Lehman: Convertibles return 1.93% in September, up 2.81% year to date

By Ronda Fears

Nashville, Oct. 11 - The convertible market reversed two months of decline even as investment-grade and non investment-grade convertible bond spreads expanded from their recent tight levels, Lehman Brothers Inc. analysts said in a report.

The Lehman Brothers convertible index posted a 1.93% return for September amid a general recovery in the equity markets and is up 2.81% for the year. Lehman's 2004 U.S. convertible recommended portfolio returned 1.25% in September and is up 4.06% year to date.

Implied volatility in investment-grade convertible bonds dipped in September to 27.4% following a steep decline in August that reached a near decade low of 13.3%. Still, the convertible analysts said implied volatility remained 5.9 points ahead of realized volatility in the underlying stocks of investment-grade converts.

The top investment-grade convertible bonds with the lowest implied volatility relative to the 90-day realized volatility on the stock, according to the Lehman analysts, are the Cendant Corp. 3.875% due 2011, SLM Corp. 1.61% due 2035, Amdocs Ltd. 0.5% due 2024, BJ Services Inc. 0.395% due 2022, and Radian Group Inc. 2.25% due 2022.

Convertible spreads widen

Credit spreads in the convertible market reversed following a two-month tightening trend, despite the continued spread contraction in U.S. corporates and junk bond markets. Investment-grade convertible bond spreads widened 25 basis points in September to 133 basis points, while non investment-grade spreads widened 31 basis points to 414 basis points.

The top five current-yield convertibles at Sept. 30, according to the Lehman analysts, are the Delta Air Lines Inc. 8% due 2023, LaBranche & Co. 6.75% due 2005, Teco Energy Inc. 9.5% due 2005, El Paso Corp. 9% due 2005, and Williams Cos. Inc. 9% due 2005.

With the recent spread reversal, the differential between investment-grade convertible bond spreads and the Lehman U.S. credit index now stands at 48 basis points, the convertible analysts said, while the differential between non investment-grade convertible bond spreads and the Lehman U.S. high-yield index is 46 basis points, presenting investors with potential relative value opportunities.

The top five busted convertibles with the highest option-adjusted spreads at Sept. 30, according to the Lehman analysts, are the Northwest Airlines Corp. 7.625% due 2023, AMR Corp. 4.5% due 2024, Continental Airlines Corp. 4.5% due 2007, ViroPharma Inc. 6% due 2007, and Primus Telecommunications Group Inc. 5.75% due 2007.

Energy related names continued to post solid gains on the back of surging oil prices with an average 3.1% return for the group in September.

As of Sept. 30, the Lehman Brothers convertible index consisted of 798 securities with average terms of 4.1% yield and 45.6% premium and a market cap of $299 billion. Credit quality of the overall market improved one notch to Baa3/Ba1.

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