Salomon analyst: Issuance should pick up for 2002 total of $50-$60 billion

By Ronda Fears

Nashville, Tenn., Sept. 5 - Convertible issuance has shrunk to its worst level in about three years but there should be a pick-up in the remainder of the year that will support a total of $50-$60 billion for 2002, according to Salomon Smith Barney convertible analysts.

The S&P 500 hitting 1,000 is something to watch for in anticipation of a turnaround is new issue flow, said Salomon convertible analyst Stuart Novick in a report Thursday.

"More than anything else, we believe that potential issuers will need to get a sense of market stability before issuance trends improve," Novick said.

"While our $50 billion-plus estimate for convertible issuance in 2002 is looking more and more optimistic, we still believe that a seasonal pickup along with some relative stability in the equity markets will result in an uptick to new issuance."

In July, Salomon convertible analysts slashed their outlook for 2002 issuance by 25% to $50-$60 billion from an estimate of $80 billion coming into this year.

The "aggressive looking" $50-$60 billion projection would work out to $1.8 billion to $4.4 billion in new issuance per month for the rest of this year - well above recent totals, the analyst said.

"But we think that a seasonal pickup and the recent calm in the equity markets will give a lift to convertible issuance in the coming months," he said.

"Still, at this point, we are leaning towards the low end of that range."

August was the weakest month for convertible new issuance since October 1998, when, on the heels of the Asia crisis, no new convertibles were issued. For the month just gone, only two new convertibles were issued, bringing in proceeds of just $315 million including the greenshoes.

It is interesting to note, Novick said, that the last time convertible issuance literally ground to a halt back in the fall of 1998 was also the last time that the S&P 500 fell below the 1,000 point benchmark.

Since the S&P 500 sank through the 1,000 point threshold on June 21, there have been only six new convertible offerings.

So, what will it take for convertible issuance to rebound? First, an equity market upturn, or at least a period of relative calm, the analyst said.

"Again examining history, we see that once the S&P moved solidly above 1,000 back in October of 1998, the convertible new issue market got healthy in a hurry. After weighing in with nothing in October of 1998, issuance shot up to $1.64 billion in November and $2.23 billion in December," Novick said.

"We don't necessarily see the 1,000 level on the S&P as a hard and fast floor under which no new converts would get issued. We do, however, see the need for some sustained rally or at least sense of equity market stability to get convert issuance rolling again."

Also, the low interest rate environment remains important, he added.

"With one-year Treasuries yielding a paltry 1.6%, potential bond issuers are trying to take advantage of opportunities to raise low-cost capital," Novick said.

"Convert buyers hoping to put money into new issues should not, however, want rates to go too low, as that development could erode one of the main advantages of issuing a convertible - the lower-than-straight-debt coupons."

Indeed, with interest rates so low, potential convert issuers may decide that the small amount of potential savings on the coupon side would be outweighed by the prospect of having to sell stock forward at relatively depressed prices, he noted.

However, money does continue to flow into bond funds as investors try to add some juice to the inflation-lagging returns on Treasuries while avoiding the turbulence in the equity market tumult, he said.

Novick said the Goldman Sachs convertible arbitrage index shows convert arb fund assets grew 10% in the second quarter. The actual intake in the quarter, according to Tremont Advisors, was $935 million for convert arb funds, unlevered, he said.

"Those inflows, combined with very limited new convertible supply and net convert market shrinkage would suggest that more convertible paper is needed to absorb those excess funds," Novick said.

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