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Recent corporate spread tightening following the Fed funds rate cut is being touted by some market players as indicative of a mature market where investors are able to anticipate events months before they happen. In the mid-1990s the lag effect between the positively correlated Fed funds rate and corporate spreads could be as much as two years. But market reaction to the Fed's recent 50 basis points of easing immediately tightened spreads 20-40 basis points, says John Kollar, corporate strategist at HSBC Securities in New York. "[This is a] structural change associated with a more mature corporate bond market," he adds. Milton Ezrati, strategist and economist at Lord, Abbett & Co. in New York, agrees the corporate market has matured, but unlike Kollar, he considers the speed with which spreads narrowed just a sigh of relief from a market heavily apprehensive of a slowing economy and a looming recession. "The market was in the midst of a near panic when the Fed eased," says Ezrati.

After selling $70 million in mortgage pass-throughs to buy five and 10-year Treasuries six weeks ago, the United Bank of Kuwait Asset Management is considering reversing the trade and selling Treasury paper to beef up its MBS exposure by $40 million. Mortgage pass-throughs have cheapened as investors have become worried about prepayments, says Robert Friend, portfolio manager of $1 billion worth of taxable fixed income in London. He adds MBS is lagging behind 5- and 10-year swap spreads and represents an historically good value. The yield curve manager is 5% long its duration relative to the J.P. Morgan Global Bond Index, which has a duration of 5.8 years. Friend is slightly bearish and will neutralize the duration once Treasuries trade up about 5 basis points, giving the 10-year a yield of 5.06%. "We need discipline, because if yields back up because the market gets ahead of the economy, we don't want to have to give back all the profits we've made off of being long," says Friend. Seventy-five percent of the portfolio consists of government paper, including Canada, Australia, Japan and Europe, with 20% in U.S. agencies and the remaining 5% in investment grade corporates.

Up-front fees on pro rata tranches ticked down slightly but are still within arm's reach of last year's annual high of 4.2 basis points. According to Portfolio Management Data, for the rolling three months ended Dec. 31, 2000 pro rata fees tip-toed down to 4.0 basis points for every one million dollars committed. Fees on institutional pieces remained steady at 2.3 basis points, which was the same for last November (LMW, 11/13/00). Marc Auerbach, associate at PMD in New York, said not much has changed in the dreary, credit-sensitive loan market. "The story is much the same. There's not a large deal volume," explained Auerbach. He added that leveraged deal volume for December wilted down to $19 million from November's $36 million. He attributed the small dip in fees to a handful of richly priced telecom deals missing the three-month radar. "It's a rolling three-month average, so some of the small, highly leveraged telecom deals have dropped off our average, which probably accounts for the slight down-tick. Small, leveraged pro rata deals are what's keeping the spreads up," explained Auerbach. One such deal is Goldman Sachs' $250 million credit for Network Plus. The Quincy, Mass.-based telecom company paid 61/2% over LIBOR to expand its network back in October last year.

Williams Companies, an operator of natural gas pipelines and a communications network based in Tulsa, Okla., successfully issued $1 billion in debt that market observers said was heavily oversubscribed. But there are some skeptics who passed on the credit because of questions over Williams Communications, the heavily indebted network provider 85% owned by Williams Companies. Williams Companies is planning to spin off the single B-rated subsidiary by August, but according to Mike Dineen, portfolio manager at MONY Life Insurance in New York, with market volatility it may be difficult. Because of the possibility of having to support the subsidiary with parent company cash flow, Dineen wouldn't touch the credit: "They have a lot of financing risk, because an IPO of Williams Communications is predicated on a receptive equity market. I

Baxter Capital Management is looking to swap some of its agencies and Treasuries for the bonds of cyclical companies, such as carmakers and manufacturers, which could see spread-tightening if the economic downturn proves to be less severe than some have predicted. James Herreman, a v.p. who oversees approximately $400 million in taxable fixed income, says it's premature to forecast a recession on the basis of poorly performing stock markets and earnings warnings. He acknowledges economic activity has fallen off, but notes the unemployment rate, for one, remains "extremely low." As a result, he believes spreads on cyclical corporate bonds could tighten over the next six to twelve months. He is unsure how much he will ultimately allocate to cyclical corporates. Herreman and his team, who have not yet identified any particular credits, would look to make moves a couple million dollars at a time out of five- to 15-year agencies and Treasuries and into corporates with similar maturities, so as to remain slightly long the 4.51-year Lehman Aggregate. The Indianapolis-based firm's Lehman Aggregate portfolios are allocated roughly 38% to MBS, 26% to corporates, 19% to agencies, 8% to Treasuries, 6% to ABS and 3% to cash.

