Equities plummet, then partially recover; some convertibles buyers step in after decline

By Rebecca Melvin

New York, May 6 - Selling pressure dominated the convertibles market early Thursday amid ongoing worries about Greece and possible contagion of the sovereign debt crisis in Europe. But some buyers actually stepped in late in the session after a sudden spike lower in equities markets sent those market indices on record-breaking plunges.

The Dow Jones Industrial Average fell more than 900 points to 10,075.57 shortly after 2:30 p.m. ET. But the Dow came back 445 points before the market close, to settle lower by 347.80 points, or 3.2%, at 10,520.32.

"There was a lot of selling this morning, but some customers coming back in this afternoon looking to buy on that big drop," a New York-based sellside desk analyst said.

Credit default swap spreads blew out, commodities fell, but U.S. Treasuries, gold and the U.S. dollar were strong.

Although the cause of the sudden drop in stocks wasn't immediately known, some sources thought it was a computer glitch and there were news reports of trader error; nevertheless, the overall drop looked like a continuation of the flight to quality and risk aversion that has been a factor all week, a New York-based sellside trader said.

Volume lightens

Market volume in the convertibles bond market was on the light side, compared to the last few sessions, with about $900 million of total volume, a sellsider said, citing Trace volume.

"But that's kind of misleading," the sellsider said. "If you subtract out about $150 million of Transocean Ltd. trades, you get about a $750 million volume day, which is lighter than we've been. We've been close to $1 billion in the last couple of sessions."

In addition to heavy volume in Transocean, there was about $57 million of Amgen Corp. convertibles traded. They were the two top volume names of the day.

Just ahead of the freefall, a sellsider told Prospect News, "it seems like a lot of stuff is for sale, and there are no, or hardly any, bids."

Volatility discouragingly heavy

Despite the fact that market volatility of the stripe that encourage hedging has been a missing ingredient in the convertibles market for which many have been pining, the magnitude of volatility seen this week has been a deterrent.

"A lot of the trading that gets done in periods of high volatility is stock trading, adjusting hedges. People are too worried about getting caught in a fast market, and liquidity isn't great. It gets sloppy; and that's difficult for people," a sellsider said.

The return of volatility with big intraday moves can be beneficial, and in anticipation of increased volatility, many convert players had been putting on more volatility-sensitive trades, turning away from the credit-sensitive trades that have been a mainstay of the market for the better part of the year.

It was too early to tell Thursday whether those trades fared well in the midst of the magnitude of the volatility, sources said.

"After big moves like this, people have to go back and reevaluate, and see how [names] look now. They need to pause, and go back and see where the dust settles, before they firm up again," a New York-based sellside trader said.

On Friday, traders will likely comb through names, looking to see where convertibles actually traded, and whether they held up at all on the downside, or came down lock step or even heavy. "I don't have the answer to that yet," a sellsider said.

Investors assess market

On Wednesday, market participants were talking about the healthy aspects of the return of volatility.

"Nobody wants to see people lose a lot of money, but for convert arb players, who like to trade well-defined risk, low premiums, hedge in stocks, the fact that the virtues of hedging is more apparent is a good thing for the convertible market," a New York-based sellside trader said Wednesday.

He said that convertibles players were looking to trade relatively short-dated, close to maturity, type names, owned with a hedge. They appeared less eager to be in credit-sensitive names, he said.

"Customers are looking for trading relatively short duration bonds that will hold up better in a down market," the trader said.

While no one "is pretending to know what is going to happen next; people feel like something is going to happen. Things are changing: whether it's Greece, Goldman Sachs or the Gulf. Things always change, and the market is going to be different, and it will require different kinds of trades," he said Wednesday.

And in addition, the pure credit trades have perhaps run their course, sources said.

Europe quiet

The European convertible market remained quiet as investors continued to operate under the shadow of Southern Europe's debt problems.

"I haven't really seen the convertible market," one trader said. "The market's dominated by the European peripheral sovereign credits."

