CenterPoint convertibles dip on lower cost recovery ruling; Calpine issues continue slide

By Ronda Fears

Nashville, Sept. 21 - Several energy convertibles were moving mostly lower Tuesday on a variety of news, and there was some pullback overall as an edgy tone clouded the market. The case of nerves wasn't entirely blamed on the Federal Reserve move to boost interest rates by 25 basis points, as that was no real surprise, but another flap about liquidations - this time by a big investment bank - which seems to have been blown out of proportion.

CenterPoint Energy Inc.'s convertibles lost a bit of ground, but traders said the credit was actually holding up pretty well against the ruling in Texas that the power company can only recoup about half, or $1.9 billion, of the stranded costs of assets it lost in the transition into a deregulated electricity market.

Southern Union Co.'s convertible also slipped, moving against the stock's rise, which traders attributed to profit-taking. But the credit got a plug following the company's venture with a General Electric Co. unit last week to buy some Enron Corp. assets out of that historic bankruptcy case.

Calpine Corp.'s convertibles all were off slightly too, as the independent power producer announced the redemption of its 5.75% convertible preferreds. That was a move anticipated by the market, one trader said, but Calpine's credit "has just been in a weak spot for a week or so."

With the higher interest rates coming to fruition, there still was nothing new on the primary market front.

In general, the convertible market had "a heavy feeling," as one source put it, and there was a sense of anxiety prevailing, but traders said there was not a huge selloff.

Some of the market's jitters came from the rumor that a big investment bank was clearing its propriety convertible book.

"The market came in a little; there was a lot of stuff for sale because people wanted to get in front of" the bank names in the chatter, said a source at a huge hedge fund in New York. "The information is false, though."

Liquidation chatter just noise

Indeed, sources from the buyside and sellside of the convertible market, along with a couple from the investment bank at the center of the rumor that it was shutting its U.S. convertible book said by the end of Tuesday that the situation was overblown.

The buzz began Monday and spread quickly, even abroad, where a market source in London said "there are a lot of rumors, though, right now, and not much clarity. It seems a little too far-fetched."

What fueled nearly "a race out the door," said a convertible trader at a hedge fund in New Jersey, was that sell offers were showing up with issues like JDS Uniphase, Juniper Networks, Ivax Pharmaceuticals and a couple of other names with markdowns while those stocks rallied after the Fed made its move.

"I noticed that some names came in. I thought it was people lightening up in front of the Fed, worried that the carry trade gets carried out again," said a fund manager, but he added, "I have seen a few good offers from [the investment bank] today, but nothing like panic sales."

In fact, sources at the bank said it was nothing but the normal course of business, shuffling inventory - convertibles - around.

It was speculated that the root of the rumor was embedded in some management changes, which also involved the firm's proprietary book moving under a new team for the sake of limiting risk.

"There isn't a huge liquidation taking place, everyone would know about it," said one source.

CenterPoint issues off 0.5 point

CenterPoint announced Tuesday that a Texas Public Utility Commission panel was recommending it recoup only about half of expenses referred to as stranded costs associated with electric generation assets it sold as part of the deregulation process.

That could jeopardize CenterPoint's triple-B investment-grade standing, as Standard & Poor's is watching the development with a negative outlook, but traders said the credit actually was holding up pretty well on the news.

"There was probably some headline selling but it seems the CenterPoint issues had already been discounted" to reflect a lower recovery rate "because the regulatory climate isn't very friendly with this sort of thing," a sellside trader said.

"It's actually good to have this news out there, because it takes the unknown out of the equation."

CenterPoint's 2.875% convertible was pegged at 104.875 bid with the 3.75% convert at 11.25 bid, both off about a half-point, he said. CenterPoint shares closed Tuesday down 20 cents, or 1.87%, to $10.48.

The Houston-based power company said the ruling would trim its request for $3.7 billion in rate hikes to cover the so-called stranded costs to around $1.9 billion.

CenterPoint also will likely appeal the ruling, following the filing sometime in October, but meanwhile the company said it was operating as if the preliminary ruling was the final decision, which would involve an estimated $1 billion charge to third-quarter earnings.

S&P said the drastic reduction in the judgment would be negative for the credit quality of CenterPoint as the BBB rating is predicated on deleveraging to the tune of about $5 billion from asset sales related to the deregulation process.

Southern Union gets buy nod

Following Southern Union's venture to buy some Enron assets out of bankruptcy, the convertibles have been sliding steadily, traders said. But on Tuesday the credit got a boost in a report by Philip C. Adams, a Gimme Credit bond analyst.

A big plus for Southern Union, Adams said, is its transformation from a natural gas distribution firm to one with a focus on transportation and storage.

With the purchase of Panhandle Eastern Pipe Line in June 2003, the transmission and storage segment accounts for 50% of total assets and 27% of revenue but 69% of operating income. Panhandle will be complemented by the $2.35 billion acquisition of Cross Country Energy from the Enron bankruptcy via CCE Holdings, Southern Union's venture with GE Commercial Finance.

Southern Union's long-dated bonds are rarely seen. But Adams said the Panhandle bonds (Baa3/BBB) look appealing at current levels - the 6.05% due 2013 is offered about 100 basis points over the 10-year Treasury - particularly benched against the newly issued 5% notes due 2015 from XTO Energy (Baa3/BBB-) which are quoted 93 basis points over the comparable Treasury.

Southern Union's 5.755 mandatory on Tuesday slipped about 0.375 point to 62.125 bid 62.375 offered, while the stock gained 8 cents, or 0.41%, to $19.80.

Japan eyed as rules may relax

The Tokyo Stock Exchange is set to relax its rules on issuing convertible bonds to make this means of capital-raising more flexible to institutional and other investors, The Nihon Keizai Shimbun reported this week. The move is to bring the rules in line with those used elsewhere and keep issuers like Sony Corp, Toshiba Corp. and other major Japanese firms at home rather than selling convertibles in other markets.

"This looks like a good development for the Japanese convertible market, bringing the domestic market up to speed with the euro market," said Hart Woodson, portfolio manager for the Gabelli Global Convertible Fund.

"As new issue activity picks up for Japanese issuers, I am sure the domestic players did not want to be left out of the party."

The Tokyo Stock Exchange is hoping to put the new rules into effect in November, according to the press report.

Some U.S.-based convertible investors have been looking at the Japanese convertible market and recently seriously eyeing the European market again, mainly due to some general malaise in the U.S. convertible market.

"You just cannot make money in a low vol, seemingly stagflationary environment, although with no bond hedge you might be okay," said a convertible fund manager based in Southern California. "Europe does have some better growth prospects from what I read. I'm not convinced, but I have been looking at converts over there as well" as Japan.

Volatility ideas expand rapidly

Lehman Brothers convertible analysts, who monthly spin a volatility watch report off the firm's weekly publication that tracks single stock volatility, are finding more and more volatility plays, their latest report on Tuesday shows.

With the implied volatility below average, and if you have a positive view on the stock, the analysts suggest buying calls if you're holding the convertibles of Cox Communications, Tyco International, Liberty Media, Transocean, Lockheed Martin, Genzyme, CenturyTel, Masco, Wells Fargo, Carnival, Fluor, Verizon, Danaher or Franklin Resources.

With the implied volatility below average, and if you have a negative view on the stock, the analysts suggest buying puts if you're holding the converts of Xcel Energy, Chiron, Dominion Resources, XL Capital or Lowe's.

With the implied volatility above average, and if you have a negative view on the stock, the analysts suggest selling calls if you're holding the converts of Manor Care or Equity Office Properties.

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