Beazer, other builders pressured by rising interest rate atmosphere; Countrywide, Household also off

By Ronda Fears

Nashville, June 9 - The convertible market settled down somewhat Wednesday after two days of agitation stemming from cash takeover risks, but the primary side of the market remained stilled by the uproar. A clearer message on higher interest rates earlier this week by Federal Reserve chairman Alan Greenspan also was holding back new deals and caused a snapback in mortgage lenders and homebuilders.

While emotions calmed, convertibles were weaker again Wednesday.

"The market again seems heavy," said a sellside market source. "People apparently are worried that vol will continue to decline in the summer, now. There are also concerns about possible redemptions, although I have not heard that there have actually been any."

The surprise bid for Mandalay Resort Group by MGM Mirage triggered the market's upset, and traders said the Mandalay convertible floater lost more ground Wednesday as MGM extended talks with Mandalay until Friday but said it would not up its $7.65 billion bid, which includes the assumption of $2.8 billion of debt.

Dealers said flow picked up considerably Wednesday but noted that, despite some cheapening in the market over the past week, there still were not a lot of buyers.

As it stood late Wednesday, market observers speculated that the small Great Plains Energy Inc. deal would be the only one for this week, but at least it wasn't an altogether shut-out.

Great Plains Energy's $150 million mandatory convertibles, with a dividend of 8% and 18% initial conversion premium - opened slightly under par of 25 and pretty much stayed there, a buyside trader said. Bookrunner Merrill Lynch closed it at 24.96, while the stock ended unchanged at $30.02.

Origination officials at several desks said they were taken back a bit by issuers' reluctance to bring deals, considering the looming rate climate. But the buyside's reaction to Mandalay was a major factor in moods, too.

Countrywide, Household off

On the heels of Countrywide Financial Corp. reporting that mortgage applications in May plunged 39% from a year ago, blaming higher interest rates, its convertible continued to slide and took peers like HSBC Holdings plc - Household - down with it.

Countrywide's 0% convertible was quoted down another 0.75 point on Wednesday with a bid of 4 points over parity and an offer of 4.25 points over. The stock edged up 29 cents, or 0.44%, to $66.93 after losing almost 3% on the news Tuesday.

The Household 8.875% mandatory lost 0.375 point to 41.125 bid, 41.625 offered with HSBC shares down 76 cents, or 0.99%, to $75.68.

In addition to mortgage application volume declining, Countrywide also reported that mortgage loans in the pipeline fell 33%.

Countrywide said its servicing portfolio passed $700 billion, up 32% from a year ago, but a convertible dealer said that may cause concern going forward in an inflationary-type environment, depending on the credit quality of those loans and mortages.

Homebuilders still tumbling

Similarly, homebuilders were beginning to feel the pain of a rising interest rate climate, as Beazer Homes USA Inc.'s new convert as well as Lennar Corp. and Danaher Corp. were all lower again Wednesday.

"So far, these guys [homebuilders] have held everything together, all the numbers still look pretty good, but there's just a lot of anxiety about rates right now and if it's [the interest rate hike] more aggressive than we expect, there could be real trouble ahead," said a buyside convert trader.

Beazer, before pricing the convertible last week, had reported a record fiscal second quarter, and the credit was upgraded by Moody's following the convertible sale plus a new bank facility. Also last week, Lennar said new home orders in second quarter are up 17% thus far. And a couple of weeks ago, Danaher affirmed its second quarter guidance.

The scare, however, was set off by Greenspan's unexpected statement this week that he might favor a more hard-line approach to raising interest rates than a measured series of rate hikes, the trader said.

Then, he said, the concern was fueled by Dominion Homes Inc. warning that its second quarter sales will be "significantly below" a year ago due to rising interest rates.

Cheapening not enough yet

Market players and onlookers say there has been some cheapening in the convertible market over the past week, most pronounced this week so far, but it hasn't reached a level yet where there are buyers flooding the market with bids.

By some estimates in the buyside, some three-quarters of the convertible market overall was given a haircut this week, by as much as 5%. Sellside market sources don't think it was that dramatic and see it more localized rather than a broad-based discounting.

Still, after a steep runup in the market over the past couple of years, many buyside sources say the softness so far has not turned any heads.

"I'm nibbling," said a multi-strategy fund manger in New York. "These trends don't always stop right away, so you don't know if you are getting in too soon."

On a parallel line of thought, several sellside traders said they expect buying to dominate by week's end, at least in some "pockets of opportunity" created by recent declines.

Correction fleeting, some say

Basically, the cheapening so far is the result of the herd mentality, said a sellside source, and as such will be short-lived.

"Do I see a major correction for the convertible market? No. There is no meltdown," he said.

"The market is deep enough and broad enough, with enough capital and enough diversification in terms of investors now to withstand this."

The price slashing over the past week, the veteran sellside source said, was just a matter of desperation, a knee-jerk reaction to the takeover risk underscored by the Mandalay situation, which was a shocker no one saw coming.

"It's a macro issue, really," he said. "If inflation is higher than people expected and that causes the Fed to raise rates higher and faster than anticipated," it would cause a serious backlash.

Not only would carrying costs balloon, he said, but credit spreads would widen and stocks would likely take a dip. Together, that all might spark a slight uptick in volatility, he said, but that would not go far to offset the damage.

What he expects, rather, is that the convertible market will continue cheapening slightly and steadily short term, through June and maybe into July or until there is a definite action taken by the Fed. Then, particularly as new-issue flow resumes, the market will settle back to levels pretty much at fair value.

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