Financials lifted by Citi exchange offer; Citi preferreds jump; health care under pressure

By Rebecca Melvin

New York, Feb. 27 - Financial convertible preferreds were active at higher levels Friday after Citigroup Inc. and the U.S. Treasury unveiled an exchange offer for the preferred shares as part of an effort to realign the ailing bank's capital structure, sources said.

The Citigroup 6.5% convertible preferreds jumped to as high as 20, before settling back to about 15, which was up 4.5 points, or 42%, from Thursday, according to a New York-based sellside trader.

Bank of America Corp. and Wells Fargo & Co. securities also strengthened.

Health care names remained under pressure after details of president Barack Obama's proposed budget suggested less support for that sector. But Omnicare Inc. recovered Friday after the geriatric drug-services company forecast 2009 profit that was better than analysts expected, another New York-based sellside trader said.

Friday was the last trading day of the month, and traders marking their books for February said they thought convertibles held their own despite losses in underlying equities, and in many cases were better.

"Overall, stuff was creeping better all through February. It wasn't as good as January, but I think it was still pretty decent," an East Coast-based buyside trader said of convertibles' performance.

On Friday, equities slumped again after the Citigroup deal spooked common stock holders, who face massive dilution from the arrangement, and after word that GDP contracted at a worse-than-expected 6.2% pace in the previous quarter, according to the Commerce Department.

For the month, the S&P 500 stock index was down 11%. It closed at a 12-year low on Friday to 735.09, which was down 17.74 points, or 2.4% on the day.

As for the primary market, yet another week passed without new issuance in the convertibles market, leaving February's new issuance level at a meager $25 million and bringing new issuance for the year to just under $800 million, which compares to about $15 billion for the same period of 2008.

Of new issuance, one New York-based sellsider said, "Supposedly there's some in the pipeline, but it's been a few weeks since NEM [Newmont Mining Corp.] ...where are they?"

Citi preferreds jump

The Citigroup preferreds doubled from Wednesday but didn't trade at that high level much, sources said, fixing the 50% higher level as more accurate.

Trades were reported at 16.85, and the paper went out at about 15, sources said. Common shares of the New York-based financial company plunged 39%, or $0.96, to $1.50.

"A lot of people are realizing the preferreds are in fact the equities. There are differentiations with the different preferreds based on what happened to Citi. But people are figuring out what a similar kind of exchange would mean for Bank of America or Wells Fargo, for example," a New York-based sellside trader said.

Under the arrangement, Citi will offer to exchange up to $27.5 billion of its existing preferred stock held by private investors at a conversion price of $3.25 per share. That's a 32% premium over Thursday's closing price of $2.46.

The administration decided to restructure the bailout package for Citigroup again with the aim that by converting $25 billion of preferred shares into common stock it would give investors more confidence that the bank has sufficient capital reserves to withstand mounting losses.

Fundamentally the offer is positive for Citigroup, but the common stock is down because "the dilution is huge, plus you have the government owning 36%," a sellsider said.

People who like it [the program] are buying the preferred," he said.

The Citi 6.5s are covered in one of three tranches of the exchange offer. And while it wasn't yet known exactly how much common stock would be exchanged for the preferreds, it was consensus that investors would participate in the tender since the alternative was unpalatable.

"Of the segments, the private issue has agreed to be done, and we'll see how much the public issue wants to participate. But I think people will participate," a buysider said.

"You'll get so much stock, you can convert with a much higher conversion ratio. It's enough to take the preferred up, even though the stock is down," the buysider said.

"We don't know what the par value is going to be, but it's very positive for the bond holders," a sellsider said. "It's not something Citi wanted to do, but holders are getting more than they had."

Citi plan lifts B of A, Wells Fargo

Using Citi as a model, Wells Fargo is worth 82 on a 46, the trader said, and Bank of America is worth 60.

"I'm sure Bank of America isn't in the same boat [as Citi], and I know Wells Fargo isn't, but they were all higher. Then they sold off, and now they are rallying up at the close," the trader said.

Charlotte, N.C.-based Bank of America's 7.25% convertible preferred traded at 395 intraday, which was up from around 360 on Thursday and 345 outright on Wednesday. The bank's common stock plunged 26%, or $1.37, to $3.95 on Friday.

San Francisco-based Wells Fargo saw its 7.5% convertible preferreds trade at 515, which was up from 460 on Wednesday. The common stock finished down 16%, or $2.30, at $12.10 on Friday.

Another confusing situation

SLM Corp. convertible preferreds, which dropped outright Thursday after the White House proposed cutting private players out of the federal college loan program, were quiet on Friday but seen at about 320, or 3 points over parity.

"They are trading at close to parity; there's not a whole lot of dividends," a trader said, referring to it as another confusing situation for investors to figure out.

A buyside analyst said: "We are in the process of evaluating SLM as a going concern. [I] can't really say right now except that it has value beyond where the stock is trading. Bad headline, but they do have value as a servicer, and there is runoff value in the existing portfolio plus they have a debt collections and private student loan business that are both pretty good."

Shares of the Reston, Va.-based student lender shed another $1.20, or 21%, to $4.60 on Friday. On Jan. 26, the SLM preferreds traded at 505 versus a share price of $9.50.

Omnicare rises on outlook

Reversing losses notched Thursday, the Omnicare 3.25% convertibles due 2035 gained in line with its shares Friday to end at 67 bid, 68 offered versus a share price of $25.93.

One trader said he had a trade at 69 versus a stock price of $25.50.

Shares of the Covington, Ky.-based geriatric pharmaceutical concern added $2.28, or nearly 10%.

Omnicare, which reported fourth-quarter results Thursday, said it expects to earn $2.50 to $2.60 per share this year. Analysts were expecting $2.40 per share.

While its stock and bonds fell Thursday following the introduction of president Obama's proposed budget, the securities rose on the quarterly report on Friday, a New York-based sellside trader said.

"Health care stocks got crushed for two days. They're destroyed with the Medicare reimbursements, health care programs and current political environment. But Omnicare came back strong today," the trader said.

He said he prefers the company's convertible preferreds over the bonds because they set up better with a heavy delta.

The Omnicare 4% convertible trust preferreds due 2023, a low point premium name, were seen at about 4 points above parity, at 35 bid, 36 offered, at the close.

Mentioned in this article

Bank of America Corp. NYSE: BAC

Citigroup, Inc. NYSE: C

Omnicare Inc. NYSE: OCR

Wells Fargo & Co. NYSE: WFC

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