Supply is turning back up again after a two-week lull, although it is still nothing like May's pace. The four-week moving average is still under $17 billion for high yield, emerging markets and corporates, down from the $20 billion plus per week in May. The primary market has also become more measured. While deals flew out the door on top of secondary market levels in May regardless of credit concerns, investors are taking a harder look in June. Average weighted credit quality of deals has remained stable around single A, although better quality credits are generally sticking at the shorter end of the curve. The high yield calendar also remains relatively active, with just short of $2 billion priced in the last week.
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Canadian Pacific: More Mergers to Come?
Canadian Pacific announced that it valued the assets of its Canadian Pacific railway unit at C$5.3 billion and its hotel business at C$2.0 billion. In February, Canadian Pacific (CP) agreed to split into five businesses in order to appease investors and the stock has been a strong performer since. The most interesting aspect to this split-up of CP is the pieces could end up being part of follow-on mergers and this is especially the case with the rail and the energy business.
STB Clears the Way for Railroad Mergers
Railroads will be able to merge again soon, but the rules of the game will be changed, the bar to approval will be higher, and arguably the economics will have been undermined by the changes. The Surface Transportation Board (STB) will lift its 15-month ban on railroad mergers that it instituted in March 2000, and new rules will take effect in July. Now rails that seek to merge must demonstrate that the combination will increase industry competition and avoid service disruption. Formerly, the regulations just required rails to show that they would preserve existing competition. The lifting of the M&A moratorium is expected to lead to a final round of mergers amongst the remaining six Class I players and by extension the many regional players.
Transportation: Sector Stalling but Rails Running on Time
Against the backdrop of soft economic indicators, and especially in the manufacturing sectors that drive freight tonnage, the transportation subsectors have presented a mixed bag. The transportation industries have generally underperformed other industrial sectors in the benchmark bond indices and have had a mixed performance on the equity side of the ledger. Among the corporate issuers, the mix of names is thin and has been weighted in BBB issuers that have seen earnings under cyclical pressure, shareholder enhancements on the rise, labor strife escalating, and/or merger activity raising questions of financial policies and integration risks. The transportation groups have been volatile, with the railroad industry standing out in contrast to the peer group of transportation subsectors and representing a pocket of calm in a group of names that have had a decidedly negative bent.
Refinery Bonds: Spreads Won't Crack
Despite recent panic over gasoline shortages and record industry margins, refining is still subject to the same supply-demand rules of the game. Profitability outlook and asset protection will remain strong even if market slides. Barring an unforeseen turn in the event risk profile of the issuers, we would expect the sector to remain largely bid and little offered. The VLO-UDS deal will work its way through the review and closing process and speculation will mount on the next leg up in the industry consolidation trend. For bondholders right now, the focus on free cash flow raises questions about where shareholders will want to see that cash deployed.
EPA Stands By Additives In California
The Environmental Protection Agency (EPA) announced that California will have to adhere to federal rules on gasoline additives to control emissions and improve air quality. California Governor Gray Davis had sought a waiver of federal rules on reformulated gasoline (RFG), arguing that the use of additives will drive up already high gas prices without improving air quality. Environmentalists will applaud the ruling, but the more cynical could see it as an affirmation of the Bush administration's political priorities, as the main beneficiaries will be the ethanol producing states in the Midwest. The ruling strikes at the center of the MTBE vs. ethanol oxygenate debate. California could require close to 550 million gallons of ethanol every year once MTBE is phased out, which is about a third of current US production.
John Hancock Financial: Have You Gotten A Call From Your Life Insurance Estate Planner Lately?
John Hancock (JHF) (A1/AA+) spoke to the new estate tax laws that will go into effect as part of the new Economic Growth and Tax Relief Act of 2001 (HR 1836) saying that it would have little effect on its earnings growth. We disagree since estate tax life insurance was a core component for future growth. This is further evidence that the companies do not have the core growth potential that they believed they did. Also, they have little in the way of diversification strategies that make huge sense. Unlike more sophisticated banks and brokers, customer-centric marketing and information-based systems are still fiction to many of the major life companies.
Banks Commentary: Move towards higher FDIC-Insurance Limits
There are presently some proposals floating around in Congress to raise the ceiling on FDIC Insurance coverage from the present $100,000 per account to up to $200,000. Some proponents contend that the limit has not been raised since 1980 and it is high time to increase it to reflect inflation and the increase in wealth among the more affluent class over the last ten years. Banks feel that they are losing deposits to mutual funds and brokerages that offer stock, bond, and money market investments and that this added coverage may partially help reverse the tide. Community banks (small banks) have argued that a higher limit would allow them to compete more effectively for municipal deposits, which have the benefit of being stickier (more likely to remain in place). However, with the growth in state and local government cash balances over the last 20 years, municipalities need higher insurance coverage limits in order to feel secure.
Equal Playing Field or Is It?: First Union's Bid Meets SunTrust's
On Monday for the first time, First Union's bid for Wachovia was equal to and then exceeded SunTrust's competing bid. At mid-day Tuesday, First Union's bid totaled about $13,734 bil., while SunTrust's was $13,719 bil. This is a reversal of fortunes for SunTrust since at the time of its hostile bid on May 14, its offer was at a 17% premium to First Union's. Now its offer is at a slight discount or roughly equal to First Union's.
We believe the destruction in the premium is due to the realization by the market that this could be a prolonged battle if not settled by the August 3 Wachovia shareholder vote. Other factors may include the realization that even if SunTrust makes the better merger candidate strategically, it is difficult for a bank to successfully complete a hostile offering.
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