Market searches for yield, but still leery of creditworthiness

By Ronda Fears

Nashville, Tenn., Aug. 15 - Convertible players were searching for yield, but credit quality was still a major concern. Caution still is the watchword of the market and kept trading muted ahead of data Friday on consumer sentiment.

Mandatories are a hot item because of the yield and the abundant supply of new paper over the last year or so, but there also are some high-grade convertible bonds like those of AOL Time Warner, PerkinElmer and Verizon finding buyers because of the wide spreads.

"Sell the worst credits because the good credits are trading like junk," said Michael Revy, manager of a convertible hedge fund for Froley Revy.

"Some of that may be due to forced selling by insurance companies."

The lower yield curve "defies gravity," Revy said, and credits like AOL, Verizon and PerkinElmer are producing "higher deltas than normal, due to wider spreads."

The yield curve has flattened out by about 35 basis points just in the past week, said a credit default swaps trader. That, the trader said, will make higher grade credits more vulnerable to widening spreads.

But, he added, it should cause a tightening in lower-grade credit spreads, although there virtually is no credit protection market for junk paper.

Remarkably, Revy said, there are still sellers of high-grade paper.

A dealer said selling is still a predominant move in convertible bonds because so many convertible investors are not traditional bondholders.

"A lot of the convertible market, and that's hedge guys and outrights alike, are just not comfortable with the credit side of the story," the dealer said.

"That's the case even when everything is pretty much normal. Now, with the default rates, downgrades, all that jazz, liquidity crises, they are extremely nervous about holding some of this paper, so when they get a decent bid, they sell."

Verizon's 0% convertible due 2021 (A1/A+) was quoted up 0.125 point to 52.25 bid, 52.5 asked for a yield-to-put of 8.12%. The stock ended off 50c to $30.45.

PerkinElmer, Inc.'s 0% convertible due 2020 (Baa1/BBB-), which was downgraded from Baa3 on Thursday by Moody's, was quoted off 0.75 point to 43.25 bid, 44.25 asked for a yield-to-put of 24%. The stock closed down 61c to $5.09.

AOL TimeWarner's 0% convertible due 2019 was quoted up 0.75 point to 47.5 bid, 48 asked for a yield-to-put of 13%. The stock ended up 81c to $11.86.

Mandatories also remain a hot item but there have been a couple of situations recently that caused a lot of pain, namely Sealed Air and Six Flags.

Sealed Air Corp.'s 8.75% convertible preferred fell again Thursday on news from the company that it had lost another court ruling related to its asbestos exposure. The convert dropped 1.3 points to 19.1 bid, 19.16 asked with the stock ending down 95c to $14.92.

Still, traders said mandatories and convertible preferreds are the most active segments of the convertible market, from a trading perspective, since new issues have dried up.

Some of the more active names Thursday mentioned by preferred traders were Ford Motor Co., Duke Energy Corp., El Paso, Alltel, CenturyTel and Prudential Financial.

Ford's 6.5% convertible trust preferred closed up 0.11 to 44.75 bid, 44.9 asked with the stock closing up 26c to $11.61.

Issuance is generally expected to pick up after Labor Day, but the pain in the market that is magnified by the lack of new issues has already begun to drive some managers to take money from the table, traders said.

"There is no calendar, comparable returns are low, volatility has really dried up," Revy said.

"Some people are liquidating, but a lot of money just stays in the mattress."

Thus, when issuance picks up, players will return with cash to put to work.

The CSFB/Tremont hedge fund figures were released Thursday, putting a quantifier on the level of pain for the hedge fund community, which accounts roughly for 75% of the convertible market's activity.

The CSFB/Tremont hedge fund index was down 1.35% for July but off just 0.03% year-to-date.

Convertible arbitrage, however, was down 1.55% for the month and 2.54% year-to-date.

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