US Airways adds on debut; financials improve, but convertible prices lagging broader market

By Rebecca Melvin

New York, May 8 - US Airways Group Inc., which priced an upsized $150 million of 7.25% convertibles, traded up early Friday when the paper was released for secondary trading but slipped back down to about par as its stock moved lower.

Financials remained firm after improving this week on relief that the U.S. government's long-awaited "stress test" didn't bring more dire news.

PNC Financial Services Group Inc. and Prudential Financial Inc. both improved during the week.

Overall, pricing in the convertible market, which had been on a tear in April, appeared to stall out, compared to the broader credit market.

"It was moving up on an absolute basis, but on a relative basis, it was not keeping up," a New York-based sellside analyst said of convertibles.

Alliant Techsystems Inc.'s 2.75% convertibles due 2011, for example, had strengthened considerably from the beginning of the year until April, but in recent weeks they hadn't improved in line with their shares.

The divergence between credit and convertibles was technical in nature rather than fundamental, sources said. They cited factors like liquidity, the credit profile of the entire space, which includes a lot of investment-grade names that have been steadier, compared to high-yield names, which have been running higher. Also, they noted that a percentage of hedge players, which have traditionally played a dominant role in the market, have remained sidelined to some degree after the high level of redemptions related to the downturn in 2008.

US Airways edges higher

US Airways' newly priced 7.25% convertibles due 2014 were at 101 bid, 102 offered around mid-session versus a share price of $3.78, which was down about 4.5%.

The paper traded up early to 104 and then settled back down to 101 bid, 102 offered, amid a decline in stock price, according to a syndicate source.

The source said the new 7.25s closed at the same level, although shares of the Tempe, Ariz.-based air carrier fell further, ending down 29 cents, or 6.8%, to $3.69.

The deal size was doubled from an originally talked $75 million.

Final pricing came at the midpoint of talk for the coupon, which was 7% to 7.5%, and at the cheap end of talk for the initial conversion premium, which was 15% to 20%.

Concurrently, the air carrier priced 15.2 million shares of common stock at $3.97 per share.

There is a greenshoe of up to an additional 2.28 million shares of common stock and a greenshoe of $22.5 million of notes.

US Airways was one of several riskier names that have come to the primary market in recent days. But from a valuation perspective it looked pretty cheap, according to two sellside analysts.

PNC, Prudential strengthen

PNC's 4% convertibles due 2011 traded up to around 95 on Friday, compared to previous trades at 93.875 and 94.25.

Shares of the Pittsburgh-based financial services company surged $8.57, or 19%, to $53.04.

Prudential Financial's floating-rate convertible notes due 2037 were active at 99, similar to Thursday's levels and seeing good activity. The paper is putable in two months. Shares of the Newark, N.J.-based insurance and financial services company closed up $3.13, or 7.3%, to $46.00 in active trade.

"The PNC and Prudential paper - that had some doubts on the credit end - are much stronger," a New York-based sellside trader said.

"PNC got knocked back a bit, but they are up around 95 today. There is a lot of relief out there. You'll probably see a lot of people moving from the common to the bond depending on where there's more upside."

The trader was referring to relief now that the U.S. government's "stress tests" have been released. The government said that 10 of the nation's 19 largest banks need a total of about $75 billion in new capital to withstand losses if the recession worsens. The banks that need more capital have until June 8 to develop a plan and have it approved by regulators.

In addition to Bank of America Corp., Wells Fargo & Co., GMAC, Citigroup Inc. and Morgan Stanley, five regional banks need to raise a combined $8.2 billion of capital.

"Anything financial, trading like straight paper, is a lot stronger," the sellsider said, noting strength in PNC and the Prudential paper.

Overall prices lag credit markets

After sustained richening through the end of April, the convertible market saw some cheapening this past week.

Credit markets were rallying dramatically, but there was some technical pressures on convertibles, sources said, citing the mixed credit profile of convertibles, the fact that hedge players haven't come back in full force, and that the crossover buyers that were helping before may have been distracted by the equities rally.

Bank of America-Merrill Lynch convertibles research analyst Tatyana Hube wrote in a note Friday, "Over the last few days, as the credit markets continued to rally, with the high-yield spreads (as measured by the H0A0 index) tightening to 1,254 bps as of yesterday from 1,354 bps at the end of April and 1,812 bps at the beginning of the year, the convertible market valuations actually cheapened from about 2% cheap at the end of April to almost 3% cheap as of yesterday (though still down from almost 4% cheap at the beginning of the year)."

Hube went on to say, "We therefore view this divergence between credit and convertible market valuations as a great opportunity to enter/increase exposure to the convertible market for non-traditional and traditional investors alike. Still being quite 'busted', convertibles have yet more to gain from ongoing credit markets recovery. We continue to expect the market to richen to 1% average cheapness mark towards the end of 2009."

A New York-based outright buysider concurred that the pricing is still better, but maybe not keeping pace with other areas of credit like high yield.

"Convertible yields at market continue to trend down, but not as fast at yields on junk, even though convertibles in general are less junky than junk, in my view, even when we dip to BB-B-CCC ratings," the buysider said.

A West Coast-based source thought the disparity might be related better equities and volatility.

As investment values recover, the implied strike for the embedded options in convertibles moves closer to being in the money. The effect is that - while volatility is coming down - your strike is moving up at a faster rate, the buysider said.

Another source, this one a New York-based sellsider, said factors like sentiment, trends, supply and demand all influence price as much as a model does.

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