Lehman finds new issues cheapened in June

By Ronda Fears

Nashville, Tenn., July 5 - New issue valuations and terms swung in favor of buyers in June, with at-issue cheapness rising for the first time in three months, said Lehman Brothers convertible analyst Jocelyn Picl.

"New issue valuations as measured by average nonweighted cheapness fell substantially in June to 4.63% from 2.35% in May, skewed in part by distressed issuer Nortel's $821 million mandatory, which priced 9.1% cheap," Picl said in a report Friday.

"The convertible market continues to be a provider of capital to distressed companies, as was the case in June in the form of an $821 million Nortel mandatory. Challenging primary and secondary market conditions suggest that new issue valuations will continue to improve [for buyers] in the short term."

Factors contributing to the increased cheapness during June, she said, were challenging conditions in the secondary market, widening credit spreads, falling stock prices, a substantial increase in mandatory issuance and lower credit quality among issuers.

New issue valuations cheapened for the first time in 3 months with all 10 new issues in June priced cheap relative to fair value, the analyst said.

Average non-weighted cheapness of new issues increased substantially to 4.63% from 2.35% in May with overall year-to-date cheapness of new issues at 2.99%, she said.

Terms also cheapened significantly in June on the back of heavy mandatory issuance, Picl noted.

Yields expanded 324 basis points to 7.66% and premiums contracted 375 bps to 22.45%, she said. Among mandatories, weighted average yield pickup rose to 541 bps from 484 bps in May. However, the analyst noted that year-to-date mandatory yield pickup of 531 bps continues to lag the historical average pickup of 600 bps to 750 bps.

While June issuance of $3.15 billion via 10 deals was essentially flat versus May's $3.19 billion level, including greenshoes, Picl pointed out that it marked the fifth month in a row of declining or flat new issuance.

Total year -to-date issuance stands at $41.83 billion, significantly lagging the 2001 run rate of $56.85 billion through June 2001.

As expected, mandatory issuance surged in June with seven issues priced, raising $2.56 billion, or 81.4% of the month's total gross proceeds. Cash-pay bonds made up the balance of June's proceeds with three issues priced totaling $585 million.

The convertible market still managed to grow, Picl said, but at a slower pace.

"Organic growth of the market in June, defined as new issues less calls, put exercises, buybacks, tenders, maturities and income, grew at the slowest level in five months expanding only $597 million," she said.

Year to date, organic growth stands at $24 billion.

Credit quality of new issues slipped a bit with investment grades accounting for 44.2% of June proceeds, down from 57.8% in May. Overall credit quality remains solid year-to-date, however, with investment grades accounting for 68% of new issue proceeds. Issuer base continues to remain diversified.

"Average credit quality was decent in June, although down markedly from April and May levels where investment grades accounted for 74.1% and 57.8% of gross proceeds, respectively," Picl said.

Breakeven and call protection both decreased for the month, to 3.2 years and 3.4 years, respectively, versus May breakeven and call protection levels of 5.1 years and 3.9 years, which is a negative for buyers Year-to-date, weighted average breakeven and call protection for all new issues stands at 3.7 years and 4.0 years, respectively.

Telecom and Utilities saw a resurgence in June through 4 mandatory issues by Nortel (NT), American Electric Power (AEP), FPL Group (FPL), and DTE Energy (DTE) totaling $1.71 billion. On a year-to-date basis, convertible issuance continues to remain well diversified with Industrials retaining the largest share at 23%.

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