Players in hiding or running for cover as stocks fall precipitously

By Ronda Fears

Nashville, Tenn., July 19 - Dealers said outright convertible players were in hiding, while arbitrageurs were adjusting hedges on stocks or running for cover either in the Treasury market or derivatives. Looking ahead, the market is watching for news on the results of Masco Corp.'s put and Solectron Corp.'s tender offer come Monday.

Some of the big decliners Friday included Johnson & Johnson, General Motors, Calpine, CMS Energy, Nortel Networks, Lucent Technologies and Ciena.

Winners, and there were a few, included United Parcel Service, AES Corp., Capital One Financial, Titan and Commscope.

"This is not for the faint of heart," said one trader.

Overall, convertibles were marked lower, estimated somewhere between the 2.79% decline in the Nasdaq and 4.63% drop in the Dow Jones Industrial Average.

But trading was very light as many players were sitting on the sidelines or busy elsewhere.

"The outright guys were in hiding. We didn't even have a lot of calls about where things were at," said the head convertible trader at a major investment bank.

"The arbs were either adjusting hedges or running for cover. Buying in Treasuries was really heavy. The yields on the two-year note are down to something like 2.5% percent, or less."

Many convertible arbs were buying Treasuries or derivatives such as asset swaps or credit default swaps.

Credit default swap, or insurance, interest has been surging for several weeks, if not months.

"Credit default swaps actually seem to be working in our favor to some degree. It used to not work so well for us," said a convertible trader at a hedge fund in New York.

"We have a fair amount of our exposure hedged on the credit side now. That is working better now, I think, because there is more insurance available. We aren't able to find a swap for some of this crappy paper, though. As it is right now, we may scratch the undercarriage a little bit, but we're going to live through the wreck."

With heavy buying in Treasuries, two-year notes were reported late Friday at a yield of 2.42%, five-year notes at 3.66% and 10-year notes at 4.56%.

"It's been my experience in times like this, with the Dow down 400 at one point, that our market pretty much just sits on the sidelines. The whole market is seeing money leave the table," said Jonathan Cohen, a convertible analyst at Deutsche Bank Securities.

"Everyone will be watching Monday to see what happens. Either we'll continue to slide, or climb out of it."

Cohen said comparing the market to October 1998, which is the last time the Dow was as low as the 8,019.26 point where it closed Friday, is not enlightening.

"We're not even talking apples and oranges. We're talking apples and kiwis," Cohen said.

"For one thing, tech was going gangbusters back then."

Another new reality is the latest rationalizations being made due to accounting scandals.

While there are not many buyers in the convertible market, chiefly due to the few palatable issues getting bid up, there are some.

"At this point, you bid on what you like and have done some work on, and you better be willing to live with it," said an outright convertible fund manager in New York.

"Everything that's out there we like is rich, but you've just got to play your conviction. Our performance has been hit during this time but now that the markets are in retreat we're still sitting better than the equity funds."

The market also is watching Monday for news on a couple of high-profile puts - Masco and Solectron.

Solectron's modified dutch auction tender offer for 64% of its 0% convertible due May 2020 will be over, as the deadline was Friday, and market sources widely anticipate a majority if not full participation in the offer.

The deadline for the put on Masco's 0% convertible due 2031 is on Monday.

On Friday, Masco added another put on April 20, 2004, at 42.957, as an incentive for holders not to put it back to the company now.

Adrian Miller, convertible analyst at Salomon Smith Barney, said it appears the sweetener will be plenty to forestall the put.

Before the sweetener, he said the Masco convert was trading about 0.24% rich and afterward about 3.56% cheap, as the implied volatility dropped to 24.1% from 46% and the implied spread rose to 335 bps from 91 bps.

"Needless to say, the addition of the put increases valuation to a point where investors should hold the issue," Miller said.

Masco shares closed down $1.05 to $21.10.

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