Wyeth, Sallie Mae, Lockheed floaters see demand; hedgies hurt by premium contractions

By Ronda Fears

Nashville, Jan. 29 - Several floating-rate convertibles saw better buying on the heels of the Federal Reserve's surprising hint that interest rates may be on the rise soon, traders said. Many of those issuers had news that propelled the stock higher too, like Bausch & Lomb Inc. with nice earnings and 2004 guidance.

For the most part, though, the convertible market was weaker in the wake of the Fed shock.

Investment premiums contracted sharply, so "things absolutely melted in, on swap," said a dealer at one of the busiest convertible trading desks.

"The high-yield market boiled over and all those names came in too."

The broader markets that influence convertibles, stocks and bonds, seemed to stabilize, but weakness persists in convertibles partly out of exhaustion at the present rich levels. Moreover, after a month of relentless bidding up the market, the Fed event gave players cause to pause the buying spree.

"The market has been soft for about a week, as the spurt of beginning-year buying exhausts itself and both investors and sell side traders step back to process the implications of the Federal Reserve open markets committee meeting language change and the related bond market move," said a fund manager in New York.

"Sellers are not particularly motivated, except with the highest duration securities. It's more a case of buyers stepping back. My sense is, and this is conjecture, that buyers will step in as securities cheapen on swap, simply because so many funds have capital to put to work.

"That is, this current softening in valuations most likely will present a buying opportunity rather than presage on ongoing cheapening of the market."

Cheapening likely temporary

Thus, market sources said unless there is a deluge of new paper injected into the convertible market, or a slew of money is taken off the table, the cheapening is just temporary.

"Broadly speaking of the market, the softness isn't going to last," a buyside trader at a hedge fund in New Jersey said.

"So if you see something you like, now may be the time to snatch it - unless there's a flood of new deals or money is taken off the table, and that would still be probably a couple of months off."

The primary market remained fairly quiet in the wake of the Fed news, but convertible market sources agree that a steady rate environment with a hint of rising rates should bode well for issuance at least through first quarter.

In fact, some think it might spur issuers that are planning some capital-raising effort this year to do so sooner rather than later.

"I'm not hearing about any behemoth deals," one capital markets official added, however.

There were a couple of additional tiny deals in the market, as has been the case thus far in 2004 except for Teva Pharmaceutical Industries Ltd.'s jumbo $1 billion deal last week off the Lehman Brothers desk.

LTC Properties Inc. is pitching a $50 million convertible perpetual preferred talked to yield 7.5% with a 100% initial conversion premium; it is scheduled to price next Wednesday.

Before the open, AAR Corp. sold $75 million of 20-year senior notes to yield 2.875%, up 30%. It was a super-private Rule 144A deal that market sources said was put in less than a handful of accounts.

Then, late in the day, Conseco Inc. filed a registration statement at the Securities and Exchange Commission to sell $350 million of mandatory convertibles and $800 million of common stock.

Conseco, which just emerged from bankruptcy six months ago, said it was an effort to restructure its capital base, as proceeds would be used to take out its $859.7 million of 10.5% step-up payable-in-kind convertible preferreds that were issued as it exited bankruptcy.

The preferreds would step up to 11% on Sept. 11, 2005 and are payable in kind until Sept. 11, 2005.

There had been keen interest in the Conseco convertible preferred despite the lack of call protection, until the strike price was set in mid-January at $20.35.

Conseco shares closed Thursday off 18 cents, or 0.78%, to $22.76.

There were no details like indicative terms on the Conseco deal, however, as it will have to go through the SEC approval process.

Meanwhile, floaters rise

Without a hefty new deal slate, or any to speak of, the Fed signal reinforced suggestions for investors to take precautions against interest rate risk in their portfolios by adjusting the duration of their portfolios.

That can be done by replacing longer term notes with shorter term notes, buying higher coupon bonds, increasing the percentage of cash held, or buying Treasuries and futures to hedge interest rate risk exposure, or by buying floating-rate notes.

And since 2002 there have been several - about 15 - floaters put into circulation with convertible features.

"Owning floating-rate converts more or less removes interest rate risk, not entirely, but [they] remove a lot of it as the rate is reset to the market rate every quarter or so," said a manager who is running a multi-strategy fund in New York.

Dealers said several convertible floaters were better bid Thursday. Some had news that helped the converts, too.

"There were better buyers for a lot of these floaters," a sellside trader said.

SLM Corp., parent to the better-known Sallie Mae student loan agency, Lockheed Martin Corp. and Wyeth were among the most popular.

Wyeth's floater, which pays six-month Libor minus 50 basis points, ended the day at 102.25 bid, 103.25 offered with the stock up 55 cents, or 1.35%, to $41.30. News helping included an item that Wyeth and MedImmune Inc. are in discussions about the fate of their joint venture, FluMist, as sales during the first portion of the flu season were disappointing.

ADC Telecommunications Inc. was another, as its 2013 floater, which pays six-month Libor plus 37.5 basis points, gained about 5 dollar points while its 1% due 2008 slid about 3 points. ADC Telecom shares closed off 17 cents, or 4.99%, to $3.24.

Bausch & Lomb's floater due 2010, which pays six-month Libor plus 50 basis points, also was better bid, ending the day at 118 bid, 118.5 offered. The eyecare products maker helped by boosting its 2004 guidance to between $2.60 and $2.65 a share. In October, the company issued 2004 guidance of $2.50 to $2.60 a share.

While there was considerable interest in floaters Thursday as a result of concern over interest rates, some fund managers said it was a cop-out of sorts.

"Floaters may be a great place to hide. Yet hiding isn't a good way to win," said a fund manager with experience in both outright and hedged strategies.

"Scary markets create opportunities for investors who understand the credits and who have the courage of their convictions. Selfishly speaking, I hope my competitors panic."

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