The move by Wayne, New Jersey-based G-1 Holdings, formerly known as GAF Corporation, to file for bankruptcy last week because of asbestos claims has sparked fears among bondholders of its subsidiary, Building Materials Corp. of America, that the assets and liabilities of both the entities may be combined. Building Materials has no asbestos liability and is not involved in the bankruptcy proceedings, but if consolidated it could be made liable and may be unable to payback bondholders. "I have been reassured by lawyers that this cannot happen unless both companies file for bankruptcy, but I've heard it from other investors, so the theory is definitely out there," says Shawn Curley, analyst at Imperial Capital Management in Los Angeles.

Credit derivatives traders were last Friday surprised to see three-year default protection trading on embattled California utilities PG&E and Edison International. Protection on Edison reportedly traded around 825 basis points, and PG&E around 850bps, they added. The trades were unusual because in the near term, units of the companies are likely either to default or be granted regulatory relief, meaning that selling protection on the names is essentially a bet on the near-term outcome of the California power crisis. Each trade was USD5 million. Regulated utility subsidiaries of both companies are facing trouble from their distribution businesses. Operating shortfalls due in large part to structural issues with electricity deregulation in California are forcing the companies to tide themselves over with short-term borrowings. Without regulatory relief, the regulated subsidiaries will have trouble staying solvent, said traders.

DBS Bank, Singapore's largest local bank, is rapidly building its treasury and derivatives operations with over 10 new hires, many of whom are from Chase Manhattan Bank. The new professionals will join in the next two weeks, said an official at DBS in Singapore. The hires include derivatives professionals, the official said, noting that DBS is keen to catch up with more established derivatives providers and traders in Asia as quickly as possible. DBS has within the last year set up foreign exchange, interest-rate, equity and credit derivatives teams (DW, 11/29/99), in a bid to become a regional player. Regulatory changes by the Monetary Authority of Singapore last month allowing interbank trading of Singapore dollar/U.S. dollar options look set to considerably boost the market, making now a good time to hire, said Water Cheung, managing director and head of derivatives, treasury and markets in Singapore. He declined to comment on the professionals joining in the next several weeks. Interest-rate and foreign exchange products remain the bank's core derivatives business. DBS is also considering hiring derivatives marketers in Thailand, and has hired several professionals in Hong Kong over the past three months, he noted.

A task force for the derivatives implementation group of the Financial Accounting Standards Board is likely to offer relief to corporates concerned about the tax treatment for hedging floating interest-rate exposure on commercial paper programs under the FASB's statement 133. Statement 133 requires derivatives to be recognized on the balance sheet at fair value. A task force for the derivatives implementation group is leaning toward allowing hedge accounting treatment for hedges on the LIBOR component of commercial paper programs, according to several members of the derivatives implementation group. Issuers likely will be able to match swaps to the program as a whole, rather than being forced to match swaps to individual issues.

Prices for five-year protection on automobile names rose last week following an announcement by units of General Motors of planned multi-billion dollar bond issuances, which were expected to be priced after DW went to press Thursday. The announcement of the issuance on Tuesday caused five-year protection for General Motors Acceptance Corp. to trade early Wednesday at 98 basis points, up from 89 bps at the beginning of Tuesday, according to Marius Maldutis, v.p. and credit derivatives trader at Morgan Stanley Dean Witter in New York. GMAC is expected to issue USD2-3 billion in five-year notes, and GM is expected to issue USD1 billion in 10- year notes, according to a GM spokeswoman in New York. Ford Motor levels widened as well, with five-year protection with restructuring trading on Wednesday at 100 basis points, up from 90bps the day before. Ford is also expected to issue debt later this quarter.