Kodak CDS spreads blow out; Tower 5.75s firm on financing noise; Reebok up on CoCo tender

By Ronda Fears

Nashville, Oct. 21 - Cheapening on the credit side of convertibles is happening sporadically, like with Eastman Kodak Co. on Thursday, but market sources say the market is still a long way from making a correction that bring prices to more realistic levels.

"We hear the market is cheapening, from the guys on the sellside, but that is a subjective term, or relative, I suppose," said a convertible trader at a big outright fund based in New York. "Credit spreads had gotten so tight, they have a long, long way to go to look cheap by any stretch of the imagination. Compared to last month, or three months ago, or whatever, yeah, they look cheap, but they aren't really."

Kodak's convertible held up rather well against the pressure, which stemmed from disappointing earnings and a negative credit rating watch, traders said, if arbitrage holders boosted their hedge.

Otherwise, traders said the market really was a tad firmer although there were some soft spots. One area of concern for the sellside especially was the developing story of wrong-doing as it relates to insurance brokering, which for some lower tier investment banks is a major source of non-interest income.

Kodak credit spreads blow out

Kodak's credit default swap spreads were "pushed way out," as a sellside source put it, on its earnings. The five-year CDS paper blew out to 135 to 140 basis points over Libor on Thursday, compared with 96 basis points a couple of days ago.

But, a buyside trader said the 3.375% convertibles managed to "hang in there, pretty steady" with heavier hedge, noting it had typically been trading on a 70% hedge. He pegged the issue off about a quarter-point to maybe a half-point lower on swap.

Kodak's convertible closed the session at 118.5 bid, while the stock ended off 11 cents, or 0.378%, to $29.39.

CreditSights analysts noted in a report Thursday that Kodak's 7.25s of 2013 traded at a bid-side level of 153 basis points over Treasuries last week and even tightened considerably to 255 basis points when the earnings were released; but they predicted the "trend will reverse this morning."

The CreditSights analysts said they are maintaining an underweight recommendation on Kodak bonds as its core business continues to decline and margins remain low in digital business - a business where there, in fact, is no track record of profitability. The company's restructuring efforts are appreciated but risks remain, the analysts added.

Standard & Poor's put Kodak's BBB- long-term and A-3 short-term ratings on negative watch, reflecting heightened concern about its profit outlook given the rapid erosion of core traditional film sales and increasing risks in its move to a business mix weighted more to digital photography.

Kodak profit outlook dimmer

Kodak's sales increased only 1% year over year to $3.36 billion and were down 2% excluding foreign currency gains. This was below Street consensus of $3.54 billion, and the company said it expects worldwide unit film sales to decline in the range of 10% to 12% this year, with unit sales down 18% to 20% within the United States. Next year, industry demand is expected to drop even further as film demand in the United States falls 30%, driving a 20% decline in demand worldwide.

Digital product sales increased 39% year over year to $1.2 billion and continue to represent a larger proportion of the company's product portfolio. However, as sales from Kodak's core consumer film business continues to fall - dropping 13% year over year to $2.1 billion - the company has not been able to recover the lost sales, earnings and cash flow that these businesses have historically generated.

Besides the profitability matters, S&P said other concerns about Kodak's credit include the company's large unfunded postretirement liabilities. On a preliminary basis, S&P said it expects any downgrade would be limited to one notch.

Tower 5.75s bobble on buzz

Tower Automotive Inc. may be able to shake the speculated 277 Park Ave. "curse" involving the upcoming coupon payment due on its 5.75% converts. After all, the Boston Red Sox beat the New York Yankees to go to the World Series, apparently breaking the folklore curse on the Bean Town team that has been a dark cloud over it since trading Babe Ruth to New York almost a century ago.

The 5.75% convertible was firmer by some accounts by 1.5 points on rumors abounding that the Novi, Mich.-based auto parts and components maker may have secured a $100 million accounts receivables collateralization deal. On Wednesday the bonds had been described as 2 points lower on a big position getting sold out due to concern about the upcoming coupon payment.

A buyside convertible market source had proffered the 277 Park Ave. curse theory related to the Tower Automotive convertible because it is already trading at distressed levels after being sold just in May, thus putting the first coupon Nov. 15 in jeopardy. The 277 Park Ave. reference comes from the underwriter and its link to other convertibles that have defaulted before the first coupon.

The Tower Automotive 5.75% convertibles closed out at 43.1875 bid on Thursday, a sellside convert trader said. Tower shares ended unchanged at $1.22 but with heavy trading volume.

Tower Automotive and R.J. Tower bonds have been "all over the map" for the entire week, a distressed bond trader said on rumors speculating the company is working on a collateralization financing package that would provide much-needed capital.

Believers pushed up the R.J. Tower 12% notes due 2013 to 67.5 bid, 69.25 offered right at the end of the day Thursday, he said. But the trader noted that the noise Thursday was about a $100 million accounts receivable securitization, which was rumored to be $200 million on Wednesday.

Nothing has been officially announced by Tower Automotive.

PMA revised offer doable

Finally, market sources said PMA Capital Corp. has put an exchange offer on the table that has a chance of flying. In fact, a market source predicted the new convertibles should trade up at least to 110.

PMA Capital on Thursday amended its offer for any and all of its $86.25 million 4.25% senior convertible debentures due 2022. Significant amendments were made, including the elimination of optional redemption provisions prior to 2008 and higher put prices, but also the reduction of the coupon from 7.5% to 6.5%.

"They are having extra shares convert at $8 - a great deal for bondholders," the trader said. "The new issue should trade up to at least 110 and the common will trade closer to book once they get the upgrade from A.M. Best, which they should.

"They are thick," he added. "It's silly. They could have done it right the first time. Interesting that the bondholders get first right to up-streamed dividends now, but it's a big plus for bondholders. This will work."

The exchange offer has been extended to midnight ET on Nov. 3.

Reebok up on CoCo removal

As expected since Sept. 30 when new accounting rules were adopted for contingent convertibles, the number of exchange offers to remove the contingent conversion features are beginning to stream into the market.

Reebok International Ltd. made the latest exchange offer, on Thursday, specifically to remove the CoCo features. The 2% convertible was bid up about a quarter on the expectation that the new convertibles being offered would be worth more.

On Sept. 30, the Financial Accounting Standards Board adopted a new accounting rule requiring issuers of convertibles with contingent conversion features to estimate potential dilution to reported earnings per share, as if the bonds were converted.

It is a far-reaching change for the convertible market and had been expected to incite a rash of exchange offers to remove the CoCo features.

On Wednesday, Yellow Roadway Corp. announced an offer to exchange its CoCo convertibles for new notes with a net share settlement feature. On Tuesday, HCC Insurance Holdings Inc. launched an exchange offer for its 2% convertible and though its offer does not specifically amend the notes for net share settlement, it includes language for the company to pay the notes in cash and/or stock.

By inserting a net share settlement feature, the minimization of dilution effected by the CoCo feature is achieved.

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