Issuance picked up on the week as corporate treasurers took advantage of low absolute yields to push debt into the market. Despite the selloff in equities, the tone in corporates remained firm as money continued to flow into the sector. Average deal size increased and the weighted average credit quality of issuance improved as well. Unlike high yield, where there has been a significant reversal of risk appetite in March, BBB corporates have kept pace with AA bonds. That said, bondholders are increasingly demanding that new issues include protection from deterioration in credit quality. American Home Products included a step-up coupon to compensate bondholders for downgrade risk, as did France Telecom in its jumbo deal last month.
S&P to Clarify its Treatment of Structural Subordination
While clarity will come on a conference call scheduled for April 3, S&P appears to be reinvigorating its approach to recognizing where the rights of bondholders have been diminished by the creation of "priority liabilities", i.e. borrowings at subsidiaries or through the pledging of common stock of subsidiaries. One of the few downgrades that occurred under this structural subordination review was the senior unsecured debt of Philip Morris. We have commented on the ramifications of the Kraft capital structure and IPO in the past, and bondholders at the MO level need to stay alert to the erosion of their asset protection that will come with the senior claims at the Kraft subsidiary.
Nortel: Another Day, Another Warning
Nortel issued a second warning and gave up the ghost on guidance. This week's announcements out of NT were consistent with wave of earnings revisions in the market, bearish comments out of Cisco, and more restructuring at Ericsson. For anyone who listened to the last conference call following NT's earlier and more shocking warning, it is clear that NT and most of the sector just do not have any idea as to when volumes will rebound. Assessing inventory channels has become more akin to psychic channeling.
Lucent/Agere: Bloody, Beaten, but Priced
Agere finally gets priced at $6. The next round of focus will be on asset sale plans, the vendor financing minefield, and bank line compliance. The unfortunate issue we have here is a company-specific problem mapped onto a very unfavorable industry environment and that whole mess super-imposed on a dubious economic outlook. That leaves bondholders in a family tree of secured bank debt and, most likely at this point, a junk-quality credit. In addition, the Agere spin-off, while beneficial for Lucent shareholders, constitutes an erosion of asset protection for bondholders.
AHP: Expensive Diet
The tumultuous AHP deal certainly underscored the highly inexact science of pricing a deal for a company with open-ended contingent liability exposure and facing ongoing appeals. We believe the final pricing was fair with a reasonable margin for error built into the deal, and the rating sensitive step-up allows for above-average costs in opt-out cases, but not for a major alteration of the legal landscape. We would guard against whitewashing the residual legal risk since, as we have seen in some other (e.g. asbestos) cases, litigation handicapping has been a disastrous exercise for bondholders in recent years.
Metals: Wild West Scalps Phelps Dodge Production
Metals producers may now see production curtailments as an intermediate term problem in the West as the well-publicized power problems are beginning to inflict more lasting earnings damage on the global leaders, such as Phelps Dodge. Plant idlings could also be a drag on earnings with the possibility of a new round of charges. The commodity markets are difficult enough to call given the inherent volatility of price, but if we add questions of volume and unit cost, things start to get pretty uncertain.
Waiting for Arnold: Mr. Universe Ponders a Run for Governor as Californians Buy Candles
As the current set of politicians dithers, some begin to dream of a day when The Last Action Hero will ride in from a movie set and save the frightened citizens of La-La land from themselves. Current Governor Gray Davis, who has spent the whole crisis in denial because uttering the "I" word might hurt his re-election chances, had better watch out, because The Terminator is rumored to be considering taking his job. Arnold, who would run as a Republican, could get legions of Kennedys to campaign for their brother-in-law if he really is The Running Man.
Stormy Weather? Unfortunately for California, It Doesn't Look Like It
California needs some help from the weather this summer, but, according to the National Oceanic and Atmospheric Administration's forecasts, it's not going to get it. The state is likely to be hit by a devastating one-two punch: continued drought in the northwest and higher than normal temperatures in southern CA in April-June. Longer term, higher than normal temperatures are likely July-September in the southwest, the northwest and portions of CA. Summer demand will be higher across the west as a result, with fewer hydro resources to help cope. With demand up in the southwest and northwest, there will be competition for limited power resources, likely driving prices up and pitting consumers in the producing regions against those in CA.