Citigroup analyst: Duration adjustments may be needed for interest rate sensitive convertibles

By Ronda Fears

Nashville, March 9 - The prospects of interest rates increasing over the next two or three quarters, or even in 2004, may have been thwarted by recent economic data points, so the duration of convertible portfolios may need to be adjusted, said Citigroup Global Markets Inc. convertible analyst Adrian Miller.

"Last Friday's weak employment data may have taken the prospects of any Fed tightening off the agenda for 2004. The payroll data have broken the standoff in the bond market, probably ushering in lower benchmark yields across the curve and somewhat more volatile trading," Miller said in a report.

Citigroup projects Fed Funds to remain steady at 1% through the next six months, then at 1.25% and at 1.5% in 12 months. The firm forecasts 10-year Treasuries at 4% in one month, 4.25% in three months, 4.75% in six months and at 5% in 12 months.

Some of the most interest rate sensitive converts are the Placer Dome Inc. 2.75% due 2023, Yellow Roadway Corp. 3.375% due 2023, Liberty Media 3.5% exchangeable, into Motorola Inc., due 2031, Electronic Data Systems Corp. 3.875% converts due 2023 and American Axle & Manufacturing Inc. 2% convertibles due 2024.

Some of the least sensitive are the Devon Energy Corp. 4.95% exchangeable, into Chevrontexaco, due 2008, WPP Group plc 3% due 2005, Advanced Energy Industries Inc. 5% due 2006, Imclone 5.5% due 2005 and Kulicke & Soffa Industries Inc. 5.25% due 2006.

As a point of reference, the analyst noted that the weighted average rate within the convertible market is 1.3%, down from 1.7% in September 2002 when the convertible market's equity profile was at historic lows.

To help investors match up to the proper Treasury benchmark, he also supplied the modified duration of various Treasury issues across durations: For six-month T-bills 0.483, for one-year Treasuries 1.043, for two-year Treasuries 1.937, for five-year Treasuries 4.557, for 10-year Treasuries 8.139, for 15-year Treasuries 9.502 and 30-year Treasuries 14.713.

"Naturally many fixed income managers are quite interested about the projected trends in rates, since the value of their holdings are directly correlated to interest rate movements," Miller said.

"Convertible investors are also interested as the value of the bond floors of their issues are subjected to the same rate changes.

"Hedge funds also care due to the potential changes in their financing costs, and also the impact on their interest rate and credit spread hedging strategies."

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