Convertibles post slight loss in May, outperform equities: Citigroup

By Rebecca Melvin

New York, June 6 - Convertible bonds posted a slight loss in May, declining between 0.2% and 1%, depending on the index, while equities dropped by a greater amount, with the major stock indices posting declines of roughly 1.5% in May, according to Citigroup's Convertibles trading desk May market report published Monday.

The Barclays Capital U.S. Convertible bond index declined about 0.2% and the Hedge Fund Research Inc. convert arb index lost about 0.4%, but both remain higher for the year to date.

In other bond markets, Citi's High Yield Index, Broad Investment Grade Index and Treasuries finished the month with small gains.

There were 10 new convertible bond issues priced in May for a total of $2.6 billion, according to Citi's monthly report.

For the year to date, 53 new convertibles have raised $17.8 billion, which is better than the comparable period of 2010 when 38 deals with $12.1 billion in proceeds were priced.

The average convertible issuer's market capitalization last month was barely above $2 billion. That's down from $3.3 billion in April and $4.3 billion in March, suggesting the absence of any large cap issuers from the roster in May, Citi's convertibles trading desk analyst Stu Novick wrote in the report.

"In fact, the biggest company to issue a convert in the U.S. last month was Lam Research, with a market cap of $5.9 billion. Additionally, half of the convert issuers in May had market caps of under $1 billion," Novick wrote.

"Until interest rates begin to climb, it's likely that many larger, better capitalized companies will forego the convert market in favor of the cheap corporate (straight) debt market," Novick wrote.

Citi calculates convertible maturities were $2.45 billion last month, and repurchases, calls and other redemptions totaled $1.9 billion, putting the net organic growth number at negative $1.7 billion.

"We don't envision an immediate drop in redemptions given probable calls, exchanges and upcoming maturities," Novick wrote, noting that Archer-Daniels-Midland Co.'s 6.25% and SYMC 'A' tranche will both mature in June, resulting in a $2.85 billion leakage from the market.

In addition, several calls, including Life Technologies Corp.'s 3.25% convertibles, a partial call of Host Hotels' 3.25% convertibles and a call of Cameron International Corp.'s 2.5% convertibles, will pull another $870 million from the asset class.

The better credits generally outperformed in May as investors switched gears and trimmed risk. Citi's Investment Grade index returned 1.3% while the High Yield Index brought in 0.4%. In High Yield, BB rated bonds topped CCC rated issues.

Volatility still low

VIX bounced off the multi-year low it posted at the end of April, climbing 4.7% in May, although it closed last month at just 15.4%, still well off from its long-term average.

Convertible new issue weighted average terms were roughly 2.4%, up 26%. The absence of any high yielding mandatories or preferreds squeezed the weighted average yield and pushed up the weighted average premium relative to recent months.

For the year to date, the weighted average new issue terms are 4.3%, up 26.1%.

For all of 2010, the weighted average new issue terms were 4.22%, up 26.1%, according to the Citi monthly report.

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