Citigroup: Convertible issuance trends in 2004, while bleak versus 2003, appear positive for 2005

By Ronda Fears

Nashville, Dec. 1 - U.S. convertible issuance ticked up slightly in November, and, moreover, issuance trends late in 2004, while bleak compared to 2003, appear positive for 2005,Citigroup Global Markets Inc. convertible analyst Stuart Novick said in a report Wednesday. At first blush, he is looking for 20% to 30% growth in issuance next year.

"The issuance trend remains stuck at a relatively low level. Indeed, annualizing the November totals would result in a full year convertible issuance total of less than $40 billion," Novick said in the report. "That would be the weakest year for new issuance since 1998."

2004 total 48% behind 2003

Issuance in November came to $3.3 billion from 16 issues, running fairly even with the 14 issues that raised $3.1 billion in October. For the year through the end of the month, there have been 177 new issues with $43.7 billion in proceeds, running 48% behind the same period of 2003 with 245 issues for $83.5 billion in proceeds.

Weighted average terms remained tilted in favor of convertible buyers last month as yields came in at 4.0%, a touch below 4.12% averaged in October, and premiums hit a low for the year at a modest 26.7%. Year-to-date weighted average terms were 3.48% up 34.84%.

"While the full year averages are not as user friendly as those posted in more recent months, they do represent a considerable shift from the 2.97% up 45.95% figures for all of 2003," Novick said.

The average size of a new convertible issued last month was just $206.9 million, a 10% decline from October.

2005 issuance looks promising

Based on the recent trends, Novick said a positive point is the notion that the convertible market is open to issuers of all sizes and there are buyers for small, relatively illiquid securities. On the negative side, however, he said there is the matter of illiquidity and the potential inability for investors to establish sizeable positions, sell positions in a quick and efficient manner or even short hard-to-borrow stock against a long convertible position.

"On balance, we're optimistic for a pickup in new issuance as we move toward 2005," Novick said in the report.

"Despite the small average deal size, activity does seem to be picking up as of late and we're hopeful that issuance improves heading into 2005. The election is now behind us, giving a lift to equities in November and while volatility slipped once again last month, it can't decline forever (can it?)."

$50-$60 billion seen in 2005

An "initial stab" at convertible issuance in 2005, Novick said, yielded a projection for total proceeds in the neighborhood of $50 billion to $60 billion, "which would represent a 20% to 30% uptick from the current annualized new issue volume of around $40 billion and a decent sized increase over the probable 2004 full year tally of around $48 billion."

He said the projection is based on the expectation of a 20% improvement in stocks and a rise in interest rates, noting that Smith Barney economic strategists are expecting the 10-year Treasury to end 2005 at around 5.25% - up from an estimated 4% at the end 2004.

"With interest rates likely to tick higher we'd also anticipate a continuation of the trend towards higher new issue yields, which may move closer to 4.5% in the coming months and a leveling off of new issue premiums, which, we believe are likely to hold within spitting distance of 30%," Novick added.

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