GrafTech bid 4.25 points over par; XL, Radian hold up against pull from stock due to charges

By Ronda Fears

Nashville, Jan. 15 - Traders reported convertibles bucked a more negative trend in stocks from earnings anxiety, particularly with regard to a couple of insurance names - XL Capital Ltd. and Radian Group Inc. - as those stocks dived on bigger-than-anticipated charges for reserves in 2003.

Moreover, dealers said it was a busy day.

"A lot of what is trading in the mainstream convertible market has no particular reasoning behind it; it's because people have to be fully invested and stay busy, hoping to pick up a point or two here and there," said a dealer at one of the big shops.

A convertible trader at a big hedge fund in New York added to that sentiment, saying "I agree that people seem to be trying to keep busy and to try to make a couple of cents here and there.

"I think given how thin margins are now, given valuations, it makes some sense to trade around positions a little more aggressively rather than buy and hold.

"Frankly, I don't think there's a lot of significant upside to the market, maybe some due to the liquidity sloshing around in the market, but no easy money to be made, except maybe flipping new issues."

Dealers say new paper, indeed, is the hottest area for volume in the convertible market right now.

Investors grow impatient

In virtually every corner of the convertible market - outrights, hedge funds and everything in between - report having more money to put to work in the asset class on the back of strong returns in 2003, but they are getting anxious for a solid slate of nice-sized deals to materialize.

"The bankers are all telling us that they have a strong shadow calendar sitting out there, but we're now in the third week of the year and haven't even hit a billion dollars yet. We've had five deals, but this time last year [according to the Prospect News Convertible Daily deal volume chart] there were four deals that totaled $4.85 billion," said a hedge fund manager in New Jersey.

"I know the projections for this year are that it's going to be a little slower, but we really need to see something, a big jumbo deal, pretty soon."

There has not been any buzz about a jumbo deal, however.

Thus, even the tiny deals that have been the bulk of new deals so far in 2004, outside of Red Hat Inc.'s debut $500 million issue, have been outrageously oversubscribed and bid up.

GrafTech International Ltd.'s $125 million of convertible notes - with talk at 1.75% to 2.25%, up 20% to 25% - was getting bid up steadily throughout the session. It last was seen with a when-issued bid of 4.25 points over par. The stock dropped 64 cents, or 4.57%, to $13.37.

Deutsche Bank Securities analysts put the GrafTech deal 6% cheap, at the middle of price talk, using a credit spread of 425 basis points over Libor and a 40% stock volatility.

Another sellside analyst, who is not involved in the deal but could not be quoted, put the GrafTech convertible 3.3% cheap, using a credit spread of 500 basis points over Treasuries and a 48% stock volatility.

Cleveland-Cliffs Inc. advanced its perpetual convertible preferred deal by a day and upsized it by $50 million amid strong demand. Terms were not squeezed as a result, but the $150 million deal did price at the tight end of guidance to yield 3.25% with a 22.5% initial conversion premium.

Still, bookrunner Morgan Stanley closed the Cleveland-Cliffs convertible up 4 points from par at 104 bid, 105 offered; the deal had been bid 2 points over issue price in the gray market. The stock gained 65 cents, or 1.29%, to $51.20.

The flood of new cash in the convertible market has made it easier to make some money flipping new issues, buyside sources said. Just a few months ago, during the latter part of 2003, players were complaining that it seemed like more new paper went south out of the gate than north, so that strategy backfired more often than not.

The big question is: At what point might money be jerked off the table?

"I feel like we've got at least until the end of January or early February before investors get too frustrated and pull up stakes," said a capital markets source at one of the busier shops.

"But we don't want there to be a big dead spot. There has got to be two or three deals a week, just to keep up interest, keep people occupied with something."

Alamosa stoked on tightening

Some players - mavericks by some accounts, savvy pacesetters by others - are reaching farther and farther down the credit ladder for opportunity to make money. In some cases it has already begun to pay off, such as with the Alamosa Holdings Inc. 6% convertible preferred due 2013 that was borne out of its recent debt exchange to avert bankruptcy.

