Convertibles firmer; new Starwood expands a bit on hedge; existing Starwood flat to weaker

By Rebecca Melvin

New York, June 28 - The convertible bond market was firmer but quiet on what market players called a typical summer Friday that happened to mark the end of the month and the end of the quarter.

The biggest focus was Starwood Property Trust Inc.'s newly priced 4% convertibles due 2019, which edged up on an outright basis and expanded by 0.25 point to 0.75 point on a hedged basis on their debut in the secondary market after the Greenwich, Conn.-based mortgage loan investor priced $400 million of the 5.5-year convertibles at the midpoint of coupon talk.

"It expanded a little bit right out the gate, and maintained right around there," a syndicate source said.

Starwood's older 4.55% convertibles were active again and a little bit weaker, but stabilized after having contracted on Thursday, sources said.

Outside of the new and old Starwood issues, the convertible market was pretty quiet, sources said.

"Once you back out the Starwood volume, there's nothing worth noting today," a New York-based trader said.

"A lot of guys will be out next week with the holiday-shortened week for the Fourth of July," he said, adding that the holiday had a dampening effect on trade already.

Barring any dramatic market-moving news next week, second-half trading probably won't get started until the week of July 8, another market source said.

Valuations firmer

As for the week concluded Friday, convertibles looked to have firmed after underperforming the broader equity and credit markets for much of the week. The broader markets had bounced back by Tuesday from weakness related to jitters regarding earlier-than-expected tapering of the Federal Reserve's accommodative policies. It took the convertible market until Thursday to improve.

"Shorter-dated, credit names did find their footing, and longer-dated, out of the money, or vol. sensitive names, got better," a New York-based trader said.

"It was really mixed, but you could say momentum names like the Cobalts and MGMs got better," the trader said.

A second source mentioned that the convertible bank preferreds like Wells Fargo's convertible preferred stabilized and were better to buy, meaning that the bid was stronger and offers were being hit after a period of weakness.

Hit by rate move

Hedged players were hurt by the rate move earlier in the month, traders said. Many funds may have been hedged for an equity selloff but were under-hedged otherwise and were unprepared for the knee-jerk reaction in the credit markets.

They were especially hard hit in the first two weeks of June, a New York-based market source said.

"They were hedged on a theoretical equity delta, but the credit market movement was against them too," the source said.

The prolonged dovish stance of the Federal Reserve led to hedged players getting caught flat footed as they were less concerned with credit, he said.

"The credit default swap market is not as liquid as it has been," he said.

The combined moves were hard for hedgies who were not protected, but outrights were able to lighten allocations and raise cash or shorten durations, and fared better for the most part.

That happened quickly during the first two weeks of June, but investors continued to buy deals and deals were still getting priced on the tight end of talked terms, he said.

"Since the back-up in rates, guys have gotten hurt if they had any kind of inventory at all," a second trader said. It wasn't just rate-sensitive issues, the whole market was hit by negative sentiment, he said.

The trader pointed out also that while new issuance was strong in June, the deals that got done "weren't all that exciting."

"I didn't like the majority of them; they were rich on a vol. basis. There were a handful of names that were okay, but you can get better value in the secondary," he said.

Nevertheless, new issuance will bode well for trading down the road, he said.

Stronger issuance, weaker deals

June was the strongest month for new issuance for the year to date. There was $4.9 billion in new issuance in 16 deals, compared to $4.1 billion in new issuance in May, and $2.55 billion in 10 deals priced the same month a year ago.

The amount of new issuance wasn't affecting the current valuations. But the valuation performance of new deals weakened with the overall market conditions.

"Compared to the end of May when you had a deal like Netsuite that was a total blow out, with the book multiple times oversubscribed, pricing through the range and you couldn't sell it fast enough, deals at the end of June were weaker," a New York-based syndicate source said.

The movement in rates and general volatility caused some widening in the secondary market and led to deal valuations cooling on a theoretical basis, he said.

But he said there were no lasting effects from the rate move. It was an immediate reaction, and has traded through once the rate market traded off and stabilized.

New Starwood edges higher

Starwood's new 4% convertibles due 2019 were quoted at 101.25 versus an underlying share price of $24.29 shortly after midsession. That was seen 0.25 point to 0.75 point better on a hedged basis.

Shares gained 82 cents, or 3.4%, to $24.75 by the end of the session.

Early, the paper was seen 100 bid, 100.75 offered, and was called "flattish" by a syndicate source.

One trader said the new deal was "not screaming exciting." While a second trader said that it did fairly well depending on hedge. Hedges varied from as light as 20% to as heavy as 60%, he said.

They were 101.25 versus $24.25 bid looking for an offer.

With the stock up about 1.6%, the new bond was a little stronger, richening maybe 0.25 point to 0.5 point on a 60% delta. Assuming a 50% delta, the paper modeled a little bit richer by 0.75 point.

"The stock had a little weakness early, but we saw a lot of prints immediately above par. Even at 10 a.m. when the stock was as low as $23.60 the bonds were still printing north of par.

Starwood priced $400 million of 5.5-year convertible senior notes in a registered, off-the-shelf deal, which has a $60 million greenshoe, and was marketed by BofA Merrill Lynch, Barclays and Goldman, Sachs & Co.

The deal priced at the midpoint of talk for the coupon and at the talked premium price point that was fixed.

The 5.5-year bullet has no calls or puts.

Prior to July 15, 2018, the notes are convertible only under certain circumstances and during certain periods.

Conversions can be settled in cash, shares or a combination of cash and shares at the company's option.

Proceeds will be used to originate and purchase additional commercial mortgage loans and other target assets and investments. The company may also use a portion of the proceeds for other general corporate purposes, including repayment of liabilities and working capital.

Older Starwood flat to weaker

Starwood's 4.55% convertibles due 2018 were said to have slipped another 0.75 point on a dollar neutral basis, which comes on top of a one point contraction dollar-neutral on Thursday when the company's new deal was announced.

The paper was 101.96, according to trace data when the stock was at about $24.24. The older Starwood also printed at 102.375, which was down from 102.625 bid, 103.625 offered on Thursday.

One trader reported further weakness in the older Starwood in the early going of the session, calling it down another 0.5 point to 0.75 point on swap following a 1 point move lower Thursday. But a second source said the paper stabilized and "found a bid" during the session.

Mentioned in this article:

Starwood Property Trust Inc. Nasdaq: STWD

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