Buyers tiptoeing back into market as premiums contract; Wells Fargo rekindles dividend fears

By Ronda Fears

Nashville, July 22 - The late afternoon announcement by Wells Fargo & Co. that it would bump its common stock dividend by a whopping 50% may send another shockwave through the convertible market, traders said.

Otherwise, traders said Tuesday was a more typical summer trading session. Several convert names with earnings out this week also were impacting activity.

After the close, there was a small $100 million deal launched for next week by Wabash National Corp., so the only deal for this week is still Constellation Brands Inc.'s mandatory coming up Thursday.

As dividend risk has been a high-profile topic in converts, both of those deals - like many new issues of late - include full dividend protection for holders.

"There has been a lot of dividend risk priced into the market, but not to the extent that would cover something like the Wells Fargo increase," said a dealer.

General Mills Inc. is a specific name the trader mentioned as posing a risk of boosting its common dividend that may not be fully priced into the convert.

The General Mills 0% due 2022 was quoted up 0.25 point to 70.75 bid, 71 offered with the stock closing up 39c, or 0.84%, to $47.07. The food giant is scheduled to report earnings Friday.

Wells Fargo's news, which didn't hit the tape until less than an hour before the markets closed, didn't move its convert much, but traders said another markdown could be in store for it Wednesday. The bank had reported earnings a week ago.

The Wells Fargo convertible floater dropped about 0.375 point to 97.25 bid, 97.75 offered, a dealer said, adding, "That should go down more with the dividend increase." The stock closed up 73c, or 1.42%, to $51.97.

In a report earlier this month, Lehman Brothers convertible analysts identified several issues at risk of being over-valued in the event of a dividend boost, including General Mills. Among others, the list also included Allergan, United Parcel Service, Xerox, First Data and Johnson & Johnson.

Xerox was moving north on fairly heavy volume, traders said. One dealer noted there wasn't any fresh news on Xerox, but it is scheduled to report earnings next Monday. Another said the Xerox 6.25% convertible preferred rose around 3.5 points to 107.875 bid, 108.125 offered with the stock up 44c, or 4.21%, to $10.89.

Lucent Technologies Inc. also shot up, ahead of its earnings that are due to be reported before Wednesday's open. The short-dated Lucent paper was better bid, according to one market source. The convertible bonds were quoted up 4-5 points. Lucent shares ended up 19c, or 11%, to $1.91.

Some buying in the Host Marriott Corp. 6.25% convertible preferred was noted, too, on the back of Cendant Corp.'s nice earnings report Tuesday. Cendant's converts, however, barely registered the good news, which included a boost to the company's guidance for 2003 earnings.

Buyers are looking for value and beginning to return to the market with bids, said Jimmy Giordano, president of JGiordano Securities Group.

"The premiums are still coming in but we've seen some buyers come back into the market to put on some of these converts with the compressed premium levels," Giordano said.

"Some of these converts have been stuck in an air pocket," he added. "They are quoted but there have been no bids. There's something of a sticker shock when these fresh bids come across."

Giordano acknowledged that the search for value is tough, but said conditions are easing a bit. He particularly likes the HCC Insurance Holdings Inc. 2% due 2021. HCC also has a 6.75% convertible trust preferred.

"These [HCC convertible bonds] have crunched a lot," Giordano said. The 2s closed Tuesday around 109 bid, 109.5 offered; the stock closed off 12c to $29.97.

"Three months ago, they were about 5 points higher. There's not much coupon, but the premium is down to 16.5% and there's hard call protection to 2006 and a put in 2004," he said. "Plus it's an A credit."

A source at one of the bulge bracket firms in New York said it was fairly active trading session, but the week was expected to be rather quiet in terms of new deal activity. He expects deal flow to pick up again probably in the second week of August.

"We've sort of hit the summer doldrums," he said.

"Volatility is coming back in," he noted, with the VIX falling by more than 5% on Tuesday. "The only thing positive is the credit markets backing up, but I think it will bounce back. There's still pretty good demand for high-yield paper."

Constellation Brands - a BB credit - is the only deal firmly on the calendar for this week, though, and not much more is expected. The $150 million three-year mandatory is expected to price with a dividend of 5.75% to 6.25% and an 18% to 22% initial conversion premium.

At the middle of price talk, Lehman puts it 4.5% cheap, using a credit spread of 550 basis points over Treasuries and a volatility skew of 28% to 25%. That compares to year-to-date mandatory new issue cheapness of 3.03%, the Lehman analysts noted, and overall new issue cheapness of 0.69%.

Constellation Brands stock closed Tuesday up 5c to $28.55.

The Wabash deal launched after the close is for $100 million of five-year noncallable senior unsecured convertible notes. Price talk puts the yield at 2.75% to 3.25% with a 27.5% to 32.5% initial conversion premium. It won't price, though, until next Monday.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.