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Convertible bonds offer an interesting middle ground between a stock and a bond, and thus, an interesting mix of risk and reward. In others words, convertible bonds can provide more upside potential than “non-convertible,” straight bonds (because of the ability to convert the security into equity) and more downside protection than stocks (because of the fixed-income nature of the security).

For investors seeking a high level of income, high-yielding convertibles might be a good option. Of course, a high yield often means increased risk. High-coupon convertibles are often issued by companies with questionable financial strength. High-yielding convertibles often trade below par and are referred to as being “busted.” As such, they provide only minimal exposure to the upside of the underlying stock.
 
Still, because of the bond component, so called “busted” convertible securities are higher up on a corporation’s ownership chain than stocks, providing more safety than an equity investment in the event of a bankruptcy. Moreover, assuming the financial condition of the issuing company improves, there is likely to be more upside potential in a convertible than in a straight bond issued by the same company. And, if performance improves enough, the convertible’s value could rise above par, allowing it to reflect more of the stock’s price performance.

Below is an abbreviated list of convertible bonds with coupon rates of 6% and higher in our Survey. The list contains both “busted” convertibles and those trading above par value. Convertibles trading above par will offer more meaningful exposure to the fluctuations in the common stock of the issuing company, while providing decent income for above-average total returns.

 

Recent

Curr

Yld to

Com

Com

Div'd

Convertible Securities

Price*

Yld(%)

Mat(%)

Tkr

Price*

Yld(%)

Alaska Commun 6.25s2018 (144A) 

102.13

6.1

5.9

ALSK

$7.85

11.0

Level 3 Communications 6.5s2016

203.86

3.2

 NMF

LVLT

$2.35

 NIL

AMR Corp. 6.25s2014            

93.96

6.7

8.5

AMR 

$4.93

 NIL

Adv. Micro Devices 6s2015      

101.27

5.9

5.7

AMD 

$6.48

 NIL

Amkor Technology 6s2014 (144A) 

219.74

2.7

 NMF

AMKR

$5.51

 NIL

Avatar Holdings 7.5s2016       

102.06

7.3

7.1

AVTR

$16.23

 NIL

Penson Worldwide 8s2014 (144A) 

87.34

9.2

13.9

PNSN

$3.28

 NIL

US Airways Group 7.25s2014     

172.16

4.2

 NMF

LCC 

$7.01

 NIL

WESCO Int'l 6s2029             

202.34

3.0

0.2

WCC 

$53.08

 NIL

* Prices as of July 19, 2011

 

Highlighted Convertibles:

Alaska Communications Systems Group (ALSK) provides leading integrated communications services in Alaska. Its wireline and wireless networks extend throughout the 49th state and into the Continental U.S. via two undersea fiber optic cable systems. Its wireline business is one of the most comprehensive in Alaska, and the wireless segment includes a state-wide third-generation (3G) network.

With plans to build a 4G LTE wireless network in Alaska later this year and the subscriber exodus slowing, revenues are expected to exceed 2010 levels. The per share earnings should also come in about six times more than last year’s very weak figure.

Although the common stock yield is higher than that of the convertible, a common stock dividend is the first cost that is cut by companies facing financial difficulties. On the other hand, interest on the convertible must be paid on time or the company goes into default, giving bondholders some control of the company.

Penson Worldwide (PNSN) provides a range of securities and futures processing infrastructure products and services such as securities and futures clearing services; margin lending; facilities management; technology and data products that include customizable front-end trading platforms; execution routing services; Internet account portfolio information services; holding and safeguarding securities and cash deposits; securities lending and borrowing; and proprietary trading services. As of December 31, 2010, Penson had 430 active securities correspondents, including 59 futures correspondents worldwide. Penson's clients are online, direct access, traditional retail brokers, large banks, institutional brokers, financial technology companies, and securities exchanges.

Penson’s 8% convertible notes due 2014 are “busted,” and thus have little or no sensitivity to movements in the common stock. The “junk-like” investment quality security, however, pays annual interest income of $80 per note and trades below par. Its current yield is 9.8% (compared to a dividendless common stock) and the yield to maturity is 17.1%. Take note that the notes mature on June 1, 2014.

US Airways Group (LCC) provides air transportation for passengers and cargo, operating approximately 3,200 flights daily to 200 communities in the United States, Canada, Europe, the Caribbean, and Latin America. As of December 31, 2010, the airline operated 339 mainline jets, supported by its regional airline subsidiaries and affiliates operating as US Airways Express. The company also operates a hub-and-spoke network, with hubs in Charlotte, Philadelphia, and Phoenix.

The 7.25% convertible notes due 2014 offer income, and are a safer haven for risk-averse investors; the volatility of the notes is about 45% less than that of the common. The value of the notes, which are currently trading deep in the money, is above conversion value and that leaves room for added value should the common stock price rise. The notes have a 4.6% current yield advantage over the common.


At the time of this article's writing, the author did not have positions in any of the companies mentioned.