Busted market holds firm amid thin trading while stocks slide

By Ronda Fears

Nashville, Tenn., Aug. 27 - Convertibles held firm against the decline in stocks, partly due to very thin trading volume but also due to the hefty premiums in the market cushioning the blow.

"It is really quiet. This is one of the quietest weeks we've seen in a while, said Rao Aisola, head of convertible research at Bear Stearns & Co.

"The market is well bid, though, across the board. The credit markets have firmed up a bit, and that helps. It appears short covering is under way."

Traders said there were more buyers in the market, enticed by the way convertibles have held up against stock declines.

"We've seen premiums contract maybe a little bit lately, probably due to spreads tightening, but there's still a lot of defensive plays. The market is still busted overall," said a dealer.

"We're not really seeing anyone take any large positions but we see some interest in investment-grade telecom names, a few techs. There is a renewed focus on credit quality in the wake of earnings, financial disclosures."

Aisola said investors are still scouring the market for choice names in tech and telecom, those with clean balance sheets, positive cash flow and lots of cash.

Level 3 Communications was weaker even though the company reworked its bank lines and one trader pointed to comments by S&P for the skepticism.

S&P said in a note that the financial flexibility afforded Level 3 by the amendments to its bank facilities is more than offset by the negative impact on liquidity from the reduction in available bank credit to $150 million from $650 million.

Given poor fundamentals of the long-haul data business and substantial leverage, S&P said the "reduction in liquidity further erodes Level 3's already limited margin of safety against execution risks."

There were areas in the telecom group gaining ground, however.

Nextel Networks' 4.75% convertible due 2007 gained 1.875 points to 72.5 bid, 73.5 asked. A trader noted that the other two Nextel converts were higher, but to a lesser degree, as investors were going for shorter-dated paper. Nextel shares ended up 40c to $8.21.

Xerox's discount convertibles firmed up, although the trust preferreds were lower with the stock. One trader explained that the discount convert is putable in April 2003, at 64.89.

The Xerox 0.57% due 2018 (B3/B) added 1.5 points to 55.5 bid, 57 asked. The 7.5% trust preferreds due 2021 were down 0.75 point to 47.74 bid, 48 asked as the stock closed off 12c to $7.

HealthSouth Corp. was pounded after announcing that unforeseen changes in Medicare reimbursement rules could adversely impact EBITDA by $175 million and reduce cash flow. Also, the company said it was planning to separate its outpatient surgery center with a partial IPO.

S&P put the HealthSouth 3.25% convertible subordinated debentures due 2003 (BB+) on negative watch and Moody's placed its Ba2 ratings on the convertible on review for possible downgrade.

Moody's said the proposed separation of the surgery division could reduce revenue streams and contribute to a more risky business profile, and the reduction in cash flow raises concern about the company's ability to maintain current credit protection levels.

HealthSouth's convert was quoted down 4.5 points to 92.75 bid. The stock closed down $5.26 to $6.71.

Retail names were mixed on Merrill Lynch's retail analyst Daniel D. Barry recommending a shift to a defensive posture, de-emphasizing economically sensitive retailers with the greatest chance of profit disappointment.

Gap Inc.'s 5.75% convertible due 2009 lost 0.75 point to 101.375 bid, 101.875 asked but the 6.9% junk bonds due 2007 were seen up 1.5 points to 88.5. Gap shares closed off 22c to $11.75.

"In general I think people are not very comfortable with the mixed signs we're getting on the economy," said a convertible trader at a hedge fund in New York.

"So everyone is treading lightly, not making any fast moves. People are especially leery of names where there's been some credit problems recently."

Calpine Corp. lost ground after announcing two transactions with total proceeds of about $253 million - a partial IPO of a Canadian income trust fund for proceeds of about $148 million and completion of $106 million project financing for a plant in Colorado.

That helps with liquidity but capital markets remain a challenge for the power producer.

"These two transactions should improve Calpine's 2002 liquidity outlook by about $250 million, putting our year-end forecast at approximately $1.0 billion in positive liquidity," said Deutsche Bank Securities Inc. electric utility analysts James Dobson and Jason West in a report.

"However, access to capital remains difficult. We would note that Calpine will be dependent on capital markets to meet 2003 liquidity needs."

Calpine's 4% convertible due 2006 (B1/B+) dropped 1.375 points to 57 bid, 58 asked. The stock closed down 51c to $5.24.

Trading will pick up somewhat in September and then more heavily in October as year-end portfolio shuffling gets under way, market sources say.

A more active new issue calendar will also boost trading volumes.

"The deal volume will start picking up in the next couple of weeks," Aisola said, particularly after the Labor Day holiday.

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