inc. fell on Wednesday after the bank's credit ratings were cut and investors expected the company to have to raise more capital.

Airlines got a boost as oil prices fell further. UAL Corp. and JetBlue Airways Corp. continued to gain following a rally on Tuesday despite reporting losses in the second quarter.

Oil prices had the opposite effect on Chesapeake Energy Corp., which saw its convertibles drop as the value of crude retreated.

Alliance Data Systems Corp., meanwhile, announced plans for a $700 million offering of five-year convertible senior notes.

Washington Mutual drops

Washington Mutual's 7.75% convertible preferred dropped on Wednesday amid a lack of confidence about the company's liquidity.

The convertible traded at 52.5, down by 2.5 points. Washington Mutual common stock (NYSE: WM) lost 20.1% or $1.17 to close at $4.65.

"Those were weaker," a sellside convertible analyst said. "They were better last night, but they kind of came in today. The market's somewhat unsure that they're going to able to go without raising capital, which they said they would yesterday."

Washington Mutual on Tuesday reported a $3.33 billion second-quarter loss, or $6.58 per share. Excluding items, the net loss was about $3.34 per share, worse than analysts' estimates of about $1.05 per share.

Seattle-based Washington Mutual is a consumer and small business banking company.

The bank said it had more than $40 billion of liquidity available at the end of the quarter, and it improved its capital ratio to 7.79% and does not expect to have to raise more capital.

On Tuesday, Moody's Investors Service placed the bank's senior unsecured rating of Baa3 on review for a possible downgrade. Standard & Poor's on Wednesday cut Washington Mutual's counterparty rating to BBB-/A-3 from BBB/A-2.

The bank's poor results fueled speculation that Washington Mutual would need to raise more capital, a convertible trader said.

"I think the feeling on the Street is they're going to have to raise more capital," the trader said. "They have dangerous levels of exposure to bad mortgages and they're running with a very thin buffer on their capital levels. The problem is their credit is weak, their stock price is in the dumps, nobody's really comfortable doing business with them now."

If the company has to raise money, it will likely be through an equity sale, the trader said.

"They won't be able to raise debt," the trader said. "Nobody will want their bonds, unless they price it so cheap that it's not worth doing."

The bank may have more success seeking a strategic investor, the trader said.

"What might happen is they find a bigger bank to buy them over," the trader said. "It would suck for the equity guys, but if the acquirer is strong enough it might be better for the credit. But I don't know who's in the mood or the position to buy them out now. JPMorgan's still digesting Bear Stearns, Bank of America has Countrywide on its mind, Citigroup's dealing with its own problems."

Airlines get fuel relief

Airlines continued to get some lift from fuel prices, which fell again on Wednesday.

UAL Corp.'s 4.5% convertible due 2021 added about 2 points outright, changing hands at 50.5 versus a $9.20. UAL common stock (Nasdaq: UAUA) finished the day 11.18% or $0.94 higher at $9.35.

JetBlue's 3.75% convertible due 2035 gained 3 points outright to trade at 71 against a stock price of $5.15. JetBlue common stock (Nasdaq: JBLU) closed at $5.25 after climbing 16.67% or $0.75.

JetBlue is a Forest Hills, N.Y.-based airline.

"JetBlues were a lot better, those were good right off the bat," a desk analyst said. "United was also better but there was more two-way flow today, so some people were taking profit on that name."

The airlines got a boost from falling oil prices and a belief that cost- and capacity-cutting measures could eventually help the carriers to return to profit, a sellside convertible trader said.

"Airlines are pretty easy to understand these days," the trader said. "Oil goes down, airlines go up. Oil goes up, airlines go down. It's almost a guaranteed pattern."

"The airlines are all furiously trying to cut costs just trying to keep up with oil prices," the trader added. "They're laying off their staff, cutting flights. We've seen some consolidation, but it hasn't really been enough. Obviously they want to cut capacity right now because people don't want to travel as much when the economy is bad and prices are going up, but they can't cut too much because when things pick up then they have to add capacity again...They're obviously in a tough spot."

The trader said a respite from oil price hikes can be significant for the airlines.

"In theory, if oil prices stop climbing or if they go down, then everything that the airlines are doing will have a chance to catch up, and people will travel more, and things will improve," the trader said. "But that's a pretty big if."

Chesapeake follows oil lower

Chesapeake's convertibles continued to mirror oil prices, trading lower on Wednesday.

The Chesapeake 2.25% convertible due 2038 dropped 3 points to 95 versus a stock price of $50.25, while the Chesapeake 2.5% convertible due 2037 was seen at 135.5 against the same stock price.

Chesapeake common stock (NYSE: CHK) fell 8.1% or $4.14 to close at $46.96.

"Energy was weaker today," a sellsider said. "Chesapeake has been active...We haven't seen outright guys pare their positions, but we haven't seen them come in to add either, so it's kind of a heavy market."

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

Its convertibles have been following the price of oil, which fell to $124.44 a barrel on the New York Mercantile Exchange on Wednesday.

Alliance Data plans offering

Alliance Data Systems planned to price $700 million of five-year convertible senior notes Wednesday after the market closed, with price talk at a coupon of 1.375% to 1.875% and an initial conversion premium of 20% to 25%.

Alliance common stock (NYSE: ADS) closed at $64.08 on Wednesday, up by 5.2% or $3.17.

There is an over-allotment option for an additional $105 million.

Banc of America, JPMorgan and Wachovia are the bookrunners of the Rule 144A offering.

Alliance, a Dallas-based marketing services company, said it plans to use the proceeds to buy back $300 million of shares, to pay about $105 million for convertible note hedge transactions and to repay two outstanding credit agreements in full to free up borrowing capacity.

"It's a great company, a good market position, models cheap," a sellsider said. "It's looking like it's going to price around 101, plus 0.75, somewhere around there. It's a very large company, they generate so much cash flow and they don't want their credit to reach what would be investment grade levels."

The sellsider, who used a credit assumption in the Treasuries plus mid-400 basis points region and a volatility in the high 30s, said Alliance wants to remain at a certain leverage level to reach an optimal capital structure because doing so could bring tax benefits and allow the company to return some funds to shareholders.

The deal could work for both hedge and outright investors, the analyst said.

Alliance has about $1 billion of credit card exposure on its balance sheets, but that exposure is mostly not subprime, the analyst said.

"They've never gotten involved in subprime," the analyst said. "They go after a more affluent clientele, and they haven't seen any problems with liquidity or access."

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