Banking & Capital Markets

Will Issuers Race Back in 2001?

Several experts predict a flood of new bond issues by solid companies. Here's why.
Ed ZwirnJanuary 2, 2001

Investment grade issuers may soon be returning to the bond market in a big way.

After months of low primary market volume, bond market specialists are increasingly expecting the return of major issuers, particularly those involved in banking and finance.

Sure, investors are being discouraged by the fact that corporate bond yields are high in relation to Treasuries, and the wide spread between the two is an indication of just how much “reward” investors are demanding for purchasing an instrument with more “risk” than one issued by Uncle Sam.

But the ability to borrow money at historically low yield levels may prove irresistible, at least for solid companies with little or no market risk.

“Given the low absolute Treasury rates, we’re likely to get busy with a lot of new corporate supply” [in early 2001], predicted a trader of investment grade debt at a primary New York dealer.

According to market sources, while the first wave of this new round of funding will be concentrated largely in the banking and finance sectors, these are not the only types of firms anxious to get in and borrow while the cost of funding remains low.

Issuers Ready Shelves

A peek inside the recent rash of shelf registrations illustrates some of the variety behind this trend.

Registrants in late December included Viacom, which filed to issue up to $5 billion of debt securities, preferred stock and warrants; Emerson Electric, which filed for up to $1.5 billion of debt (allowing $2 billion, counting a previous shelf); RGS Energy Group, $400 million of debt; nursing home operator Beverly Enterprises, $300 million of debt securities, common or preferred stock and warrants; and home builder Standard Pacific Corp., $350 million of debt and/or equity.

While these firms all have up to two years to use these shelves, an upswing in shelf registration is an indication that issuers want to have the flexibility to take advantage on an “opportunistic basis” of an improvement in funding conditions.

Conspicuously absent so far has been any action or even discussion of new issuance in the telecommunications sector. Here the handicaps are both an abundance of supply and concern over the soundness of key players. Last month’s $10 billion British Telecommunications deal was the icing on the cake in this regard.

But even here, an upswing in activity is possible.

“If we see any stability in the telecom sector, you will see issuers come out of the woodwork,” says a market source.

Waiting For Godot

The logic behind such expectations is pretty straightforward:

The yields on Treasury debt were already at about a two-year low as of late December, with the yield on 10-year paper hovering in the area of 5 percent.

On the other hand, new corporate borrowing in general has been slowing down a great deal over the past few months.

Now issuers are already seeing that they can borrow at low absolute rates while offering investors high rates of return in comparison to the risk-free benchmark, Treasury debt.

In addition, the recent two-notch shift in policy bias by the Fed from tightening to easing makes it all but certain in the minds of most that the next FOMC meeting in late January will see rates drop by at least 25 basis points.

Indeed, some bond speculators are even betting that the Fed will cut rates before then, a move that, while unusual, is not without precedent.

But, according to common wisdom, Greenspan & Co. must see an “emergency” or “crisis” of some kind in the offing before taking such a measure, which would then justify injecting liquidity into the economy. The present slow bleeding of the economy just won’t do.

Consequently, the Street must be waiting with baited breath for Thursday (Jan. 4), the date California regulators are set to consider whether to grant rate increases to California’s biggest utilities, Pacific Gas & Electric and Southern California Edison.

Moody’s Investors Service, Standard & Poor’s and Fitch each have recently said they may have to downgrade the debt of these firms below investment grade if they are not granted increases sufficient to offset a major increase in wholesale power costs.

While the increases are likely to prove politically costly in California, the failure to grant them would have potential effects far beyond the bottom lines of the parents of the two utilities, PG&E Corp. and Edison International.

A major portion of the mutual fund money invested in these debt sensitive companies is categorically earmarked for “investment grade only,” meaning that a ratings shift could generate a tectonic move of money away from the utilities, and perhaps away from utilities in general.

At least some of the bond crowd is “hoping” that the dire “California situation” may spur the Fed into an “intra-meeting” action, much the way the meltdown of Russian debt did in October 1998.

But whenever the Fed action comes, it is expected to kick-start the remaining moribund rungs of the credit spectrum in a big way.

One junk bond specialist says that while everybody assumes the Fed easing is in the cards, the market is “waiting until it actually happens.”

Some Other Things To Watch Out For

But beyond the watchful waiting, there are only a few things to look forward to in terms of definitely scheduled issues:

In agencies, both Fannie Mae and Freddie Mac will be adding a new wrinkle to their massive borrowing programs by offering subordinated debt for the first time ever.

The two Government Sponsored Enterprises are making the move into subordinated debt as part of a concerted effort to co-opt a movement in Congress to tighten their capital structures by regulatory means.

Moody’s has already rated the Fannie Mae paper Aa2, versus triple-A for the senior paper.

The issues are expected to yield about 20 to 25 basis points more than the agencies’ outstanding senior bonds, and therefore are expected to be very popular.

“When they do come, they will come with great fanfare,” says a trader.

In investment grade, the latest talk to have surfaced is of Unilever’s intention to sell between $4 billion and $5 billion to refinance acquisitions such as Bestfoods. The company has more than that left on the $15 billion shelf registration it filed in September. Unilever’s bonds are rated A1 by Moody’s and single-A-plus by S&P.

Also, Motorola is still said to be in the market to sell a large amount of euro- denominated notes through its Motorola Credit Corp. These would also probably be rated A1 by Moody’s and single-A-plus by S&P.

In junk, Charter Communications is still said to be interested in peddling some $1.2 billion soon to finance network upgrades. Morgan Stanley Dean Witter and Goldman, Sachs are expected to lead the B2, single-B-plus offering when it comes.