Convertibles whip around; Hercules Offshore adds; Dendreon eases dollar neutral, MGM flat

By Rebecca Melvin

New York, Aug. 9 - Gyrations marked Tuesday's session and convertible bond traders were struggling to keep up with extreme volatility a day after the biggest market rout since the 2008 financial crisis.

Stocks rallied into the close, but not before a sudden plunge after the Federal Open Market Committee's unexpected pledge to keep interest rates at near 0% until at least the middle of 2013. U.S. Treasuries also rallied, pushing yields down.

Price moves in convertibles were not as dramatic as on Monday. But pockets of pain continued to be felt in various high-yield names and in sectors like energy-services, and other cyclical sectors that are tightly correlated to economic activity.

"It was whippy today. People got whipsawed back and forth," a New York-based convertibles analyst said.

An East Coast-based buysider said it was a very busy day and "there was some stuff to buy and some stuff to sell."

Others said it's a tough market because players don't always know what to do, and many are waiting for stabilization, which at this point is nowhere in sight. The Dow Jones Industrial Average saw a 200-point swing in as little as two minutes, and it ended the session in a straight upward trajectory, recouping 440 points, or 4%, to 11.239.77 after losing 635 points, or 5.6%, on Monday.

Also on Tuesday, crude oil continued its August plunge, and "people were watching that," an analyst said.

Hercules Offshore Inc.'s convertibles bounced a little from a steep sell off on Monday with shares of the Houston-based oil and gas-services company regaining 10%.

Away from energy-services, Dendreon Corp. fell several points outright amid selling, but the decline was seen as only a 0.125 point lower dollar neutral, according to a New York-based sellsider.

The Dendreon 2.875% convertibles due 2016 traded at 74 versus an underlying share price of $10.35 on Tuesday, compared to 79 versus an underlying share price of $11.70 last Thursday.

MGM Resorts International's convertibles were called flat on the day on a dollar neutral basis, closing at 97.625 bid versus an underlying share price of $11.18. The MGM convertibles were closer to 99 on Monday.

The FOMC policy statement that followed a one-day meeting Tuesday was viewed as more negative than positive by at least one market player.

Despite the fact that equities ended up rallying, "it looks like folks are going to be pushed into riskier assets for a long time," the New York-based convertibles analyst said, referring to investors looking for yield in a near-zero fed funds rate environment.

The FOMC policy statement doused hopes for any kind of meaningful recovery in the short term. It said "that economic growth so far this year has been considerably slower than the Committee had expected." In conjunction with slow growth, labor market conditions deteriorated, household spending flattened, and the housing sector remained depressed.

A silver lining is that business investment in equipment and software is strong, and inflation isn't a real concern for the immediate future or longer-term.

The statement, which had three committee member dissenters, said the Committee decided to keep the target range for the federal funds rate at zero to 0.25%, and that conditions were likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.

Hercules regains some

Hercules 3.375% convertibles due 2038 were seen at 83.5 bid for $1 million bonds outright on Tuesday, which was up after a 10-point drop on Monday to about 81.

"Hercules traced as low as 80.75 and the day before they were 90.125. It just shows a big, one-day drop and that was a busted convert that matures June 2013," a Connecticut-based sellside analyst said.

"It's people realizing that this volatility could filter into fundamentals in the energy sector very quickly," he said regarding what caused Hercules to fall.

"It hits the very cyclical sectors a lot more, like energy and shipping. It creams the economically sensitive," he said.

Hercules convertibles are completely busted and not equity price sensitive, but shares of the Houston-based oil and gas-services company bounced 32 cents, or 10%, to $3.46.

Reassessing credit risk

Hercules is not in danger of default. "There are companies on death's door, but this is not one of them. But the fundamentals of the energy-services industry, like the economy, are very uncertain right now," the analyst said.

What happened on Monday, in high yield particularly, was that "a lot of people in convertible arbitrage have 2008 memories in their minds, where converts got very cheap, and high yield as a subset of convertibles were very cheap relative to convertibles."

Convertible arbitrage suffered especially in 2008 when the government banned short selling during the height of the financial crisis and when leverage inherent to the strategy magnified losses.

"People had in their minds '08. It's not just a question of value, it's a question of how cheap can things get," the analyst said, citing Chesapeake Energy Inc. trading below 40 even though "virtually no one thought it was going into bankruptcy."

"That just shows you the technical can be that strong, and it's not a matter of fundamentals," the analyst said.

We are "nowhere near as bad as '08 but you had some names that were off 5 to 8 points," the analyst said. It happened to longer-dated and shorter-dated lesser-quality credits, he said.

As to whether the market stabilizes from here, the analyst said, "I think a lot of things become self-fulfilling, and investors can be forced to unwind positions, and it can be difficult for CEOs to take big actions because of fear that they may be forced to or can't take that action.

Mentioned in this article

Dendreon Corp. Nasdaq: DNDN

Hercules Offshore Inc. Nasdaq: HERO

MGM Resorts International NYSE: MGM

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