Convertibles sink on profit taking as stocks retreat

By Ronda Fears

Nashville, Tenn., Jan. 7 - Convertible traders said profit taking set in Monday as stocks retreated on lingering worries about the upcoming earnings season. Activity was brisk, traders said, and spurred somewhat by new issue action highlighted by Radian Group Inc. launching an overnight deal to upset the Williams mandatory as the year's first new convertible. Traders said investors were trying to best judge where restructuring activity might support existing issues, particularly in light of increasing concern over creditworthiness.

"The ImClone situation blew up and it dragged the drug and healthcare groups down along with biotech. Pretty much everyone that got hit with that but there was a lot of profit taking, because remember not so long ago all the money was going into these areas, or a lot of it," said a convertible trader at a major investment bank in New York.

ImClone Systems Inc.'s 5.5% convertible due 2005, an unrated issue that sold at par in February 2000, fell 9.625 points on the day to 92.5 bid, 93.5 offered with the stock dropping $7.66 to $35.83. Last week's decline was exacerbated Monday by reports that the company's bid for a new drug that was denied by the Food and Drug Administration was much more serious that the company presented.

As a result, almost all the drug, biotech and healthcare issues fell in sympathy, along with just about any related issue. The mandatory convertibles of Express Scripts, a pharmacy benefits management services firm, dropped 3.75 points to 82.25 with the stock down $2.72 to $43.03.

There was one exception in the drug and healthcare group that stood out, however. Teva Pharmaceutical rose, in part due to an upgrade on the stock by Credit Suisse First Boston, traders said. The Teva 0.75% convert due 2021 (BBB-) gained 1.25 points to 99 bid, 100 offered and the 1.5% convert due 2005 added 1 point to 103 bid, 104 offered with the stock up $1.72 to $64.75.

Overall, in a pretty broad brushstroke, stocks retreated on rekindled concern about corporate earnings and credit standings. The Nasdaq lost 22.28, or 1.08%, to 2037.10 and the Dow Jones Industrial Average dropped 62.69, or 0.61%, to 10197.05.

But the convertible market got a bit of a diversion when Radian Group's overnight deal was launched.

"It's funny. There's always a mad rush by the investment banks to be the first one in line with the first new deal of the year," said a convertible hedge fund manager in New York. "This one actually doesn't look that cheap, but it's investment grade and a lot of people will give up a little bit for that kind of credit right now. Everyone seems to be really focused on the credit end of the deal right now. There have been so many blowups that it has everyone on edge."

Radian's $200 million of 20-year convertible notes are talked to price to yield 1.75% to 2.25% with a 40% to 44% initial conversion premium.

The 20-year notes will be non-callable for three years, with a change of control provision and a string of put options payable in cash and/or stock at Radian Group's discretion. There also are contingent conversion and contingent payment features on the issue, which is rated A2 by Moody's Investors Service and A+ by Fitch. Standard & Poor's is expected to rate the mortgage insurance company's issue at A.

Deutsche Banc Alex. Brown convertible analysts put the issue right at fair value to 2.6% cheap with an implied volatility of 29.8% to 34.5%, assuming a credit spread of 150 basis points over Libor, 50 basis points borrow cost and 35% volatility.

As stocks snapped back, traders said the profit taking that had begun late Friday gained steam. Investors were also selling to make room for new paper, to some extent.

"There was not a lot of green anywhere today," said a convertible trader at a hedge fund in New Jersey. "Several issues in the media and cable group was a bit higher, but that was about it. XL Capital was getting a little pressure from a big straight bond they just did. Retail was lower, chips and tech got hit pretty hard and most of the telcos were down."

XL Capital's European unit sold $600 million of 10-year global senior notes and the zero-coupon convertibles due May 2021 (A1/A+), which sold at 59.36, dropped 0.5 point to 63 bid and the zero-coupon convertibles due September 2021, which sold at 56.5, lost 0.375 point to 58.75 bid. XL Capital shares fell $1.35 to $88.80. XL Capital said proceeds from the senior notes will be used to repay its outstanding five-year revolving credit facilities and for general corporate purposes, which may include share repurchases and acquisitions

"Refinancing is under a microscope right now," said the convertible hedge fund trader in New Jersey. "Everyone is trying to figure out who's coming next, who can get a deal done smartly and without hurting what they already have in play. That is what a lot of the new deals this year are going to be about, but it's going to be tough."

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