Banking & Capital Markets

The Calm Between the Storms

Credit quality is finally improving for Corporate America. So, why is the underwriting calendar empty?
Ed ZwirnMay 14, 2001

After having borrowed more than $25 billion in the corporate bond market last week, issuers are taking a breather going into Tuesday’s Federal Open Market Committee meeting.

One week ago, an announced plunge in April payrolls had convinced market observers that a 50-basis point rate cut was “a done deal.” But Friday’s release of much stronger than expected retail sales and consumer confidence numbers has turned this assumption on its head.

The effect upon credit markets was sharp and pronounced. The bellwether 10-year Treasury, for example, saw its yield go up about 25 basis points in the immediate aftermath of the releases.

The corporate market, which all week had been outperforming Treasurys despite huge increases in corporate supply, backed up a bit, with the usual spate of new issue announcements and rumors put on hold until the FOMC does its thing on Tuesday.

The immediate upshot to bond issuers is that the yield on the typical 10-year investment-grade bond is now up some 20 to 25 basis points.

In the meantime, equity markets also backed up last week, falling around 1 percent, on average, on Friday alone.

Clouds Have Silver Linings

But the bearish indicators are decidedly mixed.

For one thing, the declines, while noticeable, have not been that pronounced or volatile. In addition, with the debt and equity markets moving basically in tandem, there is little evidence that any “flight” to or from “quality” is going on.

In addition, we are starting to see evidence that the credit worthiness of Corporate America is itself improving. Moody’s on Friday reported that upgrades have sharply exceeded downgrades so far this quarter. If this holds true through the end of June, this will mark the reversal of a trend that has seen downgrades outnumber upgrades over the past 11 consecutive quarters.

Outlook For the Week

But, whatever the more long-range outlook, all bets for the short term are off until Tuesday afternoon.

Spreads to Treasurys have tightened, an impressive enough achievement in the wake of last Wednesday’s and Thursday’s (May 9 and 10) placement of more than $20 billion of bonds (including Wednesday’s $11.9 billion WorldCom global issue.

But the general direction is downward.

“We’re seeing lower prices,” says David Coard, manager of fixed income sales and trading for the Williams Capital Group. “People are sitting on the sidelines [and] thinking that the Fed may only move 25 basis points Tuesday, or if we get a 50-point cut, there may be nothing else behind it.”

But Coard thinks that even if the Fed does everything it is expected to do—cut rates by 50 basis points and not shift its bias—”a lot of market participants will bet against a further rate cut in June.”

As a result, there are no new names in the investment grade pipeline, and only about $2 billion of hangers-on among the issuers that have already announced intentions to come to the market.

The situation is roughly similar in the junk market.

Absolute yields for the more speculative end of the bond market are up a bit, inasmuch as high-yield bonds have outperformed Treasurys, but not as much as Treasurys themselves have backed up.

Through the close of business Thursday, the spread between the Merrill Lynch High Yield Master II Index and the 10-year Treasury had tightened to 743 basis points, from 754 basis points at the end of the preceding week.

In addition, investors are continuing to put more funds into the market than they are taking out, reports Martin S. Fridson, Merrill Lynch’s chief high-yield strategist.

“Fueling the high-yield market’s rise was a $556.4 million (1.07 percent of assets) cash influx to high yield mutual funds in the week ending May 9,” he writes in a report published May 10, noting that this is the fourth consecutive weekly rise.

There are other positive indicators.

Charter Communications, almost unnoticed in the Wednesday/Thursday rush to price bonds, was reportedly a huge success in its placement of B+/B2 bonds.

At $1.5 billion, the St. Louis-based firm controlled by Microsoft co- founder Paul Allen, borrowed 50 percent more than the $1 billion it had asked for, and at levels well within what was sought when the offering was announced the day before.

The deal consisted of $350 million of 9.625 percent 8.5-year senior notes priced at par to yield 434 basis points over Treasurys, and $575 million of 10 percent 10-year senior notes priced at par to yield 471 basis points over.

Also included was $575 million ($1.018 face value) of 10-year senior discount notes paying no interest for five years, priced at 56.502 cents on the dollar to yield 11.75 percent, or 646 basis points over Treasuries, through maturity.

But the junk pipeline is basically as dry as that of investment grade.

Whatever plans issuers may be cooking up, there are few new names and not too many old ones on the list of announced deals.

Among these are Navistar International Corp., which has announced plans to privately sell $300 million of five-year (Ba1/BBB-) senior notes, and Callon Petroleum, which is expected to issue $225 million of seven- year B2-rated senior notes.

4 Powerful Communication Strategies for Your Next Board Meeting