DENVER -- The theory is a popular one in investment lore: Bad news is like a cockroach. See one and there's bound to be an army behind the baseboard.
Denver International Airport has had its share of bad-news cockroaches, and city officials are having a devilish time trying to stamp them out. Problems with the automated baggage system have caused three delays, downgrades by two rating agencies, and plummeting prices for airport bonds.
With Denver officials in New York City this week telling their story and getting ready to peddle more bonds, now is a good time to ask the professionals whether Denver air bonds are worth the bother.
The consensus of experts contacted by The Bond Buyer? If you believe in the project, take a deep breath and buy the bonds, especially the hard-hit lower-coupon bonds that have a greater chance for appreciation in a good market. If you don't believe in the project, you don't own the bonds anyway.
"We're still a comfortable holder of the credit," said Joe Dean, fixedincome portfolio manager for Greenwich Advisers/Smith Barney Shearson, whose funds are one of the major holders of Denver air bonds.
"I find it hard to believe, unless there's something more behind the scenes we're not aware of, that the airport won't open sometime in the fall," Dean said.
The notorious Washington Public Power Supply System bonds aside, few "story" bonds have as gripping a tale behind them as the Denver International revenue bonds. On a credit like this, only experts need apply. When the bonds came to market in 1991 and 1992, they were snapped up by large investors starved for supply and the high yields offered by the "Denver airs," as they are known on trading desks.
The 80 to 100 institutional managers who bought these revenue bonds enjoyed spectacular gains early on, as a raging bull bond market pulled Denver airs along with it. But a story bond with a credit rating hovering just above junk doesn't trade so well in a bear market, and when the bear came back last fall and the first half of this year, the price of Denver air bonds plummeted on the open market.
Worse for Denver and its bondholders, the pesky baggage problem cropped up. The third delay in opening the airport in May led Standard & Poor's Corp. to downgrade the credit to junk status. Moody's Investors Service cut the bonds to one notch above junk. And Fitch Investors Service placed the credit on Fitch Alert with negative implications.
Worse for investors, builders of the baggage system still can't tell Denver when the system will be ready so the airport can open. Investors hate uncertainty just about more than they hate anything. As a result, the airport bonds have lost even more value, with the benchmark 6 3/4% coupon bond trading from 88 cents to 91 cents on the dollar through the summer.
"These bonds have deteriorated more than the general market," said Bradley Kreidle, a trader with George K. Baum & Co. in Denver who specializes in trading Denver airs. "They have dropped 100 basis points lower than the market."
From their peak value on Oct. 20, 1993, through Tuesday, the total return on the 6 3/4% coupon bond has been a negative 11.33% and the yield to maturity has flown to 7.80% from 6%, according to Kreidle's figures.
If Denver airport bonds got hammered 100 basis points more on the yield than the overall market and if the average spread between the market and Denver air bonds is 123 basis points, with a high of 175 and a low of 75, it means that the market doesn't think much of Denver air bonds. Another way to put it is that the bonds are cheap.
Analysts use a couple of basic tools to expose cheap bonds, or to check if bonds are trading the way they should during market swings, given their coupon and maturity date. Those tools are duration and convexity.
Duration measures a bond's volatility. Bonds with shorter maturities and lower coupons have a lower duration, or volatility. Convexity is a measure of how fast duration changes during market moves.
During this year's bear market, Denver air bonds held true to classical theory. As a result, all Denver air bonds are cheap compared with the market, and some of the Denver airs are cheaper than others.
While the 6 3/4% coupon bonds were getting creamed this year, the 8.5% bonds held up better, losing 4.87% on a total return basis from their high last fall to the present, according to George K. Baum figures. Bonds in the middle coupon range lost at rates between the low and high coupon bonds, as theory suggests they would.
Investors are now asking themselves if they should own Denver airs or sell them. If so, which bond?
All of the fund managers contacted by The Bond Buyer point their fingers at the bonds with high durations: lower-coupon bonds with longer maturities. True, the 6 1/2% coupon bonds maturing in 2025 have been beaten up the worst, but they will bounce back the fastest in a good market, according to Kreidle's charts.
Of course, investors are not concentrating on the spreads between different bonds so much as whether the debt will be repaid in full or not, managers say.
"Why should we care about whether we've got positive or negative convexity?" asked Bill Grady, portfolio manager at Van Kampen Merritt. "You can't really separate the credit concerns from whether it is cheap or not."
Grady said many market participants believe that Moody's will downgrade the Denver air bonds to junk, which would force many funds to sell them. So far, despite the lower prices, Denver air bond sales have been sporadic. There have been no big blocks of $50 million or more. Should Moody's downgrade, the bonds will be hit harder than ever, Grady predicted.
On the other hand, if the airport opens, "it could be back to investment grade before you know it," Grady said.
"Some of the bonds do look interesting if you believe in this project. You don't want to buy the 8 3/4s. You'd want to buy the deep-discounted bonds," Grady said.
Greenwich Partners manager Dean is still a bull on Denver airs.
"What you have right now is a bond that has all the potential negative implications built into the prices," he said. "If there's a positive surprise, and you know the airport's going to open, these bonds could do very well."
