Convertibles track higher with stocks; strategies appear to shift; Ford slips on hedge

By Rebecca Melvin

New York, April 10 - The convertible bond market was more active on Wednesday than earlier in the week, and it was generally tracking higher with a rally in the stock markets as well as strength in the credit markets. But there were no notable trends or name-specific moves, market players said.

"With stock markets rising and credit tighter, things were well bid," a New York-based convertibles analyst said.

Starwood Property Trust Inc.'s 4.55% convertible was one of the issues tracking higher with their underlying shares. The bonds were up nearly a point on a 1% rise in the shares of the Greenwich, Conn.-based mortgage loan investor.

Teleflex Inc.'s 3.875% convertibles due 2018 put in about a 1-point gain on about a 1% move in the underlying shares of the Limerick, Pa.-based medical device company.

Teleflex was used as an example of how hedged investors may be shifting strategies in what seems to be an ever-rising stock market environment.

The Teleflex convertibles may have been set up initially with a view toward the stock going down, but instead the stock is up about 40% in the last three-quarters of a year.

"This stock was trading with a 60 handle nine months ago. Now it's up 40% and you still have four years to go [until the bond matures]," a New York-based trader said.

"So the model might say delta up, but players are just letting it ride," he added, noting that the Teleflex convertible breaks even at 180 and the bond is currently at 149.5.

A second source was skeptical about not selling more borrowed stock in response to the stock price rise. "To let your deltas ride and not re-hedge on the way up means that effectively you're going to get long stocks here, and that's probably not something that's advisable to do. I mean it sounds like you've decided that stocks are going to continue to go up," he said.

Ford Motor Co.'s 4.25% convertibles were active in trade on Wednesday and higher outright amid a 2.5% rise in the underlying shares. But the paper was seen to have contracted about 0.375 point on a hedged basis amid more selling than buying in the market, according to a New York-based analyst.

Overall, there was nothing trading that was "overly dramatic," a trader said.

The market is seen at fair value to rich and there "is not a ton of value out there," the analyst said.

"That translates into people not trading a lot and price action doesn't move around a lot," the analyst said.

A second analyst said that it was a "fairly busy trading day," especially since it was quieter earlier in the week and "people were ready to trade."

He said action Tuesday in TRW Automotive Holdings Corp. did not carry through to Wednesday, however. "There were buyers coming in and good two-way flow in TRW on Tuesday," he said.

Also on Wednesday, several gold names were lower outright with lower shares.

In the broader markets, equities rallied with both the Dow Jones industrial average and the S&P 500 stock index closing at record highs. The Dow jumped 128.78 points, or 0.88%, to 14,802.24; the S&P 500 climbed 19.12 points, or 1.2%, to 1,587.73; and the Nasdaq Composite index jumped 59.40 points, or 1.8%, to 3,297.25.

The Federal Open Market Committee released its minutes from the last policy meeting early due to a glitch the prior day when the minutes were released to some policymakers and others a day early. The minutes showed that some policymakers expected the Fed to begin tapering asset purchases by midyear and end them by the end of the year, while several others expected to slow the pace of purchases later in the year.

With stock markets going up, there are some convertible outright players that are underperforming, but "they are not incentivized to do anything," a trader said.

Valuations continue to grind higher, an analyst said. "The high-yield stuff, the marginal credit names remain well bid. It's a function of everything being tighter. Investment grade is up, stocks are up, interest rates are up," the analyst said.

As for what drove the rally on Wednesday, the analyst said he wasn't sure. "There wasn't much on the economic docket today. The macro story is coming out of Japan," he said.

"The whole market over there is on fire with the currency devaluation. People have been looking at that market a lot more closely, even people who don't traditionally play there," he said.

"People are speculating that investors there are going to redeploy capital and cash that is sitting latent in Japan. If they sell Japanese government bonds, they are going to end up buying the bonds of other countries like the U.S. and Europe and that is putting a bid into Treasuries," the analyst said.

Teleflex under hedged

Teleflex's 3.875% convertibles due 2017 traded during the session at 149.5, which was up a point.

Teleflex shares gained 82 cents, or nearly 1%, to $87.01.

Teleflex was mentioned as a name illustrating how hedged players are adjusting to steadily rising stocks.

"The stock kept going up and it's a different kind of play," the trader said.

"Until there's an alternative investment and there's a rise in rates, the market is going to shrug off anything but cataclysmic fear," the trader said.

"The biggest risk in the market right now is absolute complacency," the trader said.

If the stock drops from $86 to $80, that's volatility not risk. It would take the stock dropping 15 points for the bonds to improve, he said.

Ford comes in a bit

Ford's 4.25% convertibles due 2016 traded up a couple of points outright to about 160 bid, or 160 bid, 160.75 offered at the end of the session versus Ford's closing share price of $13.12.

Shares of the Dearborn, Mich.-based automaker climbed 32 cents, or 2.5% on the day, which was a move that was just beyond what might be typical in the name.

"It's not completely an outlier," an analyst said of the stock move.

Ford's 4.25% convertible is a large $800 million issue that trades regularly, but volume in the name on Wednesday was heavier than usual.

"Ford picked up good two-way flow, but the bonds came in dollar-neutral tracking on about a 75% delta, which was in 0.375 point due to technical pressure there," he said.

"There were more sellers than buyers in the name," he said.

Mentioned in this article:

Ford Motor Co. NYSE: F

Starwood Property Trust Inc. Nasdaq: STWD

Teleflex Inc. NYSE: TFX

TRW Automotive Holdings Corp. NYSE: TRW

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