Banking & Capital Markets

Corporate Debt and Those High-Priced Spreads

U.S. businesses are still paying a lot more to borrow than the U.S. government. Also, SEC loosens regs, tightens noose.
Andrew OsterlandOctober 1, 2001

U.S. stocks rebounded somewhat last week, posting gains on four of the last five trading days. Equally encouraging, spreads between investment-grade corporate bonds and U.S. Treasuries narrowed on both Thursday and Friday. That marks the first time corporate bonds have outperformed Treasuries on consecutive days since the September 11 attacks.

Investment grade spreads, however, remain at their widest levels since January. The average corporate bond rated BBB or better is currently trading 185 basis points over comparable Treasuries. The spread was 155 points on September 10. Still, thanks to the recent cuts in interest rates by Fed chairman Alan Greenspan — and another will likely come October 2 — debt remains dirt cheap.

On Thursday of last week, the two-year Treasury note yielded 2.76 percent, the lowest yield since it was launched as an investment in the early 1970s. Likewise, five-year notes yielded 3.73 percent — a 38-year low. Those companies that can take advantage of the cheap coupons are doing exactly that. Bristol-Myers Squibb raised $5 billion in a two-part offering completed last Tuesday. Tyson Foods and Devon Energy Corp. issued $2.25 billion and $3 billion in bonds respectively to help finance recent acquisitions.

Investors are showing little interest in high-yield offerings, however. Junk bonds, like stocks, have suffered some of their worst losses on record of late. Since the terrorist attacks, no non-investment-grade issuer has tapped the debt market. And that probably won’t change if a bona fide recession develops.

Meanwhile, the IPO market continues to flounder. September was the first month in more than 25 years without a single company successfully completing an IPO. The latest hopefuls to withdraw offerings include X10 Wireless Technology, Childcare Network Inc., and Tomax Corp.

Remarkably, several IPOs are scheduled to price in the next several weeks. The biggest horse at the gate is Principal Financial Group. Managers at the mutual insurance company based in Des Moines, Iowa, are looking to raise around $1.7 billion in an IPO slated to hit the market in the middle of October. Two healthcare-related companies, Given Imaging Ltd. and Therasense Inc., are also on the IPO calendar for October. In addition, Houston-based MercFuel Inc., an aviation fuel services specialist, is slated to launch an IPO over the next few weeks. Of course, given the recent flight cutbacks by most U.S. airlines, it may not be the greatest time in the world for a provider of airline fuel to go public.

Regulatory Relief for Airlines…

Speaking of which, the Securities and Exchange Commission is planning to help airlines, as well as insurance companies, still reeling from the fallout of the World Trade Center attacks. Harvey Pitt, the newly appointed chairman of the nation’s top securities regulator, indicated last week that he would reduce the registration requirements to issue public stock for companies in the two industries. Usually it takes at least several weeks to complete the filings required to sell stock. But the reduced regulatory burden could allow cash-strapped airlines and insurers to come to market as early as this week.

For insurance companies (whose stocks have rebounded in anticipation of higher insurance premiums to come), the SEC’s action should help restore their battered balance sheets. The airlines, however, face more-dire circumstances. Already the beneficiaries of a $5 billion bailout from the federal government, the airlines are rapidly burning through cash as their planes continue to fly half-empty.

Observers also point out that any new funding for the airlines won’t come cheap. Indeed, the spreads between U.S. Treasury notes and airline paper continue to widen. Continental Airlines bonds due in 2029, for example, carry a 6.25 percent coupon. But those bonds traded at a yield of 8.4 percent last Friday — well up from a 6.55 percent yield prior to the September 11 attacks. And given the precipitous drops in their share prices, airlines may be forced to raise equity capital on very poor terms — chairman Pitt’s help notwithstanding.

…but Not for Wall Street

The SEC’s generosity towards industries that have been crippled by the terrorist attacks doesn’t appear to be spilling over to the securities brokerage sector. It seems the regulator’s enforcement division is now attempting to reassemble information from its earlier probe of broker kickbacks. As you may recall, those alleged kickbacks came in the form of outsized commissions to investment banks, in return for allocations of popular IPOs to investors.

Much of the SEC’s information was lost in the collapse of 7 World Trade Center, which housed the commission’s New York regional office. Regulators are combing computer files for electronic backups, however, and retrieving copies of documents from the National Association of Securities Dealers, law firms, and investment banks like Credit Suisse First Boston — one of the more prominent targets of the investigation.

With several Wall Street banks working to recover from direct damage incurred in the attacks, and with the SEC focused on shoring up a skittish stock market, the probe won’t be priority No. 1 for the agency. But it also won’t be abandoned. ”This is one case that will definitely not be put on ice,” a person close to the investigation told The Wall Street Journal.

Underwriter Rankings

The third-quarter league tables for Wall Street investment banks were released on Friday by Thomson Financial Securities. Merrill Lynch narrowly topped Citigroup’s Salomon Smith Barney (SSB) unit as lead underwriter, with $170.8 billion in global and U.S. debt and stock underwritings, versus $160.8 billion for SSB. For the year, Merrill has handled $645.2 billion in new issuance while SSB has underwritten $599 billion. SSB, however, was the more profitable of the two firms, earning $1.88 billion in fees so far this year compared with $1.45 billion for Merrill. Morgan Stanley earned the second-most fee income with $1.54 billion in the first nine months.

Not surprisingly, the industry numbers look lousy compared with last year. IPOs as well as secondary stock offerings were already down sharply this year before the September 11 attacks. Since then they have dwindled to a trickle and will likely remain weak for the rest of the year. Until recently the market for new corporate debt gave investment bankers a nice counterbalance to the declining equity market. But with risk-averse investors interested only in blue-chip, plain-vanilla offerings, that business is also likely to suffer in the months ahead.

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