Trading very thin, but dividend anxiety sparks markdowns; slow issuance seen through holiday

By Ronda Fears

Nashville, Aug. 22 - Trading was very thin Friday, but dealers were marking most of the convertible market lower. Specifically, some traders noted some sharp markdowns as a result of renewed dividend anxiety.

The primary market remained stilled by the summer doldrums, with only one issue injected this week while another got scrapped amid the lull. Capital markets sources say there probably won't be much in the way of new issues until after the Labor Day holiday.

With liquidity constrained by so many players taking vacations, which also has been the biggest obstacle to launching new deals, many fund managers are doing homework, looking for opportunity. Some have been eyeing issues that have been cheapening, for buying, while a fair portion of the market is for sale.

To some extent, though, buyside sources say the blows to hedge fund returns have made that group a bit skeptical of buying lately. But one hedge fund manager said the only successful way to play the convert market right now is with a long position.

"July was intensely difficult. A more bullish [economic] outlook drove stocks up but the Treasury and credit markets took the heat. On top of that, volatility cratered," said the hedge fund manager, who co-manages an international portfolio with about one-third of the $1.5 billion in assets under management invested in the U.S.

"Treasuries were just bludgeoned. The 10-year yields have backed up around 150 basis points to nearly 4.5% today. It was a bloodbath, and it spilled over into all the credit markets, including converts."

August has not provided a great deal of relief, he added, but looking back at July has steered him to commit to a long position at least near-term.

"The hedged strategy lost ground because vol collapsed and the credit strategy was leveled by the carnage in the bond markets," he said.

"The balanced strategy, or long convertible, showed the only positive returns in the face of rising stocks. So if you are bullish, then that's how you want to play the market right now. At least probably the next couple of months, though about the end of third quarter, that seems to be smart."

During the latter part of this week, sellside traders reported that the mood in the market seems to be leaning more toward buying, but there also has been renewed anxiety about dividend risk this week that sparked some selling Friday.

"Outrights are pretty much hanging with the status quo. They are doing pretty well," said a senior convert trader at a bulge bracket firm.

"If they are selling right now, it's to take some profits and put that capital somewhere else, probably any new paper that looks okay. Or, they are getting rid of stuff they are nervous about, like maybe about dividends or call protection."

When it comes to unloading converts because of dividend or call anxiety, however, it's not limited to the outrights. Several sources at hedge funds were chattering about dividend risk Thursday and Friday, specifically pointing to a list of "suspects" circulated Thursday by one of the smaller shops.

AmeriSourceBergen Corp., Freeport-McMoRan Copper & Gold Inc. and Northrop Grumman Corp. were mentioned in that vein.

The AmeriSource Bergen 5% due 2007 dropped 1 to 1.25 points on the day to 126.25 bid, 125.625 offered while the stock lost 88c, or 1.46%, to $59.26.

Freeport McMoRan's newest 7% due 2011 fell 3.875 points to 121.125 bid, 121.625 offered and the old 8.25% due 2006 plunged 12 points to 194.25 bid, 194.75 offered. The underlying stock closed down $1.71, or 5.89%, to $27.32.

Northrop's 7.25% mandatory due 2004 fell 1.75 to 2 points to 104 bid, 104.5 offered while the stock dropped $2.29, or 2.36%, to $94.82. A buyside trader said there was some general profit taking in Northrop, following a strong run this week, as well as some selling that was specifically related to dividend anxiety.

For the second day in row, Interpublic Group of Cos. Inc.'s newest convert gained ground, too.

While the company was among the latest list of dividend candidates, its 4.5% due 2023 convert is seen insulated from the blow to yield in the event Interpublic's results turn positive and it begins paying a common dividend. The ad agency has three other converts.

Interpublic's 4.5s rose 1 to 1.25 points on the day to 138.125 bid, 138.625 offered. The stock closed up 18c, or 1.3%, to 14.07.

A sellside trader noted another reason for the firmness in Interpublic in the past couple of days might be related to activity in some of its bank negotiations.

On Wednesday, Interpublic said in an SEC filing that on Friday - the day immediately following the blackout in the Northeast U.S. and Canada - a number of its subsidiaries entered into a subsidiary guaranty in favor of the lenders under Interpublic's 5-year credit agreement dated June 27, 2000, and amended Dec. 31, 2002, and 364-day credit agreement dated May 15, 2003.

Otherwise, dealers noted selling in American Electric Power Co., which had managed to dodge blame in the outage last week, as it came under fire by the Ohio Public Utilities Commission and in a Wall Street Journal story. The company responded, saying that its automated controls in fact prevented the spread of blackouts, but traders said there was some heavy selling in both the stock and the AEP convert.

AEP's 9.25% mandatory due 2005 dropped 0.75 point on the day to 44.75 bid, 45 offered, according to a dealer. The stock lost 40c, or 1.4%, to $28.07.

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