Convertibles strengthen with credit, equity markets; financials gain; Alcoa doubles deal size

By Rebecca Melvin

New York, March 18 - Convertibles were described as "getting better" Wednesday, pulled higher by stronger credit and equity markets that reacted positively to the latest policy statement from the Federal Open Market Committee, convertible players said.

"Names were getting better," a West Coast-based sellside trader said.

"Definitely better bid in general before and after the Fed," another sellsider said.

But credit hedges were hurt by the news, and the immediate market reaction was that many offers were cancelled since players needed time to digest the news, one sellside analyst said.

"It's not like we had a slew of orders, but if anyone was selling anything, they pulled back," the New York-based sellsider said.

The FOMC said that in addition to standing pat on its target fed funds lending rate of 0% to 0.25%, the Fed will bolster its balance sheet by buying up to $300 billion of long-dated Treasuries during the next six months.

It said it will also purchase an additional $750 billion of mortgage-backed securities this year, bringing the total to $1.25 trillion. And an additional $100 billion of Fannie and Freddie agency debt will also be purchased this year, bringing the total to $200 billion.

Treasuries surged, while credit in general tightened and equities rallied. The dollar sagged on the news, however.

The moves, which stand to benefit the banking system, sent financials higher.

Bank of America Corp.'s 7.25% convertible preferreds jumped to 425 from 395; Wells Fargo & Co.'s convertible preferreds edged up to 485 from 475, and Webster Financial Corp.'s 8.5% convertible preferreds closed at 365, up from previous levels.

Transocean Inc. and Intel Corp. were both in trade at better levels. Intel was upgraded to "buy" from "hold" by a Needham & Co. analyst, who said the Santa Clara, Calif.-based chip maker should be able to keep prices and its mix of products stable, helping to improve profit margins in the second quarter.

Meanwhile, Alcoa Inc.'s planned convertibles extended gains in the gray market Wednesday, and the deal was upsized and repriced ahead of final terms that came after the market close.

The new five-year Alcoa convertibles will yield 5.25% with an initial conversion premium of 22.5%, according to a syndicate source.

Financials gain

Federal policy again affected financial names.

"With that announcement, credit was moving by leaps and bounds. If anyone was showing anything, they pulled back," a sellside analyst said.

"People are trying to digest how this impacts their positions," the analyst said, adding that credit tightened and credit hedges were hurt.

The analyst forecast that investment-grade names, which had the most sensitivity to the recent moves, would be very active in the aftermath of the news.

Charlotte, N.C-based Bank of America's 7.25% convertible preferred rose 425, while its common stock rose 22.3%, or $1.40, to close at $7.67.

San Francisco-based Wells Fargo saw its 7.5% convertible preferreds gained to about 485. The common stock finished up by 17.5%, or $2.56, to close at $17.22.

The convertible preferreds of Waterbury, Conn.-based Webster Financial, a commercial bank holding company, also rose to 365, which was still described as a bargain by one sellsider. The Webster Financial common stock added $0.29, or 6.5%, to $4.73.

Borrow issues sink Citi

New York-based Citigroup's 6.5% convertible preferreds were seen at about 26. But parity was worth 40, a buysider said, attributing the discrepancy to a tough borrow. Meanwhile Citigroup common stock rose $0.57, or 22.7%, to $3.08.

"It's the biggest discount to parity I have ever seen," the West Coast-based buysider said.

Although some convertibles players predicted that the Citigroup exchange offer would be amended if the stock price continued to rise to a level at which preferred holders would gain more than the face value of the paper, Bank of America-Merrill Lynch analysts expected the exchange would likely go forward as planned.

"Not going forward with conversion transaction likely would reignite concerns over Citi's capital position, and could force government to intervene at further expense to common shareholders," equity-linked analyst Tatyana Hube and credit strategist Yuriy Shchuchinov wrote in research published late Wednesday.

"FASB's proposals on modifying fair value/OTTI accounting would not stem impending accrual losses, nor reverse past marks. Citi's capital adequacy depends on conversion, in our opinion," the analysts wrote.

They believe that arb spreads for all four preferred series (E, F, AA and T) have widened considerably on (1) fears the conversion will not be consummated, (2) the notion that FASB action will lessen Citigroup's capital needs, and (3) worries that sharply wider incremental stock borrow costs that make efforts to arbitrage the spread prohibitive.

High borrow costs are technical, and they will remain, as full arbitrage of the spread requires short liquidity of about 80% of the five billion share free float, the analysts believe.

These analysts believe that given Citigroup's shares doubling since conversion ratios were announced, there is opportunity for common holders who believe the exchange will be completed as announced to swap into Citi preferred shares subject to the upcoming exchange, given how far below their "fair" conversion values they trade.

The risk to preferred holders if conversion does not go through is considerable, as preferred dividends have been suspended. The company indicated a preliminary S-4 filing is planned Friday.

Assuming a traditional 20-trading day exchange offer period, the analysts estimated the exchange should be completed in 45 to 60 days.

Alcoa size doubles

The planned Alcoa convertibles rose another point in the gray market to trade around 107 at early afternoon, and the deal was doubled in size to $500 million up from the $250 million initially planned.

Alcoa common stock declined 2%, or $0.11, to $5.48, which extended an 8.7% drop on Tuesday.

The issue, which priced after the close of markets, was also repriced from initial talk due to strong demand. Talk on the coupon was adjusted to 5.25% to 5.75%, down from 5.75% to 6.25%; and talk on the initial conversion premium was adjusted upward to 20%, from 15% to 20%.

The deal priced at the rich end of revised talk for the coupon and beyond the rich end for revised talk on the initial conversion premium.

Credit Suisse and Morgan Stanley were joint bookrunners of the registered offering.

A buysider said, "I do [like it], but it still doesn't compare to secondary market opportunities in my own portfolio already...I have many, many names that are 50% cheap."

Pittsburgh-based Alcoa, an aluminum producer, is also planning to sell 150 million shares of its common stock.

Proceeds are expected to be used to repay outstanding debt under the company's senior unsecured 364-day revolving credit facility, with any remainder for general corporate purposes.

Mentioned in this article:

Alcoa Inc. NYSE: AA

Bank of America Corp. NYSE:BAC

Intel Corp. Nasdaq: INTC

Transocean Inc. NYSE: RIG

Webster Financial Corp. NYSE: WBS

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