Convertibles market moves up with stocks, but trading remains thin

By Ronda Fears

Nashville, Tenn., Oct.3 - Convertible traders said Wednesday began rocky but the profit taking that many feared never gained legs. Instead, traders said the market moved higher on a sharp spike in stocks as buying to cover short positions helped fuel a rally that took off on several bits of positive news. One positive note was the Bush Administration's proposal to pump $60 billion to $75 billion into the U.S. economy. Still, traders said the secondary market for convertibles is much slower than normal.

Because of the extreme flux in the markets over the past three weeks, the interruption to the market and such thin trading conditions, many traders still are not comfortable quoting convertible bond levels.

"We just don't have the volume we did before Sept. 11. In a lot of cases, the bond level doesn't mean much. We don't have a liquidity problem that won't fix itself, but it's tough right now. People were pretty skittish before the tragedy, but now they are even more leery to make any hasty decisions," said a convertible trader at one of the major investment banks based in New York.

"Hedge accounts have been pretty busy in the stock market, but they are looking for delta, which has virtually disappeared. So much of the convertible market is busted. There was some activity related to the upcoming new issues, but just a little."

Shrinking delta, which measures sensitivity of a convertible's stock option to the underlying stock price, means that the option value is decreasing because the convertible is moving out of the money.

"It's tricky," said a convertible hedge fund trader in New Jersey. "I've been looking for something to buy in the secondary. I've just put together my own independent list of zeroes that have short-dated puts to look at."

Many of the high-premium zero-coupon convertibles issued over the past couple of years included several premium puts, many beginning as early as in the first year.

Outright convertible investors also are looking at the zero-coupon group because of the puts, and also because much of that paper is investment-grade and has high conversion premiums that cushion the effect of falling stock prices.

"We haven't done a whole lot since the markets reopened (Sept. 17), but we're doing a lot of homework on some niches that we think hold a lot of possibility," said a convertible fund manager in Boston.

"The zero-coupon paper that was the rave last year is looking better to us right now. A lot of those issues are in oil and gas, too, which we think is near its bottom so now is the time to get in. The catchphrase, though, is slow and easy. We're not making any quick moves, especially not in the way of selling."

Dealers still say there is some crossover interest in convertibles from high yield bond investors.

High yield spreads are continuing to widen despite a 4.9% increase in the Russell 2000 index since Sept. 21, said Moody's Investors Service analyst Kamalesh Rao in a report Wednesday. A barrage of downgrades since the terrorist attacks has contributed to the poor performance of high yield bonds, he added, noting that since Sept. 11, Moody's has downgraded 22 domestic corporate high yield issuers and upgraded only two. He noted, though, that investment-grade yield spreads have narrowed recently.

But Rao said this situation has been more controlled than the Russian devaluation in August 1998 and, moreover, Treasury spreads have not jumped in a manner that suggests panic over liquidity.

Convertible players are anxious for the new issue pipeline to flow, but credit analysts say the cost of capital has increased since before Sept. 11 and syndicate officials still struggle with fluctuating credit spreads as well as volatile stock prices.

"There is little doubt that the cost of borrowing for corporations has climbed in past three weeks," Rao said. "Corporate bond spreads were relatively wide even at the end of August, so the fact that spreads have continued to balloon underscores the stark difference between the mood of the corporate bond market and that of the Treasury market."

Traders said converts moved slightly higher as stocks gained further on the Fed news as well as good news from Cisco Systems Inc. The Dow industrials closed up 169.45, or 1.89%, to 9120.04, and the Nasdaq shot up by 98.85, or 6.62%, to 1591.18.

Convertible market players were looking to Province Healthcare Co.'s new deal, which is set to price after Thursday's close. The Province Healthcare 4.5% convertible notes due 2005, which sold last November at par, were quoted down 2 points on the day at 112.5 as the common shares lost $2.22 to $32.73. End

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