Recent strength dissipates as spreads widen; EDS plunges

By Ronda Fears

Nashville, Tenn., Sept. 19 - Much of the convertible market gave in to pressures from the broader markets Thursday as stocks dove and credit spreads widened, particularly for high yield paper. Selective Insurance Group Inc. advanced its deal, but it lost ground out of the gate.

Electronic Data Systems Corp. convertibles plummeted on its warning, which combined with numerous other warnings and credit spread expansion caused enough pressure that sparked heavy selling.

Homebuilders Lennar Corp. and D.R. Horton Inc. were torn down by the decline in housing starts.

There wasn't much shelter to be had, but traders noticed some high yield buyers looking for E*Trade Group and American Tower Corp.

"It's a ruthless market," said Jonathan Cunningham, head of convertible research at Jefferies & Co.

"It takes no prisoners, EDS being a prime example today."

The EDS convertibles were not hit quite as severely as the stock, but it was dramatic and there was a huge sell off, particularly in the mandatory.

The EDS 7.625% mandatory fell 15.52 points, or about 42%, to 21.53. The 0% due lost 3 points to 73.875 bid.

EDS shares were decimated, falling nearly 53%, or $19.26, to $17.20.

"I've been in this business for nearly 20 years, saw numerous crises of confidence, but a three-year bear market is a new experience for me," Cunningham said.

"Unless you were in the market in the 70s, you've probably not seen anything like this, maybe not even back then."

Not even new deals held much hope for the market, especially outright players.

Selective's new $100 million discount convert was well received, sources said, pricing early at the aggressive end of guidance but it fell victim to the market tone.

The new 1.62%/0% was quoted ending at 37.875 bid, 38.125 asked after pricing at 38. Selective shares ended down 90c to $21.63.

The deal came at a yield of 4.25% and an initial conversion premium of 30%.

There was some buzz about potential new deals coming up, but the names being bandied about did not excite anyone.

"There's the old stand-bys like Duke Energy, Williams, CMS Energy, who all want to do a deal, but probably couldn't right now," said a convertible fund manager in New York.

"We heard a couple of other names mentioned today, Vishay Intertechnology Inc. and El Paso, but I can't get excited about either of those."

Hedged players are faring rather well right now, although a considerable amount of the relative gains seen recently were receding.

Outright players are treading water, trying to avoid landmines and hoping the storm will pass soon.

"The hedged convert market, not the outright market, has gotten a lot stronger over the past week," said a convertible trader at a hedge fund in New Jersey.

Some of that is beginning to slip away, due to ongoing pressure from the stocks but more so because credit spreads have reverted back to a widening pattern again.

Thus, putting a value on convertible bonds has gone from challenging to nearly impossible, aggravated by actions at the credit rating agencies.

"It's damned near impossible to value them," said Cunningham, speaking of fallen angel credits and situations like EDS where there's a sharp downturn in the stock and the credit is downgraded, yet liquidity seems okay.

Traders said the improper valuations on some convertible bonds becomes apparent when high yield buyers step in.

"We were seeing some high yield buyers in our market today, and that usually signals to me that there's an imbalance somewhere in our price, something's not getting priced in right," said a dealer.

Credit work traditionally has not been a strong suit in the convertible market, but it has become of utmost concern. Not only to convert players, however. Stockholders have had to become aware of the credit side of the stories they play, lest they get caught in the landslide when the credit begins to crumble.

"All of a sudden, everybody, including traditional equity funds, have to look at balance sheets," Cunningham said.

"It's a tough market to make money in. It's not enough to look at cash flow, E/P ratios anymore."

Headline risk is a meager description of the magnitude that one news item can cause, one source said, but it keeps the market sharp and on its toes.

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