Fannie Mae, Sovereign, Lehman crash, Wachovia improves on Fannie-Freddie bailout; UAL ignores rumor

By Kenneth Lim

Boston, Sept. 8 - Financials had a mixed session on Monday as a government bailout of mortgage institutions Fannie Mae and Freddie Mac dominated trading in the convertible market.

Fannie Mae's 8.75% mandatory convertible preferreds due 2011 lost almost all of their value to trade at parity following the bailout, which cut dividends on the preferreds.

Sovereign Bancorp Inc., one of the largest holders of Fannie Mae preferreds, saw its 4.375% convertible perpetual preferreds drop about a dollar. Lehman Brothers Holdings Inc.'s new 8.75% mandatory convertible preferreds also lost about 10 points outright.

Wachovia Corp.'s 7.5% perpetual convertible preferred, however, improved as investors thought the mortgage lender would benefit from the bailout.

Outside of the financials, UAL Corp. stayed quiet despite a mid-morning scare when a newspaper's years-old story about the company filing for bankruptcy was mistakenly put back into circulation.

"I didn't see any UAUA today," a sellsider said. "I saw about that bankruptcy thing, though. But I think even if you traded it, the trade may not be allowed in the end."

Fannie Mae crumbles

Fannie Mae's preferreds collapsed on Monday in the wake of a government bailout of the mortgage giant.

Fannie Mae's 8.75% mandatory convertible preferred fell to parity of about 1.25 on Monday, losing about 90% of its value from before the weekend. Fannie Mae common stock (NYSE: FNM) dropped 89.63% or $6.31 to close at $0.73.

"We thought the preferred holders would receive some kind of preferred treatment by the government...the fact that the firms themselves had depended pretty heavily on preferred financing and the preferreds were so widely used," a sellside analyst said. "They did not do that, and the dividend will be suspended. If you've got a convertible preferred...your dividend got yanked out from under you, the common stock is probably going to zero."

The U.S. government said over the weekend that it will take over Fannie Mae and Freddie Mac. The U.S. Treasury will inject $1 billion in each company in exchange for senior preferred stock and warrants. The government will also buy mortgage-backed securities held by the two companies. But dividends on the preferreds were suspended.

Bailout hits some banks

Sovereign Bancorp and Lehman Brothers were two of the bigger victims of the plan, given their significant holdings of Fannie Mae common and preferred stock, market sources said.

Sovereign's 4.375% convertible closed at 14.55 against a common stock price of $9.02. Sovereign common stock (NYSE: SOV) fell 6.63%.

Lehman Brothers' 8.75% convertible preferred was seen at 555 against a stock price of $13.40, down about 10 points outright. Lehman Brothers common stock (NYSE: LEH) closed at $14.15, a 12.65% or $2.05 decline.

"I heard from someone who said that the Lehman preferreds were also getting weak off of the Fannie Mae deal," a trader said. "I expect why the Lehman preferreds were weaker today was people were expecting those dividends to be cut."

Other banks gain

Wachovia was among the banks that improved on news of the bailout.

Wachovia's 7.5% convertible preferred traded at 87 versus a stock price of $18, up about 3 points outright. Wachovia common stock (NYSE: WB) jumped 13.37% or $2.24 to close at $18.99.

The different fortunes across the financials were largely a factor of the size and nature of each bank's exposure to Fannie Mae and Freddie Mac and their relationship to the mortgage business, observers said.

"I think it has more to do with where they are in the home mortgage process or cycle," the trader said. "The banks that have more of a mortgage lender type bank, like Wachovia, I think the sense is there's going to be a stronger bid now for those mortgages, they can sell to Fannie or Freddie, they can start making money again on that part of the business. Some like Lehman...they may start cutting their own dividends."

But the bailout also helped to chase away some shadows that had plagued the bigger market, a desk analyst said.

"I think the market is sort of applauding the fact that a big piece of uncertainty is gone away, right," the analyst said. "The government did step in, they're going to guarantee the debt of Freddie and Fannie, you can see a lot of this rallying today. But from an outlook standpoint, you look at the companies themselves and their own financials."

MRU, Mylan plan deals

MRU Holdings, Inc. plans to offer up to $250 million of equity or convertible debt securities, the company announced in an 8-K filing.

Market sources told Prospect News they had not seen price talk on Monday, and speculated that allocations could be limited given the small market capitalization of MRU.

"It's a market cap of $22 million and they're raising $250 million," a sellsider said. "Even if they're doing convertibles, I don't think it's going to go out to many people."

MRU, a New York-based provider of student loans, said it will use the proceeds to finance the growth of its business, finance private student loan originations, repay outstanding bridge and other note obligations and for general purposes.

Mylan Inc. plans to offer $400 million of seven-year convertible notes, the company said in a press release.

There is an over-allotment option for an additional $60 million on the Rule 144A offering.

Proceeds will be used to fund the hedge and warrant transactions, to pay down an outstanding Libor plus 250 basis points senior secured revolving credit facility and senior secured term loan facilities that current bear interest of Libor plus 300 bps to Libor plus 325 bps.

Mylan is a Canonsburg, Pa.-based maker of generic drugs.

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