The Alamosa convertible shot up 28 points on Thursday to 455; it was issued about six weeks ago with a par of 250.

"We've been active in those [Alamosa converts] since they came out a month and a half ago, but they have really been busy this week," said a convertible dealer at one of the big shops.

"The preferred was trading at 1,200 over and that tightened sharply because they did a high-yield deal in the 600 range. They were stoked over that, as well as the [fact that the] stock's had a good run."

Alamosa shares have risen from $4 in October when the revised exchange offer was made, and ultimately accepted, to close Thursday up 26 cents, or 4.75%, to $5.73.

The Lubbock, Texas-based company, an affiliate of Sprint PCS that provides wireless personal services in the southwestern and midwestern United States, sold $250 million of 8.5% eight-year senior notes at par on Wednesday.

The preferred is a $174.5 million issue created by the company's exchange of its 12½% senior notes due 2011, 13 5/8% senior notes due 2011 and 12 7/8% discount notes due 2010.

In October, Lehman Brothers head of U.S. convertible research Venu Krishna recommended that convertible investors interested in the Alamosa situation should buy the 12 7/8% discount notes due 2010 in order to participate in the exchange and, thereby, ultimately own the new convert.

As a base case, Lehman valued the convertible preferred at 357.36 relative to Alamosa's then-current stock price of $4, modeling it with a credit spread of 1,050 basis points over Treasuries and 45% stock volatility.

The company has the option to pay dividends over the first five years in cash, stock, a new series C convertible preferred or a combination of the three, making it a type of payable-in-kind security. The series C convertible preferred will have similar terms as series B but with a higher conversion price of $4.25.

Since the convertible is already in-the-money and carries a high delta of 89%, it is clearly very stock sensitive. Thus, the uptick in the stock price accounted for 2.8% of the increase in estimated value of the new convertible.

Insurer converts buck backlash

The stocks of XL and Radian were hit fairly hard Thursday on news of higher reserves charges at both property and casualty insurance firms, but traders said the convertibles held up well to the pressure.

Radian's 2.25% convertible due 2022 was marked down 2 dollar points to 104.75 bid, 105.25 offered, a trader said, but on swap it was flat. The stock fell $3.08, or 5.99%, to $48.35.

XL's two 0% convertibles were fractionally higher Thursday but hovering at or near their respective put prices, which become a factor later this year, while the stock dropped $1.35, or 1.68%, to $79.15.

XL's convertible due May 2021, issued at 59.357, was quoted up 0.25 point Thursday to 64 bid, 64.25 offered. Call protection expires on the issue May 23, when it also becomes putable at 64.188.

XL's convertible due September 2021, issued at 56.501, was quoted essentially unchanged Thursday at 61.75 bid, 62 offered. It is callable and putable Sept. 7. An additional contingent payment adjustment of 50 basis points made in 2002 boosted the accretion rate for a year from 2.875% to 3.375%. The contingent payment adjustment was triggered again in 2003 and, as a result, the accretion rate has risen to 3.52%. The 2004 put and call price has increased to 62.2505.

On Wednesday, XL said it has finally laid to rest the ill-fated claims legacy stemming from its Nac Re Corp. acquisition in 1999, with nearly $1 billion in reserve charges for 2003. Also, the Bermuda-based insurer said it plans to raise $750 million in capital, primarily through a mandatory convertible. No timeframe other than during the first half of the year was supplied. (See full report on Page 1 of this edition.)

Radian boosted its loss reserves by $96 million to $111 million in anticipation of claims from a single manufactured housing transaction originated and serviced by Conseco Finance Corp. The company said it will result in a $62 million, or 66 cents per share, after-tax reduction in earnings for fourth quarter.

Also, Radian said it has direct exposure in two other transactions with a different manufactured housing lender, representing a total exposure of $140 million, and one of its subsidiaries has $255 million in reinsured manufactured housing exposure. But, Radian said it does not expect losses on those transactions.

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