Salomon now expects 2002 issuance likely falling short of $50 billion mark

By Ronda Fears

Nashville, Tenn., Oct. 4 - For the third month in a row, convertible analysts at Salomon Smith Barney have lowered their forecast for new issues, now saying it will be tough to hit the $50 billion mark for 2002.

"Our previous estimate of convert issuance for this year was approximately $50 billion. Given the on-going weakness in equities, we now believe that the final tally will fall short of that mark," analyst Stuart Novick said in a recent report.

"With the equity markets falling to multi-year lows, the prospect of further convertible issuance in the near term is dimmed. The $50 billion low end of our previously estimated issuance range seems increasingly aggressive given the lackluster environment for stocks."

Through Sept. 30, issuance was at $43.7 billion versus $72.3 billion in the 2001 period, according to Salomon. In July, Salomon slashed the outlook for 2002 issuance by 25% to $50-$60 billion from an estimate of $80 billion coming into this year. In August, Salomon said it looked like the low end of the new estimate was more likely.

What it will take to revive the convertible new issue market is not a mystery but the timing of a recovery is difficult to gauge.

"Several factors could help get convertible issuance up off the floor. Probably most important among them is some sense that the equity markets have bottomed or at least stabilized," Novick said.

There were hopes that a bottom was hit after the shaky performance in August. However, equities nose-dived again in September as both the S&P 500 and the Nasdaq dropped 10.9% while the small-market oriented Russell 2000 declined 7.3%.

"Low interest rates remain important, too, although with already low rates trending even lower - Treasury yields are at 40 year lows - potential convert issuers may decide that a diminished yield advantage compared to straight debt imbedded in a convertible issue no longer warrants the forward sale of stock at a relatively depressed price," Novick said.

Demand is still very strong, though.

"Hedge funds, comprising the majority of today's convertible investor base, continue to post equity market bettering returns, meaning that cash is likely to keep flowing in to those investment vehicles," Novick said.

Specifically, convert arbitrage funds posted returns of about +0.5% in September, according to CSFB Tremont.

"While it is true that convertible arb funds have not performed all that well since the start of the year - down about 2% year to date according to Tremont - they have put up good returns relative to equities," Novick said.

"The outperformance should at least prevent any large scale redemptions for the time being and could possibly lead to more capital inflows in the near term. That means that more capital will be available to invest in converts."

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