This Week in Capital Markets:

Several "Litmus Tests" Await Bonds
Ed ZwirnOctober 16, 2000

These are nervous times for the financial markets.

The preceding weeks had seen equities tumble due to earnings disappointments and doubts about the high-tech arena. Ditto for bonds, which had been volatile due to energy-driven inflation fears, weakness in the junk/high-tech arena, and jitters rebounding from the stock market weakness itself.

But all bets were off last Thursday. The President, who had been celebrating his wedding anniversary (no jokes now) with a stay in New York City, was roused from his bed that morning with news of the latest violent developments in the Middle East. Crude oil shot up at least 11% in the immediate aftermath. Markets, which had opened on the upside, quickly reversed themselves.

When the dust had settled, the Dow Jones Industrial Average was down more than 380 points. Investment grade corporate bonds were off some 20 basis points, intraday, and junk bonds were off the screen.

Deat Cat Bounce?

Now that the inevitable “dead cat bounce” has set in, the trendline, for the debt market at least, will become apparent now that players have returned from the weekend and gotten back to serious business. Nothing of major significance had been scheduled to price anyway Friday, but nobody has officially backed away from major offerings, at least at this point.

What the Middle East has in store for us is anybody’s guess. Overshadowed by this is the domestic concern over inflation. Friday’s Producer Price Index (PPI) update proved disappointing, with a 0.9% overall increase. Wednesday’s Consumer Price Index (CPI), being more of a following indicator, is unlikely to prove any more nettlesome than the rest of the news out there.

But the bond offering “pipeline” is as crowded as ever. In the absence of clear directional indications, players have been reluctant to pronounce the fate of issues that have been in the works for some time.

Here are a few developments to look to as litmus tests for the rest of this week:

  • Unilever N.V. is slated late Tuesday afternoon to wrap up the road show for its $7 billion offering of global bonds via lead underwriters Goldman Sachs, JP Morgan and UBS Warburg. The launch and pricing is supposed to happen Wednesday. After nearly a week during which they declined to specify the maturates involved, dealers now say there will be a two- year floater at about 10 basis points over the three-month London Interbank Offered Rate (LIBOR) and three fixed-rate tranches: A three- year fixed note at about 100 to 105 basis points over Treasuries, a five- year note at 120 to 125 points over Treasuries and a 10-year note in the area of 155 points over Treasuries.

The fact that these maturities do not look out farther than 10 years certainly reflects market skittishness, and a source at one of the lead underwriters concedes privately the possibility that the deal won’t come off if volatility picks up again.

  • Telecom issues have been trying the market since Labor Day. Accounting for at least 25% of the new debt that has come to market recently, offerings in the sector — most from recently downgraded companies — have been pricing to rousing receptions by coming to market on the cheap side. For a while it seemed that “bad” news may have helped the deals along by enabling investors to lock in wider- than-expected spreads in companies they already knew. But markets may be slowly catching up to ratings agencies, and the more speculative end of the telecom debt market was rocked last week by reports Deutsche Bank and others may actually be losing money on junk deals.

Whether this spills over to investment grade will be made apparent as soon as this week, as details of the Telecom Italia $5 billion multi-tranche global offering emerge. In the meantime, France Telecom is set to borrow about that amount in euros via a group said to include two French dealers and one from the United States. The firm had earlier been reported to be in the market to borrow as much as $10 billion, most of that in dollars.

Looking ahead, now that a possible merger of some kind between British Telecom and AT&T looks to be off, underwriters are hoping to get a crack at a long-planned $10 billion British Telecom issue. The deal was first knocked out of the box over concern that the firm’s debt was going to be downgraded. Then, it had to make way for an issue from Spain’s Telefonica. More recently, a BT issue has been reportedly held up due to the AT&T talks.

  • The agency market also figures prominently in the weekly pipeline. Freddie Mac has announced plans to price $4 billion to $5 billion of reopened five-year Reference Notes and $2 billion to $3 billion of new 30-year bonds. Both issues, which are led by Credit Suisse First Boston, JP Morgan and UBS Warburg, are also expected by mid-week

Last week’s $9 billion of two- and seven-year Fannie Mae Benchmark Notes, which priced Wednesday, received at least $3.5 billion of its book from overseas. This is far from unusual. The shorter issue, which was well oversubscribed, received a greater-than-normal boost from Middle East investors (go figure). But the longer maturities involved in this week’s Freddie Mac issues will, if anything, lessen the “flight to quality” impact. And, if anything, continued volatility would put pressure on those trying to peddle the 30-year issue.