Caesars, Sallie Mae floaters up on rate hike concerns; Pharma Resources dives as outlook cut

By Ronda Fears

Nashville, April 13 - Buyside players used words like "carnage" and phrases like "it's ugly out there today" to describe the convertible market Tuesday as stocks took a sharp dive and, compounding the pain, Treasuries dropped too.

Sellside traders said they stayed busy, but several noted that their screens were predominantly red, indicating much of the market was lower.

Perhaps because of the loud wails and groans emanating from the secondary market, the small deal launched by Walter Industries Inc. for Wednesday's business was not seen in the gray market yet, at all.

Of the very few instances of gains, the floating-rate convertibles of SLM Corp., Lockheed Martin Corp. and Caesars Entertainment Inc. were mentioned - as their popularity rises in a higher interest rate environment.

Pharmaceutical Resources Inc., however, caved in to selling pressure Tuesday, losing 4 to 4.5 points, after the company issued a warning about its first quarter earnings. The bonds had been holding up against pressure from competition in its generic drugs, particularly one for hepatitis C.

Rate risk pains hedge funds

Robust retail sales took the brunt of the blame for the markets pulling back because of an elevated level of concern that interest rates would be on the rise sooner that previously expected. But recent positive jobs data is another linchpin in the altered expectations.

Nevertheless, the prevailing Conventional Wisdom now puts the Federal Reserve raising interest rates as early as August or September, versus a previous consensus of November or December.

As a result of the potential boost to the cost of capital, stocks took a hard hit with the Dow Jones Industrial Average dropping more than 134 points and the Nasdaq losing more than 35 points; but both remain above key psychological levels with the Dow at 10,381.28 and the Nasdaq at 2,030.08.

Treasuries were the source of a great deal of the pain among convertible players, particularly hedge funds, as bonds had one of the largest single-session drops since the April 2 employment report sent shockwaves through the market.

"Treasury yields backed up to a three-month high this morning. I think the 10-year went to something like 4.5%," said a convertible trader at a hedge fund in New York.

Another convertible trader at a hedge fund in New Jersey said, "It's an ugly day today. Last year when rates backed up I took a hit of about 1% and I vowed to not be over-exposed again."

Hike talk dims shine of metals

As a result of the market dynamics Tuesday, interest rate sensitive issues were getting sold off, particularly by the hedge funds.

The precious metals sector was a particular area of focus, specifically the Apex Silver Mines Ltd. and Freeport McMoRan Copper & Gold Inc. convertibles.

But, sellside traders pointed out that while hedge funds were selling these issues, outright convertible players were buying.

Freeport McMoRan's new 5.5% convertible preferred lost about 2 points on the day to 96.5 bid, 97 offered, and its 7% convertible bonds fell 4.5 points to 152 bid, 152.25 offered. The underlying stock lost $1.97, or 5.24%, to close at $35.66.

Apex Silver's new 2.875% convertible bond fell a similar 4 to 5 points. One sellside shop closed it at 95 bid, 96 offered. The stock plummeted $2.10, or 9.84% on the day, to end at $19.25.

Gold and silver prices took a hit Tuesday on a rally in the dollar against the euro and yen but have been hovering at record levels.

The June contract for gold fell $13.20, or 3.1%, to $407.70 an ounce on the New York Mercantile Exchange, and the May contract for silver dropped 58 cents, or 7.2%, to $7.45 an ounce.

Floaters rise on rate hike buzz

Conversely, floaters gain interest in a climate of rising interest rates, and in the last year or two there have been several introduced into the convertible universe.

Specifically mentioned gaining Tuesday by traders were SLM - better known as Sallie Mae - Lockheed Martin and Caesars.

Caesars was not all that popular when it was put into circulation. Caesars sold the chunky $300 million convertible senior unsecured floating-rate notes to yield the three-month Libor with a 70% initial conversion premium - at the cheap end of guidance for a yield of the three-month Libor minus 50 basis points to flat with a 70% to 75% initial conversion premium.

But lots of buyside sources still thought the paper was too expensive for the Las Vegas casino operator's credit.

On Tuesday, however, the Caesars convertible was finding buyers. The floater added 0.25 points to 102.375 bid, 102.625 offered while the underlying stock dropped a nickel, or 0.36%, to close at $13.94.

Sallie Mae's convertible, which pays the three-month Libor minus 5 basis points through May 2007 and then becomes a 0% bond, added 0.125 point. It was quoted at the close at 99.5 bid, 100 offered. The stock fell 97 cents on the day, or 2.29%, to $41.30.

The Lockheed Martin convertible, which pays the three-month Libor minus 25 basis points through August 2008 and then becomes a 0% bond, was range bound at 100.5 bid, 101 offered. The stock closed down 46 cents, or 0.98%, at $46.45.

All three of those floaters were issued at par.

Walter new deal silent in gray

Walter Industries' new deal surfaced early Tuesday but was nowhere to be seen in the gray market, according to buyside traders. But, some felt like the issue was reasonably attractive.

Part of the lack of activity in the issue could be the turmoil in the markets, one buyside trader said, but some of it is a skittishness among players to participate in the when-issued market.

"I saw nothing on this [Walter deal] in the gray today. The whole gray market is really drying up," the trader said.

"People are skittish about picking something up in the gray. With deals getting priced at fair value, you're liable not to get paid anything, or lose, for the risk."

The $125 million of 20-year convertible notes are talked to yield 3.5% to 4.0% with a 35% to 40% initial conversion premium for Wednesday's business. The notes will be sold on swap, with about $10 million of proceeds slated to purchase shares sold short by convertible note purchasers.

Another buyside trader said that, compared to other new deals lately, the Walter issue looked relatively attractive.

"The pricing seems to be a little better, as far as the coupon is concerned, but the premium is still too pricey," the trader said.

"There seems to be a rush to the door before it closes, before rates start to ratchet up," he added, which may improve terms from the buyer's perspective.

Pharma Resources recoils

Pharmaceutical Resources convertibles dropped 4 to 4.5 points Tuesday on selling pressure as the company warned that first quarter earnings would fall short of expectations. The company cited delays in a number of generic drugs.

The convertible had been on a roller coaster the past week but was holding up fairly well until the headlines hit the tape Tuesday.

The Pharma Resources 2.875% convertible due 2010 dropped to 94.5 bid, 96 offered, according to one dealer. It had stayed about even, on a dollar neutral basis, after rallying a bit on good news last week only to give those gains up later in the week on news of competition in its jointly-marketed hepatitis C drug.

Pharma Resources said Tuesday it expects to earn 80 cents a share, up about 20% from year-ago levels, but considerably below analysts' estimate of $1.04. Separately, the company also announced it would buy generic drug maker Kali Laboratories for $135 million in cash and stock warrants.

Last Thursday, Schering-Plough launched a generic version of its hepatitis C medicine ribavirin, a day after Pharma Resources and Novartis AG won approval to market a generic version of the drug. Pharma Resources had acquired the rights to the drug from closely-held Three Rivers Pharmaceuticals LLC.

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