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J.P. Morgan sees value in convertible bonds
By Lisa Twaronite, MarketWatch
Last update: 7:45 p.m. EDT March 31, 2009
The capitalization of the U.S. CB market was roughly halved in 2008, and currently stands at $210 billion - while the face value of the bonds is $280 billion - J.P. Morgan
SAN FRANCISCO (MarketWatch) -- Convertible bonds were among the potentially valuable assets left trampled underfoot as hedge funds stampeded out of securities in the past half year, leaving bargains for investors who want to look through the rubble.
Convertible bonds (CBs) are classic hybrid products: debt instruments whose purchasers can exchange them for a predetermined number of the issuing company's shares, at a set price. CBs offer investors the downside protection of a bond plus the upside potential of the share price. Like straight bonds, the instruments generally carry a fixed coupon and pay back the original investment at maturity. But the hybrid security often comes with an option to buy the issuer's stock at predetermined strike price.
CBs "are currently trading below their fair values as a result of the forced de-leveraging of arbitrage accounts," said J.P. Morgan analysts Marko Kolanovic, Kapil Dhingra and Amyn Bharwani in a research report released Tuesday.
A CB holder is automatically diversified, because the instrument itself is exposed to three asset classes - corporate bonds, stocks and equity volatility -- that are "less than perfectly correlated and therefore partially offset each other's risk," the analysts said.
The U.S. CB market is largely skewed towards small- and mid-cap, non-investment grade or non-rated issues, and the sector breakdown is skewed towards financials, heath care, technology, and consumer discretionary issuers, the analysts said.
"The market events of 2008 upset the balance between participants in the convertible bond market. As arbitrage accounts reduced leverage, the prices of many convertible bonds were pushed below their fair values. These valuation levels are now becoming attractive to fundamental credit and equity investors," they said.
The analysts said arbitrage accounts were significant holders of CBs. They would buy and hedge new issues and profit from the spread between the bond's price and the bond's fair value.
"These arbitrage accounts usually relied on leverage to finance their positions," they said, and had to cash out of their holdings beginning in September 2008.
Distressed levels
Some CBs issued by companies with weak credit have even been trading at distressed levels -- 60% or more below the bond's face value.
The capitalization of the U.S. CB market was roughly halved in 2008, and currently stands at $210 billion - while the face value of the bonds is $280 billion, JPMorgan said.
"CBs lost a large portion of their equity and equity volatility sensitivity and started to trade similar to straight bonds," they said.
A CB issued by Advanced Micro Devices Inc. has a coupon of 5.75% and matures in 2012. It is currently trading at distressed level of 45 cents per dollar, the analysts said. AMD shares closed Tuesday at $3.05, down 4.4%.
"Based on the current suppressed valuations, the CB is providing an annualized yield of 35% and should outperform the stock under a wide range of stock performance scenarios both on the upside and on the downside," they said, suggesting that investors "replace part of their AMD holding with 5.75% 2012 CBs as a downside stock hedge and a source of attractive yield."
Another CB the analysts cited was Chesapeake Energy Corp.'s 2.75% coupon issue, maturing in 2035. The bond is puttable - meaning, investors can put, or sell, the shares back to issue at a specified price - at par, or face value, in 2015, and matures in 2035. It is currently yielding 8% through the put date.
"The attractiveness comes from the embedded six-year equity and hence implicit commodity (natural gas) option. In case we experience another large spike in energy prices any time over the next six years, this convertible could generate a windfall profit in a portfolio," the JPMorgan analysts said.
Smithfield Foods Inc.'s 4% convertible maturing in 2013 is now trading at 68 cents per dollar of face value, implying a 14% annual yield until maturity, the analysts said. Smithfield Foods shares closed Tuesday at $9.46, up 6.9%.
"The current convertible bond yield is approximately the same as the yield of straight SFD bonds. Therefore, the convertible can be a good addition/replacement for straight SFD bonds as any upside equity exposure comes at no additional cost," said JPMorgan. "Equity investors can include this convertible in their portfolios as a source of attractive yield and as a downside hedge (replacement) for SFD stock holding."
US Bancorp's 0% convertible matures in 2035, and is puttable for par in December of 2010. The CB is currently trading at $89, implying a 7% annualized yield to put, the analysts said.
"We recommend this convertible bond to credit investors as a superior risk/reward replacement for USB straight bonds," the analysts said. End of Story
Lisa Twaronite reports for MarketWatch from San Francisco.
