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Convertible bonds offer an interesting middle ground between a stock and a bond, and thus, an interesting middle ground between 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. Further, 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 7.5% 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.
  

 

Annual

Recent

Conv

Conv

Com

Com

Com

Convertible Securities

Income

Price

 Yld(%)

YTM(%)

Price

Yld(%)

Ticker

NorthStar Rlty 11.5s2013(144A) 

$115.00

67.92

16.9

60.1

$5.94

6.7

NRF 

Kohlberg Cap'l 8.75s2016 (144A)

$87.50

97.04

9.0

9.9

$6.02

11.3

KCAP

Hutchinson Technology 8.5s2026 

$85.00

74.84

11.4

12.8

$2.35

 NIL

HTCH

Rite Aid 8.5s2015              

$85.00

104.42

8.1

7.0

$1.51

 NIL

RAD 

Penson Worldwide 8s2014 (144A) 

$80.00

34.37

23.3

89.1

$0.48

 NIL

PNSN

Avatar Holdings 7.5s2016       

$75.00

96.13

7.8

8.9

$12.80

 NIL

AVHI

CapLease 7.5s2027 (144A)       

$75.00

99.00

7.6

7.8

$4.11

 NIL

LSE 

Hilltop (Afford Res) 7.5s2025  

$75.00

106.01

7.1

7.2

$8.12

 NIL

HTH 

KKR Financial 7.5s2017         

$75.00

139.44

5.4

 NMF

$9.15

6.6

KFN 

NorthStar Rlty 7.5s2031 (144A) 

$75.00

100.00

7.5

7.6

$5.94

6.7

NRF 

*Prices as of May 3, 2012

 

Selected Convertibles Highlights:

AV Homes, Inc. (AVHI, formerly, Avatar Holdings) operates in the real estate industry with businesses in Florida and Arizona. The company engages in the development, sale, and management of active adult communities and primary residential communities. It also works on the construction of highways and shopping centers.

Financial results for 2011 were somewhat disappointing. Although sales increased over 50% to $89 million, from $59.1 million in 2010, the bottom line was again in the red for the fourth consecutive year. The company reported a loss of $4.25 a share, compared to losses of $3.07, $3.11, and $6.17 in 2010, 2009, and 2008, respectively.

The Homebuilding Industry remains unstable, even as the economy shows various signs of recovery, albeit at a slow rate. The stock is way off the $87 per-share high enjoyed in 2006, and it does not pay dividends at this time. The company’s 7.5% convertible notes due 2016 offer income as well as excellent downside protection.

In addition, the convertible notes offer a generous 7.8% current yield vis-à-vis the dividendless common, and noteholders could realize capital gains if the industry picks up in the near future.

Hutchinson Technology (HTCH) is the leading manufacturer of suspension assemblies for (magnetic) hard-disk drives, which contributed 98% to 2011 sales. The company has also developed a medical device in its other reporting division (2%) that uses an optical technology to measure local oxygen saturation of hemoglobin in tissue.

Weak financial results for the 2012 fiscal first quarter (ended December 25, 2011) forced Value Line to lower expectations for the full fiscal year. The effects of flooding in Thailand caused the company to suspend operations there resulted in a 30% decline in the number of assembly units shipped.

The company continues to repair and restore its plant in Thailand and production could resume as early as July this year. However, pre-flood output levels would not be attained until mid-fiscal 2013.

Shares of the company are expected to peak at $6.00 a share over the pull to 2015-17. However, with a beta of 1.80, the volatility is well above market average and the safety is more limited. The company’s 8.5% convertible notes due 2026 offer better stability and income.

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