Portfolio shuffling underscored by search for quality as spreads widen

By Ronda Fears

Nashville, Tenn., Sept. 30 - Convertibles trading volume was at a decent clip Monday as the month and quarter came to an end. A desperate search for quality was the mission but widening credit spreads created more of an atmosphere of dodging landmines.

Rising volatility offered some opportunity for convert arbs, however.

"Doom and gloom! I think it's priced in but you always go beyond fair value, right?" said a buyside trader. "Secure helmets and take cover."

Selling was taking place in virtually every sector, traders said, with some noteworthy buying in pure traditional healthcare names.

But there really was no cover to be found within the market.

Thus some players who could were buying Treasuries. Others were boosting cash reserves. And those mandated to remain fully invested were sorting through the field and their holdings, looking to shuffle the deck in hopes of coming up with a better position.

"The tone and level of dissension, et cetera, about the war leads me to believe that investors keep pushing the horizon for any recovery farther and farther. This will mean that companies with six months of fire power will be in trouble," said Michael Revy, portfolio manager for a Froley Revy hedge fund.

"Irresolute action, or the perception of such, will make this market see no recovery soon and we will probably see more for sale."

Even improving fundamentals will get discounted, Revy said, as investors remain unnerved from not knowing the outcome of the war in addition to the November elections. Any election victory by anti-business forces will add to investor fear, he said.

Spreads were widening, although not at an alarming rate but enough to cause concern that the tightening trend was over.

"It seems like you've got a grip and then the rug gets pulled out from under you," said the buyside trader.

"Right now there's really nowhere to hide out. You just get out there in the middle of it and throw your punches and hope you can hold your head up when the bell rings."

The boxing analogy certainly seemed appropriate for much of the convertible market.

But in the grand scheme of things the asset class still is holding up better than some other investment choices. One convertible fund trader noted that if you can stand the risk, some convertible yields are almost comparable to those seen in the junk bond market.

Comcast Corp. was moved to junkland by Moody's but the rating agency said AT&T Comcast Corp. would be investment grade, albeit with weak credit fundamentals for high-grade debt, after the merger with AT&T Broadband.

Comcast's converts, however, were little changed as the bulk of that is exchangeable debt that converts into Sprint PCS shares. PCS gained 7c to $1.96.

The broad telecom index was lower but there were some select names moving up as Nextel Communications Inc. and Motorola Inc. announced that plans to launch Nextel's Nationwide Direct Connect service are on track with completion targeted by yearend 2003.

Nextel's 4.25% convertible due 2007 added 1 point to 74.25 bid, 75.25 asked. Also, the 5.25% convertible due 2010 and 6% convertible due 2011 both gained 0.25 point. Nextel shares closed up 25c to $7.55.

Motorola, however, slipped.

The Motorola 0% convertible due 2013 lost 0.25 point to 69.875 bid, 70.875 asked as the stock closed off 11c to $10.18.

The Liberty Media/Motorola 3.5% exchangeable due 2031 also lost 0.25 point to 62.625 bid, 63.125 asked. That issue, traders said, was hurt by the ongoing consolidation in Europe.

Cable names were weak along with the telecom group.

Some heavy selling was seen in the retail group as projections of a weak Christmas shopping season converged with concerns about the port lockout on the West Coast, which could delay inventory shipments.

Virtually all the consumer retailing names were lower, although those like cemetery operator Service Corp. and tobacco distributor Vector Group Ltd. were higher.

Service's 6.75% convertible due 2008 were quoted up 2.375 points to 79.375 bid, 79.875 asked as the stock rose 32c to $3.50.

Utility names were also higher, but traders said there was not many bids for any of the convertibles in the group as the sector that once was considered a safe haven has assumed a great deal of risk with energy trading.

Moreover, players lament the diffused line of safety that was once the difference between investment-grade credits and junk bonds.

"It is hard to tell where problems might crop up in alternative investment portfolios, on top of the well-publicized effects of falling equity prices," said Bank of America Securities global market analysts David Goldman and Jeffrey Rosenberg in a report Monday.

"Credit fundamentals continue to suffer, economic data continue to look weaker and the coupon curve continues to steepen, as market expectations shift towards a higher probability of Fed ease. We continue to believe that an ease at the next Fed meeting is highly improbable."

From a fundamental perspective, many analysts are very cautious on the outlook for corporate credit quality.

"We are not owed a credit recovery," said Timothy K. Patrick, global head of high-grade credit research at Bank of America Securities.

"And we believe the challenges of revenue growth and declining pricing pressures do not augur well for creditors."

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