... mi verrebbe da pensare che J.P. Morgan deve venderne ancora una buona dose
By Lisa Twaronite, MarketWatch
Last update: 7:45 p.m. EDT March 31, 2009
The capitalization of the U.S. CB market was roughly halved in 2008, and currently stands at $210 billion - while the face value of the bonds is $280 billion - J.P. Morgan
SAN FRANCISCO (MarketWatch) -- Convertible bonds were among the potentially valuable assets left trampled underfoot as hedge funds stampeded out of securities in the past half year, leaving bargains for investors who want to look through the rubble.
Convertible bonds (CBs) are classic hybrid products: debt instruments whose purchasers can exchange them for a predetermined number of the issuing company's shares, at a set price. CBs offer investors the downside protection of a bond plus the upside potential of the share price. Like straight bonds, the instruments generally carry a fixed coupon and pay back the original investment at maturity. But the hybrid security often comes with an option to buy the issuer's stock at predetermined strike price.
CBs "are currently trading below their fair values as a result of the forced de-leveraging of arbitrage accounts," said J.P. Morgan analysts Marko Kolanovic, Kapil Dhingra and Amyn Bharwani in a research report released Tuesday.
A CB holder is automatically diversified, because the instrument itself is exposed to three asset classes - corporate bonds, stocks and equity volatility -- that are "less than perfectly correlated and therefore partially offset each other's risk," the analysts said.
The U.S. CB market is largely skewed towards small- and mid-cap, non-investment grade or non-rated issues, and the sector breakdown is skewed towards financials, heath care, technology, and consumer discretionary issuers, the analysts said.
"The market events of 2008 upset the balance between participants in the convertible bond market. As arbitrage accounts reduced leverage, the prices of many convertible bonds were pushed below their fair values. These valuation levels are now becoming attractive to fundamental credit and equity investors," they said.
The analysts said arbitrage accounts were significant holders of CBs. They would buy and hedge new issues and profit from the spread between the bond's price and the bond's fair value.
"These arbitrage accounts usually relied on leverage to finance their positions," they said, and had to cash out of their holdings beginning in September 2008.
Distressed levels
Some CBs issued by companies with weak credit have even been trading at distressed levels -- 60% or more below the bond's face value.
The capitalization of the U.S. CB market was roughly halved in 2008, and currently stands at $210 billion - while the face value of the bonds is $280 billion, JPMorgan said.
"CBs lost a large portion of their equity and equity volatility sensitivity and started to trade similar to straight bonds," they said.
A CB issued by Advanced Micro Devices Inc. has a coupon of 5.75% and matures in 2012. It is currently trading at distressed level of 45 cents per dollar, the analysts said. AMD shares closed Tuesday at $3.05, down 4.4%.
"Based on the current suppressed valuations, the CB is providing an annualized yield of 35% and should outperform the stock under a wide range of stock performance scenarios both on the upside and on the downside," they said, suggesting that investors "replace part of their AMD holding with 5.75% 2012 CBs as a downside stock hedge and a source of attractive yield."
Another CB the analysts cited was Chesapeake Energy Corp.'s 2.75% coupon issue, maturing in 2035. The bond is puttable - meaning, investors can put, or sell, the shares back to issue at a specified price - at par, or face value, in 2015, and matures in 2035. It is currently yielding 8% through the put date.
"The attractiveness comes from the embedded six-year equity and hence implicit commodity (natural gas) option. In case we experience another large spike in energy prices any time over the next six years, this convertible could generate a windfall profit in a portfolio," the JPMorgan analysts said.
Smithfield Foods Inc.'s 4% convertible maturing in 2013 is now trading at 68 cents per dollar of face value, implying a 14% annual yield until maturity, the analysts said. Smithfield Foods shares closed Tuesday at $9.46, up 6.9%.
"The current convertible bond yield is approximately the same as the yield of straight SFD bonds. Therefore, the convertible can be a good addition/replacement for straight SFD bonds as any upside equity exposure comes at no additional cost," said JPMorgan. "Equity investors can include this convertible in their portfolios as a source of attractive yield and as a downside hedge (replacement) for SFD stock holding."
US Bancorp's 0% convertible matures in 2035, and is puttable for par in December of 2010. The CB is currently trading at $89, implying a 7% annualized yield to put, the analysts said.
"We recommend this convertible bond to credit investors as a superior risk/reward replacement for USB straight bonds," the analysts said. End of Story
Lisa Twaronite reports for MarketWatch from San Francisco.
... mi verrebbe da pensare che J.P. Morgan deve venderne ancora una buona dose
