Mirant bankruptcy creates a bloodbath, compounded by violent correction in bonds

By Ronda Fears

Nashville, July 15 - There were few places for convertible players to hide as a sharp blow to Treasuries reverberated through the upper end of the credit spectrum, while Mirant Inc.'s bankruptcy sent shockwaves throughout the lower end.

Mirant's converts - both the 2.5s and 5.75s - plunged in the neighborhood of 25 points on the day with one sellside trader commenting, "It was a bloodbath." Other power names, particularly Calpine Corp. and CMS Energy Corp., were weaker in sympathy and lower credits in general declined.

A big question echoing through the convertible market with regard to Mirant, however, was which of the banks were net long the 5-year credit default swaps - as the bankruptcy was not a huge surprise. The bankruptcy will trigger those contracts, but it was still a mystery as to which of big derivatives desks might be at risk.

Four new issues priced, another was on tap from Pegasus Solutions Inc. after Tuesday's close and Dynegy Inc. - another troubled power concern - announced a $300 million convert as part of a huge restructuring package. The Dynegy deal is anticipated next week, with guidance possibly late this week.

Traders said most new issues also came in "a lot" with the overall market Tuesday, however, so even that area wasn't a source of most of the activity. Of note, however, one buyside trader noted selling in the new JetBlue Airways Inc. convert, which closed the day down about 1-2 points.

The bond market was the culprit steering converts sharply lower.

"Today, it was a bond market story. It was pretty bad today," said a convert trader at a hedge fund in New Jersey, noting Treasuries lost something like 2.5 to 2.75 points.

"The bond market nearly destroyed everybody. I am just trying to keep the bleeding to a minimum."

Lots of hedged convert players have been talking about "severe" pain in recent weeks, and that segment accounts for upwards of 75% of flow in convertibles.

To quantify the pain, to some degree, one hedge fund manager of around $200 million in assets said his portfolio is down around 85 basis points for July but is still positive year-to-date. Another managing a portfolio with a firm that has some $2 billion of assets under management said he was down about 2.5% for June, which pretty much wiped out profits year-to-date.

The CSFB/Tremont hedge fund return figures were out Tuesday, showing the convertible arbitrage strategy off 0.62% for June but up 8.15% on a year-to-date basis.

There is a convergence of several factors that have created the pain.

Veteran portfolio manager Michael Revy said with interest rates tanking, new issue coupons decreasing or remaining low, stock volatilities collapsing while new issue premiums remain wide, stock dividends rising and bond call risk at extreme levels, "there's not a whole lot of places to hide in convertible land."

Notable declines were seen in Tyco International Ltd. and Shaw Group Inc., and traders expect the same for Lucent Technologies Inc. and Motorola Inc. for Wednesday.

Tyco came in pretty hard, one trader said. Another said the not-so-fantastic numbers out of General Electric Co. "may have brought out a few sellers in Tyco."

Both Tyco converts - the 2.75s and 3.125s - lost 1 to 2 points on the day while the stock added 5c to $19.55.

Shaw Group was hit in the wake of lowering its 2003 and 2004 earnings guidance (again) on Friday, which sparked a downgrade by Standard & Poor's. S&P cut the senior debt to BB- from BB, noting that while Shaw kept its 2004 free cash flow guidance at $90 million to $110 million range, it is now highly contingent on asset sales.

The Shaw 0% convert due 2021 was quoted down 0.5 point to 64.25 bid, 64.5 offered as the stock dropped 65c, or 6.66%, to $9.11.

Lucent was in a similar position. "Lucent looks like it's going to get hit hard [Wednesday]," a buyside trader said, even after taking a pretty good blow on Tuesday.

Succumbing to pressures from prolonged spending cutbacks by its wireless customers, Lucent on Tuesday said it would not meet its targets for profitability in fiscal 2003, which ends in September, and in fact the telecom equipment maker sees wider third quarter losses than projected by Wall Street analysts.

Lucent said it now expects to return to profits sometime in fiscal 2004.

In response, S&P put Lucent's ratings on negative watch.

The new Lucent 2.75% converts both lost about 2 points on the day, with the 2023 issue at 87.875 bid, 88.375 offered and the 2025 issue at 89.25 bid, 89.75 offered. The old Lucent converts were about 1 point lower, with the 7.75s at 79 bid, 80 offered and the 8s at 99.75 bid, 100 offered.

Lucent shares fell 6c, or 3%, to $1.92.

While the impact of what was described as a "violent correction" in Treasuries was a broad topic of the session, Mirant's bankruptcy was a specific focal point pressuring much of the lower credit spectrum along with the bankruptcy of Loral Space and Communications Ltd.

Some shops moved quite a bit of Mirant converts, noting a lot of buyers.

Mirant's 2.5s - the subject of an exchange offer that broke down chiefly as a result of the lack of cooperation from its banks - fell about 25 points to around 35 bid and the 5.75s dropped in tandem. The stock never opened, after closing at $2.01 on Monday.

"Most of the buying today was short-covering," a sellside trader said.

"We are waiting for the stock to open; that's when the selling will begin."

In bankruptcy court papers, Mirant listed $20.6 billion in assets and $11.4 billion of debt.

The big loser in Mirant converts, traders said, are holders of the 6.25% convertible preferreds as "they barely register on the credit foodchain, if at all."

The Mirant 6.25% convert closed Monday at 13.08 and was indicated Tuesday at 2 bid, 3 offered.

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