Bond Rally Pinned on Short-Term Trading

Bonds of many troubled banks have rallied in the second half of July, buoyed by crisis-free earnings reports and rumors of mergers and other capital assistance.

But traders cautioned that activity is light and offers to sell the bonds few. Such indicators suggested that the price rises are due to short-term trading moves by a few investors, not a ground-swell of investor confidence.

"It has improved dramatically, but there's not a lot of activity," said one bank bond trader.

No Nasty Surprises

The absence of negative surprises in the banks' earnings reports has been a key to the bonds' price rise, traders said. The possibility of a merger or federally assisted takeover is also helping some bonds, according to William Downes, a vice president at Keefe, Bruyette & Woods Inc.

"People bidding for these things are speculating that in some kind of assisted deal the bondholders would get taken along," Mr. Downes said.

Bank of Boston Corp.'s sub-ordinated notes were trading Monday at 82 cents on the dollar, up from 74 cents in mid-July. Similarly, notes of Shawmut National Corp. were changing hands at 71 cents on the dollar, up from 60 cents two weeks earlier.

These two companies with Boston headquarters are widely rumored to be discussing a merger.

Even Southeast Rises

As for Southeast Banking Corp., the Miami-based company that released earnings late Friday, its 10.5% notes due in 2001 were bid at 19 cents on the dollar, up from 15 cents two weeks earlier. Southeast previously disclosed it is in talks with regulators over some form of government assistance.

And bonds of troubled MNC Financial Inc., Baltimore, were bid at 50 cents on the dollar, up from 41 cents.

The exception was Midlantic Corp., Edison, N.J. Its notes were bid at 39 cents on the dollar, down from 41 cents early this month. Thomson BankWatch, a closely watched bank rating agency, cut its rating on Midlantic to the lowest possible designation late last week.

The price moves by the troubled-bank bonds were echoed by strength in the market for higher rated bank bonds. Citicorp's 9.75% notes due in 1999 were trading at a yield of 10.15%, a decrease in risk premium from their 10.5% yield just after Manufacturers Hanover Corp. and Chemical Banking Corp. announced they would merge.

Bond performance in the investment-grade market is described in terms of yield, rather than price. A lower yield suggests investors are demanding less of a risk premium to buy the bonds.

"It looks like there's better buying interest," said Michael Hynes, a managing director at Smith Barney, Harris Upham & Co.

Volume Is Thin

Still, trading is light throughout the bank bond market. In addition, the price rises are "choppy," occurring in leaps rather than steady moves upward. These trends suggested that the price rises are being fueled mainly by institutional investors taking short-term positions.

Traders said a number of these investors appear to have short positions - they have sold bonds they borrowed, hoping the prices will fall - and they are trying to close out those positions by buying bonds before they rally any further.

Monitor

A move to raise equity capital is being readied by Allied Irish Banks. It plans to offer 4.7 million American depositary receipts through underwriters including Merrill Lynch & Co., a move that would raise nearly $80 million.

The government has authorized the New Bedford Institute for Savings to buy the assets of the failed Sentry Savings Bank of Hyannis, Mass. The transaction includes $167 in government assistance. Sentry has $462 million in deposit accounts.

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