Buyers chase bargains on the way up, spreads also improve

By Ronda Fears

Nashville, Tenn., Oct. 10 - The convertibles market was dominated by buyers Thursday - although there's not a large contingency thinking the rally will be extended in any large way.

But thanks to the demand the market gained considerable ground, aided not only by the rise in stocks but a settling in credit spreads.

"The day started out really sort of slow with the retail figures coming in. Around mid-morning, though, someone opened the floodgates," said the head convertible trader at a major investment bank.

"Then the chase was on."

Short covering accounted for some of the move in stocks, traders speculated, but converts saw plenty of buyers, even in some retail names that were heading south on the Big Board.

Insurance issues also were a major source of strength, traders said.

"A lot of the beaten-down sectors were finding buyers step in," the dealer said, as investors made selections among the rubble in an effort to find bargains for names they believe will lead their respective groups in the eventual turnaround.

Credit spreads did not tighten significantly, traders said, but at least seemed to stabilize, which helped ease investors' nerves somewhat.

Damage control was a major theme in the market, as well, with Ford Motor Co. planning a road show to talk directly with its biggest investors and Mirant Corp. defending itself against another downgrade by Moody's.

Some slippage in recent advances in convertible returns was indicated as the Froley Revy convertible bond index reported a total return decline of 0.25% for September. That's behind a 1.2% gain in August, which followed a 7.05% drop in July.

But players seem to think the market is improving for outright convertible investors, which have suffered disproportionately in the downswing compared to hedge funds.

Hedge funds, however, which account for upward of 70% of flow in convertibles, have had a tough go of it lately. That's largely due to speculations, right or wrong, about whether stocks have reach capitulation, said a hedge fund trader.

Hedgefund.net, a private hedge fund database, reported that its total hedge fund index was down 0.15% in September versus a 0.56% gain in August. Convertible arbitrage, though, gained 1.13% in September compared with a gain of 0.55% in August. Risk arb, another strategy followed by hedge funds in the convertible market, was up just 0.1% in September versus a 0.83% gain in August.

"The market, overall, will begin to look a lot better once we see that the turn has been made," the fund trader said.

"Right now there's two groups of converts, busted issues and those that are rich. When premiums start coming in as stocks move up, then there will be a frenzy of activity going on as people want to get into position. We're seeing spurts of that here and there but that will only hold if stocks have indeed hit a bottom."

In retail, though a fair number of the group went south, Kohl's Corp., Skechers Inc. and Costco Wholesale Corp. were gainers. The Kohl's convert moved on buying against a big drop in the common.

Among insurance names, The St. Paul Cos. Inc. and MetLife Inc. issues were the big winners.

The market is still waiting for details on St. Paul's spin-off of its Platinum Underwriters Holdings Ltd. unit this month, too, which will include a $125 million mandatory.

Network Associates Inc. also gained nicely on better earnings, with the 5.25% convertible due 2006 soaring 8.875 points to 100.375 bid, 100.5 asked. The stock gained $2.16 to $10.76 on huge volume.

Duke Energy Corp. also gained on heavy volume in the stock, which traders largely attributed to short covering, but the two mandatory issues saw only modest interest.

Mirant, however, was among the losers of the day, failing to calm investors after Moody's cut its credit deeper into junk territory.

Due to the current lack of investor confidence, Moody's noted that Mirant's access to public debt markets is very limited. Furthermore, Moody's said, its banks have also pulled back from the sector as a whole, resulting in significantly increased refinancing risk.

At this point, Moody's said Mirant's most significant challenges will be reducing its debt to a level commensurate with its cashflow and refinancing debt maturities in 2004.

"We're disappointed in this action, but not surprised," said Ray Hill, chief financial officer of Mirant, in a company statement.

"We've moved aggressively to strengthen liquidity and reduce trading and marketing activity to ensure that our business is able to service customers despite rating agency actions. Ratings downgrades do not trigger any default or acceleration of debt obligations for Mirant, but they could require us to post additional collateral."

He said that is estimated to be in the range of $300 million, which he said is very manageable given Mirant's liquidity of $1.7 billion.

Mirant's 5.75% due 2007 dropped 1.625 points to 31.25 bid, 32.25 asked with the stock ending down 7c to $1.26.

Calpine Corp.'s junk bonds were said to be down 3 points and its bank debt off sharply, but the converts held up, traders said.

Ford, though, apparently went a long way toward convincing investors that it will get a handle on its situation. Ford's CEO, Bill Ford Jr. - the great-grandson of the founder - and CFO Allan Gilmour will meet key investors beginning next week.

Company officials said meetings will be held with large institutional investors in New York next Thursday, a day after the company is scheduled to report third quarter results. There will be a presentation in Boston on Oct. 21.

Buyers flocked to Ford.

The 6.5% convertible trust preferred due 2032 saw volume of 2.5 million versus the 30-day average of roughly 750,000. The issue gained 1.8 points to 33.2. Ford common shares ended up 45c to $7.60.

Fleming Cos. Inc. also saw a turnaround, but by virtue of a pitch to its employees in a company memo that leaked to news media and ran across the tape.

The 5.25% convertible due 2009 gained 1.125 points to 29.5 bid, 34.5 asked as Fleming shares closed up 72c to $3.90.

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