Merrill convertible analyst notes rich secondary market helped with growth

By Ronda Fears

Nashville, Jan. 2 - The convertible market grew by $80 billion in 2003, according to Merrill Lynch & Co. Inc. statistics, and a large degree of that growth came from the rich secondary market, which surged in December much like during the entire year.

Merrill convertible analyst Tatyana Hube noted in a report Friday that in December redemptions and the like almost entirely offset new issues injected into the market. She tallied a net gain of $460 million to the convertible universe from the new issue slate last month.

For the month, however, she said the convertible market grew by $7.1 billion, which she attributed to "solid performance of the convertible secondary market."

The total market value for Merrill's master convertible index increased to $292.8 billion at the end of December, up from $212 billion at year-end 2002 and more than double the $120.6 billion market value at the end of 1997.

Conversion premiums shrank on the outperformance of the underlying equities, but Hube said the convertible market remains rich. The average conversion premium dropped from 52.6% at the end of November to 48.8% at the end of December.

The average theoretical discount for Merrill's convertibles index remained rich at 0.02% at the end of December, or right at about fair value, Hube said, "as supply still lags demand and market volatility stays low."

Popular cash-paying convertible bonds are now a majority of the market's profile, however, following the contributions from new issues in 2003. Coupon convertible bonds made up 58.2% of the Merrill index at year-end 2003, up from 43.5% at year-end 2002. Zero-coupon bonds saw a counteracting decline, dropping to 19.8% of the market at year-end from 30.6% in 2002.

In December, the top 10 convertible performers, ranked by contribution to Merrill's broader total return index in terms of absolute performance were the General Motors Corp. 6.25% due 2033, up 15.21%; Ford Motor Co. 6.5% convertible trust preferred, up 13.77%; Tyco International Ltd. 2.75% due Jan. 15, 2018, up 10.25%; General Motors 5.25% due March 6, 2032, up 12.95%; Tyco 3.125% due Jan. 15, 2023, up 12.44%; United States Steel Corp. 7% convertible preferred, up 39.15%; Sirius Satellite Radio Inc. 3.5% due June 1, 2008, up 51.13%; Xerox Credit Corp. 7.5% convertible trust preferred, up 10.63%; Xerox Corp. 6.25% mandatory convertible, up 11.53%; and, Liberty Media/AOL Time Warner Inc. 0.75% due March 30, 2023, up 5.98%.

In December, the bottom 10 convertible performers, ranked by contribution to Merrill's broader total return index, in terms of absolute performance were the Sandisk Corp. 4.5% due Nov. 15, 2006, down 22.89%; Advanced Micro Devices Inc. 4.5% Dec. 1, 2007, down 13.71%; Washington Mutual Inc. 5.375% convertible preferred, down 7.97%; Nortel Networks Corp. 7% mandatory convertible, down 6.21%; Lucent Technologies Inc. 2.75% due June 15, 2025, down 7.56%; Corning Inc. 3.5% due Nov. 1, 2008, down 7.29%; Corning 7% mandatory convertible, down 8.87%; Lucent 2.75% due June 15, 2023, down 5.51%; Lowes Cos. Inc. 0% due Feb. 16, 2021, down 5.05%; and Agere Systems Inc. 6.5% due Dec. 15, 2009, down 7.19%.

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