Convertibles mostly lower amid slightly better liquidity; Smithfield lower on credit worries; Red Hat down

By Rebecca Melvin

New York, Sept. 24 - The convertible bond market was somewhat more liquid on Wednesday than in the previous three sessions, as market players "adjusted" to the temporary ban on short selling of financial stocks, sources said. But pricing still drifted lower for the most part.

"People are adjusting to it," a New York-based sellside trader said of the ban on financial short selling. "But, today IBM is on there [the list]. And that's a tech company in my book. So there's a worry. There's hesitation in our market and pockets of illiquidity."

The temporary ban expires Oct. 2, and some players seem to be waiting for that date to start doing any trading.

"Yes, there are other sectors, but you have to remember that so much of new issuance has been in financials," a New York-based sellside desk analyst pointed out.

For the year to date, $35 billion in new issuance in the market was among financial issuers, he said.

There is also the worries possibility that the ban may be extended if it is deemed necessary to continue to give time the government time to work out a rescue plan for the financial market.

The problems in convertibles, however, aren't limited to those that the government plan has the scope to fix, another New York-based sellsider said.

Other pitfalls harming the convertibles market are redemptions and the Lehman Brothers' bankruptcy filing, the sellsider said.

"There are people that can't access their assets and they have to liquidate wherever they can," he said.

There were some names in trade; but they were mostly to the downside, however.

Smithfield Foods Inc. convertibles fell on an outright and hedged basis due to concerns about the food industry in general getting hit by credit problems. The market was eyeing Pilgrim's Pride Corp., which had trading of its stock halted late Wednesday after its stock fell 38%.

Pilgrim's Pride is not a convertible issuer, but the nation's largest chicken producer is a comparable for convert issues including Smithfield's and Tyson Foods Inc.

Red Hat Inc. was also lower Wednesday despite the fact that the convertibles in question have a put in three months and the company is cash flow positive and well able to fund the redemption.

Smithfield comes in on credit worries

Smithfield Food's 4% convertibles due 2013 traded at par versus a share price of $17.50 on Wednesday, but were seen closing lower at 97 versus $16.92.

That compared to a price over par at about 101.5 on Tuesday.

Shares of the Smithfield, Va.-based food processor (NYSE: SFD) fell $1.68, or 9%, to $16.92.

"We were active in food names," a trader said on Wednesday. "Pride's stock is down and Smithfield bonds came in and we're not quite sure why."

Market participants seemed pretty nervous that whatever issues affecting ailing Pilgrim's Pride could also affect Tyson and Smithfield as well, he said.

"They're worried about some of the food processors relying on credit a fair amount," he said.

Pilgrim's Pride shares hit a 52-week amid concerns that high grain costs and tightened credit could pose a dangerous recipe for the company.

But Pittsburg, Tex.-based Pilgrim's Pride is strictly a chicken company and it is saddled with a large debt load. Tyson, on the other hand, is chicken, beef, pork and prepared foods; while Smithfield is a pork and beef processor.

Tyson Foods shares (NYSE: TSN) fell 5.3%. Its 3.25% convertible senior notes due 2013, issued earlier this month, were last at 95.8.

Red Hat trades at 96

Red Hat's 0.5% convertibles due 2024 traded all over the place, but all lower Wednesday.

Late Wednesday, the convertible bonds were seen on Trace at 96. Shares of the Raleigh, N.C.-based Linux software provider software company closed down 5 cents, or 0.28%, at $17.90, which was off its lows for the session.

Traders disputed the price as "an oddball low print," and one source said the market was higher at 97.5, compared to 98 on Tuesday and last week.

"I understand it's a low-coupon piece of paper; but the thing matures in three months. That makes it just 14.66% yield to the put when this company has a positive cash balance."

A reasonable spread would be 100 basis points over Libor, the trader said. "There's just not that much risk behind the trade. It should be 99.5. And I think that's low," he said.

Bidders are willing to pay more for the paper, traders said, chocking up the low print to market participants needing to raise cash quickly.

"And they choose Red Hat because it is more liquid," a sellside trader said.

"It's a little concerning. There are buyers of these securities at higher prices," the analyst said.

In general prices in the convertibles market were lower Wednesday. "It was hard to find anybody who wanted to buy anything. It's hard to say where the floor will be," he said.

After the close, Red Hat posted second-quarter earnings that beat estimates, helped by growth in its subscriptions business. But shares still fell 3.4% in after hours trading.

Red Hat's net income rose to $22 million from $19.1 million in the year-ago quarter. Revenue rose 29% to $164.4 million, which was better than Red Hat's own guidance of $162 million to $164 million.

Looking ahead

The government's rescue plan currently being hammered out in Washington wasn't being looked upon as a panacea by all convertibles players.

It will help prop up the overall credit market, but it's not going to turn around the market immediately, a sellside analyst said.

"I'm not certain that's going to be the cure for the convert market," the analyst said. "I think people aren't sure what's going to happen. The bailout is going to happen; it needs to happen. But there are things other than the ban on short selling that are compounding the problems."

Those things include redemptions, people looking for liquidity, getting access to assets such as those that are tied up by the Lehman Brothers bankruptcy, and credit continuing to go wider, he said.

"August was flattish," the analyst said. "But this month is horrendous."

Wednesday on Capitol Hill, the politicians were debating how much was enough to fix the financial markets, which Fed chief Ben Bernanke called "quite fragile."

Some lawmakers were seeking to offer up a much-reduced rescue plan such as $150 billion instead of the initially requested $700 billion, with promises that if more were needed it would be forthcoming.

Bernanke stressed that the markets needed to have confidence that enough might was being put toward the problem as to be a serious solution.

He called it the "most significant financial crisis in the post-war period," but he stopped short of defining just what that might look like in terms of specific loss of gross domestic product and higher unemployment.

"A lot of these people have very little understanding of financial markets, and they just pander to their constituents. They look at it as bailing out Wall Street instead of as a situation in which there was danger of the financial system collapsing," a sellside analyst said.

Everything is moving so quickly, there was very little perspective on the future. "There will be more regulation, and more ways around it," the sellsider said.

Meanwhile, trading volumes Wednesday were down in equities as well as other markets like convertibles.

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