Weekly Supply & Flows Update
The primary market is winding down fast as we head into the July 4 holiday week and then into summer. A total of $11.8 billion came to market with higher quality borrowers concentrated in the very short end of the curve and lower credit companies continue to lock in absolute rates that look attractive on a historic basis. Notable deals for the week include: Mission Energy Holding (Ba1/BB-), which managed to cobble together $800 million in demand. The funds will be funneled up to the parent, which will stave off bankruptcy until fall pending additional relief from the California Legislature; Egypt (Ba1/BBB-), which is set to price its first international offering; and Bombardier (A3/A-), a relatively new borrower in the Yankee market. With junk deals making up over 1/3 of new issues, the weighted average credit quality on the week declined to mid/high BBB.
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Eaton: Diversity More Important than Size
Eaton's (ETN) stock took a wild ride last week that tells a story both about the edginess in the market and also about the state of the manufacturing sector. The stock action captures the psychology in the market, but more important for future cyclical reality is what the company said about the economy. Eaton's earnings warning and associated commentary serve to underline the negative sentiment coming out of the manufacturing sector. While ETN management did reaffirm what we have been hearing from a broad cross section of industrial concerns about a weak second half, there is little be alarmed about for Eaton bondholders.
U.S. Industries Freefall Highlights Risk in Bank Line Refi/Senior Sub Combos
The case of U.S. Industries (Ba2?/CCC+), underscores just how fast BB tier bank line refinancings can come unraveled. USI is knocking at the doorstep of bankruptcy as it explores alternatives with its lenders, and this is only a little over three months after the company was sporting investment grade ratings on both sides and only two months after the company was in the market trying to execute a senior sub deal.
Raytheon: In the Washington Group Tar Pits
RTN increased in a fairly dramatic fashion its estimates to complete the two defaulted Washington Group projects. This continuing cash drain and negative earnings impact is another setback for RTN bondholders that comes on top of what has been a disappointing defense budget process. The company has taken some steps this quarter including equity issuance to stabilize its balance sheet measures, but any more setbacks could require additional action to fend off the rating agencies.
Lucent: The Load Gets Heavier
LU downgraded to Ba1. The Moody's action, while not unexpected, does have the effect of making a convertible preferred deal more unlikely by further constricting the investor base. The fact that Moody's left them on negative watch and S&P's BB+ assumes the asset sales get done on an expedited basis implies that anyone looking at a convertible could be facing single B risk over the near term and that could prove prohibitive. The immediate technical risk to bondholders is that Lucent falls out of the benchmark indices now and the risk of some more forced sellers becomes very real. The problem with these types of downgrades at such a critical period is that they are almost a self-fulfilling prophecy. The banks respond by pulling in the reins to protect their position, and investors are going to start staring at that $750 million 7/15/01 maturity and getting a bit edgy. We think the liquidity crisis just turned up the road and is coming LU's way.
JP Morgan Chase & Bank of America: Beware the SUV Residual Writedown
An emerging major investor worry, is auto leasing residual write-downs, which began last year in the overall car leasing business, but now seems to be spreading to the SUV leasing market. SUV's were the fastest growing sector of the automobile business through the 1990s. Moody's noted in a recent industry outlook of the captive auto finance industry that "a record number of SUV leases are currently on the market, partly as a result of subsidized programs by the parent auto manufacturers to boost sales". We concur with Moody's that "residual values on these SUV products will be lower than originally estimated due to the higher volumes coming off lease, as well as the untested scope of the used vehicle market for SUVs".
Washington Mutual to Buy Dime Bancorp: Acquisition Happy in Dreary Seattle
We believe the Wamu deal for Dime is a good one since it destroys an immaterial amount (less than $30 million)of Wamu's shareholder value. This is a very small price to pay for Wamu to significantly extend its franchise by getting a good platform in the New York City metropolitan area. Also, Wamu's recent deal for Bank United has yielded higher than expected cost saves and revenue synergies. On its conference call, the bank gave the impression, that Dime could exceed synergy expectations as well. Higher synergies can make up for the initial small decline in EVA aka shareholder value. These synergies can be additive to shareholders value too.