Spread compression helped boost convertible returns: Salomon

By Ronda Fears

Nashville, Dec. 5 - Convertible returns in November got a significant boost from the spread compression in high-yield bonds, which in return was a response to the perception of a much improved credit environment, Salomon Smith Barney analysts pointed out in a report Thursday.

"The name of the game within the fixed income markets in general and the convertible market in particular was the narrowing of credit spreads," said convertible analysts Adrian Miller and Stuart Novick in the report.

"Across the high yield market, weighted average spreads came in anywhere from 100 bps to 250 bps depending on the duration, credit and industry group. This perception of a much improved credit environment had an obvious affect on the convertible market."

The high yield market's robust +7.6% return in November had a dramatic effect on the credit-sensitive sector of the convertible market, which is about 60% of the whole U.S. convert market.

U.S. convertibles posted a cap-weighted return of +6.8% for November, while the underlying stocks gained +18.5%.

"Within the convertible market, the spread compression was most evident in the technology, telecommunication and telecom equipment space," the analysts said.

"On average, the convertible market saw spreads within these categories come in during November to the tune of 100 bps, 150-200 bps and 300 bps, respectively. When you do the math, this magnitude of spread compression coupled with the current average duration for many of the names in these groups, translates into very strong price improvement."

There were many cases in which spreads narrowed even more dramatically, the analysts noted, such as the American Tower 5% convertible due 2010. As of Oct. 31, that convertible was trading with an implied spread of 2,500 basis points - with a premium of 1,434% and an option delta below 1.0%.

A month later, after American Tower stock surged 175%, the implied spread tightened to 1,350 basis points. The analysts noted that the huge premium on the issue would have prevented it from participated in the stock movement to any great degree.

Even more dramatic was Amkor Technology's 5.0% convertible due 2007, the analysts added. From October to November, the implied spread on this issue fell from 3,000 basis points to 1,375 basis points.

"One could say this was an early Christmas present for holders of this issue since most rational investors would have never envisioned such a one month move," the analysts said.

"These two examples were not isolated cases, as there were many more."

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