Short-dated convertibles may offer optionality, limited downside in volatile market: Citi

By Rebecca Melvin

New York, June 4 - Short-dated convertibles are a place to commit funds in the convertible bond market right now, given recent market swings and resulting illiquidity, according to a note published Friday by Citi's convertibles sales and trading desk.

The short-dated, coupon-paying bonds have puts or maturities of between six months and two years. They have an issue size of at least $100 million, and they are trading at a price of between 90 and 135, and with a relatively low point premium.

The low premium gives investors some optionality and limited downside, if the price of the underlying stock lags or interest rates widen out, the Citi sales and trading personnel said.

About 100 names in Citi's database fit those parameters, and they included, among names trading close to par: Transocean Ltd.'s 1.625% convertibles due 2037, Savvis Inc.'s 3% convertibles due 2012, GenCorp Inc.'s 2.5% convertibles due 2011 and NII Holdings Inc.'s 3.125% convertibles due 2012.

Among names trading above par were Qwest Communications International Inc.'s 3.5% convertibles due 2010, Informatica Corp.'s 3% convertibles due 2011, Rovi Corp.'s 2.625% convertibles of 2011, CMS Energy Corp.'s 2.875% convertibles of 2011 and Ventas Inc.'s 3.875% convertibles due 2011.

The par or under group represents short-dated yield-to-put or yield-to-maturity plays with a small amount of value attached to an out-of-the-money call. The above par group has some remaining call protection (a minimum of a few months), considerable option value and a bond floor at par via a relatively short-dated put or maturity date, the Citi note stated.

"Recent market swings have again highlighted a recurring theme for the convertible market in times of extreme stress - illiquidity," the Citi note stated.

In the note, Citi explained that despite the fact that market participants might view a particular convertible to be "cheap," a lack of natural buyers for certain securities, including small-sized issues from small companies, and due to the fact that much of the market is priced well above par, replicating equity rather than balanced yield instruments, has tended to make the paper even cheaper due to a lack of bids.

In addition, the Citi note stated, longer-dated paper may remain undervalued as weak hedge fund flows provide no impetus for value convergence.

"We'd suggest that those with funds to invest focus on convertible issues with relatively short-term maturities or put dates, the idea being that those 'events' will ultimately provide natural liquidity to the convert holder absent secondary market improvements," the Citi note stated.

Mentioned in this article:

CMS Energy Corp. NYSE: CMS

GenCorp. Inc. NYSE: GY

Informatica Corp. Nasdaq: INFA

NII Holdings Inc. Nasdaq: NIHD

Qwest Communications International Inc. NYSE: Q

Rovi corp. Nasdaq: ROVI

Savvis Inc. Nasdaq: SVVS

Transocean Ltd. NYSE: RIG

Ventas Inc. NYSE: VTR

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