Overall market improves but losers fall big, like Northrop

By Ronda Fears

Nashville, Tenn., Oct. 17 - In general, convertibles improved with the gain in stocks and narrowing credit spreads Thursday and the flow was heavy. Fears about corporate profits seemed to ease but there were some negative surprises, like at Northrop Grumman Corp., and the reaction was fierce.

Also, PMA Capital Corp. priced a small deal at the aggressive end of talk as demand rages for new paper.

"It's a pretty good market today. Stocks were up nicely and the credit markets seem to be steadying," said Yaw Debrah, head of U.S. convertible research at Merrill Lynch & Co.

"The market's so starved for paper that it [PMA's new deal] was well received, I'm sure."

PMA sold $75 million of 20-year convertible senior unsecured notes at par to yield 4.25% and with a 32% initial conversion premium.

Syndicate sources said the deal did get a nice reception, and noted that there was a lot of competition among the investment banks to win the deal.

The new PMA deal closed 1 point above par at 101 bid, 101.25 asked but that was down from a gray market bid of 102 at Wednesday's close.

PMA shares ended off 3c to $12.37.

Most of the convert market gained ground but there were some losers and the issues that fell, fell hard.

Among them was Northrop Grumman, whose mandatory fell more than 11 points on the defense company's surprising loss reported before the open. Northrop also lowered its guidance for 2002 earnings.

"The Northrop headline was a shocker, no one saw that coming," said a trader at a hedge fund in New York.

"Merger arbs, who were positioned based on the TRW deal, went into a mad scramble to dump the stock in order to adjust their hedges. It looked like a landslide."

Northrop posted a third quarter net loss of 56c per share versus a net profit of 84c per share a year ago. Before special charges, earnings from continuing operations were $1.53 a share, but that also missed analysts' expectation of $1.57 a share.

Also, Northrop cut its guidance for 2002 earnings to $5.65-$5.75 a share, down from $6.60-$7.10 three months ago. The forecasts exclude effects from the TRW acquisition, which is expected to close in the fourth quarter this year.

Northrop's 7% mandatory plunged 11.65 points to 110 in a big sell-off. Volume in the converts was 364,860 versus the 30-day average of 20,697.

Northrop shares fell $13.51 to close at $101.50.

Tightening credit spreads, or at least some stabilization, helped converts as well as the bounce in stocks.

But, much like some believe the stock rally may not hold, many are skeptical of the uptick in the credit markets.

"Converts are seeing a little bit of this good news trickle down but my bet is that before we begin to feel the full impact there will be a reversal," said the head convertible trader at a major investment bank.

"What we are seeing is some tightening [of credit spreads] as a result of the Treasury sell-off, not the result of any material price gains. Of course, that helps, but the bottom line is that not a lot has changed.

"The credit problems these issuers faced last week are still there. Now, with earnings coming out and some showing a lot of improvement, there could be some traction. Even that, I think will take a while to really show up in our market."

One of the more noticeable improvements on the credit side was Ford Motor Co., as it sharply contrasts the declines it has seen recently.

Ford's 6.5% convertible trust preferred regained 1.38 points to 35.88 on heavy buying, dealers said. Ford shares added 23c to $8.49.

"We thought it was very interesting that S&P characterized Ford's balance sheet as the stronger of the two, between it and General Motors," said a convertible trader at a hedge fund in New Jersey.

"I think people in the market were picking Ford over GM today, though, on it being relatively cheaper than GM."

GM's converts were higher but to a much less extent.

The GM 4.5% edged up 0.08 point to 23 and the 5.25% closed up 0.49 to 21.04. GM shares rose $1.26 to $35.40.

Cummins Inc. common shares participated in the rally after the company reported better-than-expected earnings, saying it has addressed investor concerns about liquidity and pension funding. The enginemaker, however, warned that fourth quarter may not be a strong.

Cummins shares gained $2.35 to $24.35.

But the convertible dropped sharply, and one dealer said it was because of a large trade.

The Cummins 7% convertible trust preferred fell 3.75 points to 38.75.

Telecom names were trading mostly as if the market believes earnings will improve for the group, traders said.

That sentiment seemed to be panning out.

Sprint PCS-linked issues were mixed but mostly flat to higher.

After the close, Sprint Corp. reported a third quarter profit on cost-cutting efforts. The wireless unit, Sprint PCS, posted an operating loss of 1c per share, improved dramatically from a loss of 29c a share a year ago.

Nortel Networks Corp. also was higher, with the 4.25% due 2008 quoted up 1.5 points to 31 bid, 32 asked as the stock closed up 6c to 59c.

The telecom equipment maker reported after the bell that its net loss of $1.8 billion, or 42 cents a share also sharply narrowed from a net loss of $3.47 billion a year ago. Nortel said it still expects to break even by the second quarter of 2003, excluding costs.

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