Airlines sucked lower in downdraft

The airlines sector has fared much worse than the overall market this week as risk aversion has gripped investors.

"They are bad credits, with bad balance sheets, and more likely to get sold off. They are some of the weakest names today," a sellsider said Thursday.

AMR Corp.'s 6.25% convertibles due 2014, a high-volatility name, has fallen hard this week, trading Thursday at 98.25 versus a share price of $6.75, compared to a trade Monday at 107 versus a share price of $7.50, according to a New York-based sellside desk analyst.

Shares of the Fort Worth-based air carrier fell 37 cents, or 5.2%, on Thursday to $6.75.

UAL Corp.'s 6% convertibles due 2029 traded at 221.5 versus a share price of $18.00, which was down from 235-ish versus a share price of $19.25 on Wednesday and down from the 260s on Monday.

Shares of the Chicago-based carrier fell $1.81, or 9%, to $17.97 on Thursday.

KKR, Exterran in trade

Traders were loathe to say how convertibles did for the day, but did mention a few names that traded.

KKR Financial Holdings LLC's 7.5% convertibles due 2017 were in trade at 121.5 versus a share price of $8.00 on Thursday, which was down 2.75 points from previous levels, and compared to shares of the San Francisco-based real-estate-investment trust and specialty finance company that were lower by 2.3%.

"The common had been up when they pulled the offering earlier this week," a sellsider said. The company withdrew a proposed offering of common shares on Wednesday, blaming market conditions.

Exterran Holdings Inc.'s 4.25% convertibles due 2014 traded after the Houston-based natural gas compression company posted a first-quarter profit on lower revenue.

The Exterran 4.25% bonds traded at 139.25 early, compared to 140.5 bid, 140.75 offered, versus a share price of $28.64 on Wednesday.

On April 5, Exterran's 4.25% convertibles settled at 129.19 versus a share price of $25.55.

Exterran shares on Thursday lost 6.4%, settling at $26.12.

Exterran reported net income of $16.7 million, or 27 cents a share, compared to a net loss of $59.4 million, or 97 cents a share, for the first quarter a year ago.

But there was a net loss from continuing operations in the most recent quarter of $1.5 million, or 2 cents per share, excluding an after-tax gain of $8.8 million on the sale of assets related to its former Cawthorne Channel project and a non-cash after-tax asset impairment charge of $1.1 million.

Revenue was $576.3 million for the first quarter, compared to $703.2 million for the first quarter 2009.

Ernie Danner, Exterran Holdings' president and chief executive, said, "With a continued focus on controlling operating and capital costs throughout the company, we generated significant cash flow and reduced our outstanding debt balance by $117 million in the first quarter."

"While we are encouraged by the continuing stabilization of our North America contract operations compression fleet utilization, we believe weak natural gas prices may limit our near-term growth opportunities," Danner said in a release.

"We are optimistic about the longer-term outlook for our business. This outlook is driven by an improvement in the overall level of new business inquiry and bid activity for our worldwide products and services. We also believe the growth opportunities associated with industry development of emerging shale gas plays in North America and energy infrastructure projects in Latin America and the Eastern Hemisphere will be beneficial to us over the long-term," Danner said.

A sellsider who reported trades of Exterran on Wednesday, said on Thursday that the position he had been dealing with had been sold.

"Everybody rotates out of stuff, and trading has been tough to do in a week when you have all this macro stuff and international stuff, and a heavy week of earnings on top of it," the source said.

"Convertibles names are still coming in fast and furious, with 20, 30 or 40 names a day, and they tend to be a more mixed bag, in terms of quality, big misses and big beats. Earnings are big sources of volatility or catalysts. Everyday you have an InterMune Inc.," a sellsider said.

Mentioned in this article:

Amgen Inc. Nasdaq: AMGN

AMR Corp. NYSE: AMR

Exterran Holdings Inc. NYSE: EXH

InterMune Inc. Nasdaq: ITMN

KKR Financial Corp. NYSE: KFN

Transocean Ltd. NYSE: RIG

UAL Corp. Nasdaq: UAUA

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