Churning buoys trading flow but active issues continue to shrink; power, retailers focal points

By Ronda Fears

Nashville, Tenn., Oct. 3 - Ongoing portfolio shuffling is sustaining flow in the secondary market, but traders said the list of active convertible issues is growing ever slimmer. It was a mixed bag for converts as stocks ended lower after a rocky session.

"Considering the fact that so many names are out of the money and we have no new issues, flow is really good," said Rao Aisola, head of convertible research at Bear Stearns & Co.

"There's a lot of churning going on, window dressing et cetera, going into the fall. Right now it's very cloudy. It will be an interesting October."

Retailers were a point of focus Thursday, with nice two-way flow seen in Gap Inc. while there was a big sell-off staged in Kohl's Corp. as it was considered extremely over-valued.

Power names also were in the spotlight again, as Duke Energy Corp. slipped into the market with a straight bond after the closing bell and bankruptcy buzz circulated over The AES Corp. even as it launched a $1.6 billion secured bank facility and an exchange offer for up to $500 million in notes.

Moreover, the frustration in convertibles caused by the lack of new issues and an ever-richening secondary market with shrinking opportunities has some fearful that money will be taken off the table altogether.

Several sell-side sources believe that is already happening, but note it is difficult to nearly impossible to gauge.

Some buy-side sources, even a couple of major players in the convertible market, have talked about liquidating convertible holdings or at least holding onto capital rather than chasing the small group of converts they think are appealing.

"It's been horrible. In the last couple of days we've unwound some positions where the premium has blown out to a points where we have no business being involved," said John Seibel, head of trading at Silverado Capital Management.

"Our performance has bought us some time. I will not reach out [to bid on already rich converts]. We don't have to. We'll wait it out and hope for better days.

"We're not going to walk away from the market altogether, but this year's basically over. Done. I'm going to set my sights for next year and hope for some new issues that are real deals with real coupons.

"That's probably not going to happen right off, because the market is so starved for new paper. When supply is zilch, they'll get away with these stupid structures, the split coupons and all that jazz."

Syndicate sources say that realistically there will probably be only five or six more new convertible issues for the remainder of the year.

That leaves players to pick over the secondary market, sifting through what trader say is a shrinking list of popular trade ideas.

"We're seeing decent flow," said the head convertible trader at a major investment bank.

"It's just that everything, or what's trading, is getting pretty rich and so some of those issues are not seeing as much action. Some of this is going on literally because there's nothing else to do, no new issues to look at."

Retail names were feeling pressure from weak sales and a bleak outlook for the holiday shopping season, along with the ongoing lockout of longshoremen on West Coast ports.

Traders said there was good two-way flow in Gap, though, as some took the company's appointment of a new chief executive officer as an indicator that a turnaround could be forthcoming.

Gap's 5.75% convertible due 2009 were quoted closing down 2.75 points to 91.125 bid, 91.5 asked. The stock ended off 79c to $9.17.

"It's not a bad time to position yourself in retail," said Bear Stearns' Aisola.

"Retail has been weak the past couple of days. Going into the December season, there's always a lot of volatility and you can capitalize on that."

For most of the day, the focus in power names pinpointed AES and its plan to try to avert troubles as dreary as bankruptcy. But, then, late in day headlines streamed across the tape that Duke Energy sold $350 million of 30-year senior bonds.

The spate of news in power names follows the downgrades of El Paso Corp.'s subordinated debt to junk on Wednesday.

AES said it is attempting to slash its debt by obtaining the new bank facility and carrying out the debt exchange, which would push off all its maturing debt, including notes due later this year, until 2005.

Standard & Poor's and Fitch Ratings both lowered AES' ratings, including the convertible subordinated notes to B- from B and convertible trust preferreds to CCC+ from B-, and kept the ratings on negative watch.

The downgrades were largely due to the fact that the new financing arrangement will subordinate current noteholders to the new exchange notes.

While the burden of debt maturities would be lifted, S&P said AES still needs to execute an asset sale program to pay down the bank facility over time and if it cannot execute asset sales, solvency could be threatened.

Fitch views the proposed transactions as a positive step for AES and said that barring any further unforeseen deterioration, credit metrics are expected to stabilize and there is potential for improvement in late 2003 to early 2004.

Market reaction to the news was mixed and confusing.

"There was a great deal of confusion about the AES bonds, both the converts and the straight bonds, and how they will be ranked after the exchange," said a dealer.

"Basically, the junk bond market took it positively. The converts were lower, though, likely because they may rank lower than the junk bonds even."

AES' 9.375% subordinated junk bonds due 2010 were quoted up 2 points to 52 bid after the market close.

The AES 4.5% convertible subordinated bonds due 2005 were quoted down 1 point to 49.5 bid. The two AES convertible trust preferreds were quoted down about 1.125 points.

AES shares ended down 48c to $2.09.

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