Delta bonds back off prior gains, MCI up; funds see $26 million outflow

By Paul Deckelman and Paul A. Harris

New York, Aug. 20 - Delta Air Line Inc. bonds, which had gyrated wildly Thursday between early big gains and later small ones, were seen headed in the opposite direction Friday, falling back several points from their Thursday closing levels. MCI, Inc. bonds, however, were firmer on the session, although nobody saw any fresh news out about the restructured long-distance carrier.

Primaryside activity was quiet, with no deals seen having priced by the time trading wrapped up for the day.

And for the first time in a long time - longer than just about anybody can remember - the high yield mutual fund flow numbers that normally circulate around following the Thursday market close were nowhere to be seen at that time, apparently due to technical difficulties at the source, AMG Data Services in Arcata, Calif. The word was that they would not emerge until Friday morning, which is exactly when they finally did make their appearance. Market players familiar with the numbers told Prospect News that $25.8 million more left the funds in the week ended this past Wednesday than had come into them.

It was the fourth straight week in which the weekly number was in the red, although in three of those weeks, the outflow was under $100 million, and in two of those weeks - the most recent week, ended Wednesday, and the week ended Aug. 4 -- it was under $30 million - chump change, really, for a statistic which sometimes has measured in the billion-dollar-plus range.

In the previous week, ended Aug. 11, the net outflow had been $91.3 million. All told, over the past four weeks, outflows have totaled some $504.1 million, including the $358 million hemorrhage seen in the week ended July 28, according to a Prospect News analysis of the weekly mutual fund figures. That has at least partly offset the approximately $977.42 million cumulative net inflow which had been seen over the four weeks before that, from late June through most of July, according to the Prospect News analysis of the fund-flow figures, which are considered a key barometer of overall junk market liquidity trends.

But while the flow numbers have been going back and forth, in blocs of several weeks at a time, for the year to date, things have been pretty much all negative since around February (when big outflows, including two consecutive billion-dollar-plus losses, more than wiped out all of the inflows seen in the first four weeks of the year). The junk funds have a cumulative net outflow for the year so far of about $4.925 billion, according to the Prospect News analysis. Outflows have now been seen in 20 weeks out of the 33 since the start of the year, with inflows in only the remaining 13.

"It's not meaningful at all," a source added quickly. "What we have here is a lack of direction without conviction.

"A little comes in one week, a little goes out the next: it doesn't mean a thing."

Delta sinks again

In the secondary market, Delta Air Lines' bonds on Friday lost some of the altitude they had gained in a tumultuous session Thursday, when investors took the bonds up in the early going, enthused by the idea that the beleaguered Atlanta-based air carrier will revamp its underperforming operations according to a turnaround plan presented by chairman Gerald Grinstein to Delta's board on Wednesday, and that it might be able to persuade its 7,500 unionized pilots to accept the $1 billion pay cut Delta says it needs to keep operating in the long run. However, most of those gains had melted away by the end of Thursday's session after Standard & Poor's downgraded Delta's ratings, warning that its plan to seek consent from investors in its aircraft-secured bonds for indenture changes that would give the company more financial flexibility might lead to what the ratings agency called a "coercive" debt exchange on worse terms for current debtholders.

On Friday, there was no news seen out about the carrier - Thursday's closed-door talks with the pilots had produced no headlines, with the union taking Delta's pay cut request, and whatever equity or other goodies it might be offering to induce the captains to go along, under consideration.

Still the bonds were heading downward, with a trader quoting the Delta 7.70% notes due 2005 at 44.5 bid, 45.5 offered, "a little weaker" than Thursday's 46 bid, 48 offered.

"Everything was moving around in the capital structure," he said, "but there were no dramatic moves."

The trader said that one would think that with the price of crude oil, the airline industry's recent main nemesis, backing away from the threatened $50 a barrel (it ended at $47.86 per barrel for U.S. light crude for September delivery, down 84 cents on the New York Mercantile Exchange, retreating from Thursday's record close of $48.70), the airlines might take heart. But noting that Northwest Airlines Corp.'s 9 7/8% notes due 2007 were likewise lower, ending off half a point at 71.5 bid, 73.5 offered, he opined that "I guess oil [price declines] wasn't that big a deal for these guys."

Another trader pegged the Delta 7.70s at 45 bid, 47 offered, down from 49 bid, 50 offered late Thursday, and saw the company's 8.30% bonds due 2029 drop to 27 bid, 28 offered from 29 bid, 30 offered previously.

Allegheny Energy higher on upgrade

Elsewhere, the trader saw Allegheny Energy Inc.'s 8½% notes due 2012 two points higher at 105 bid, 106 offered, after S&P raised its corporate credit ratings on the Greensburg, Pa.-based electric generating company, citing the company's improved financial performance.

S&P raised the corporate credit ratings of both Allegheny Energy and its subsidiaries to B+ from B and said the outlook was positive.

"The higher rating on Allegheny reflects that of a company whose business risk profile is improving toward that of a typical integrated utility," S&P analyst Tobias Hsieh write in his upgrade message, "but [is] still heavily burdened with debt incurred from largely discontinued merchant and trading operations." The total non-securitized debt load is about $5.1 billion.

MCI better

Traders saw MCI's bonds about half a point to three-quarter of a point better, although none of them saw any fresh news out on the Ashburn Va.-based long-distance carrier, which emerged from Chapter 11 earlier in the year and which now is the subject of takeover speculation - of a sort - involving Leucadia National Corp., which has accumulated just under 5% of MCI's shares and which has asked federal regulators for permission to buy up to 50% of the company's shares.

MCI's 7.735% notes due 2014 rose to 91.25 bid, 91.75 offered from 90.5 bid, 91 offered Thursday, while its 6.688% notes due 2009 were seen at 93.75 bid, 94.25 offered, up from 93 bid, 93.5 offered Thursday. At another desk, a trader saw MCI's 5.908% notes due 2007 a quarter-point better, at 98 bid, 98.5 offered.

Kmart passthrough sellers

A trader said that "it looks like a lot of sellers" of Kmart Corp. structured paper were coming into the market in the latter part of the week, "because it looks like the properties have been cherry-picked, and what was left over, people aren't too happy with. I don't know if there was a writedown" or something like that.

"There are so many" of the real estate-backed bonds, he said, each secured by different stores owned by the Troy, Mich.-based discount retailing giant, which emerged from Chapter 11 a year ago after shuttering about one-quarter of what used to be about 2,100 stores, and it has since been selling off closed locations to such retailers as Sears Roebuck & Co. and Home Depot. In recent months, it has announced plans to sell some 73 store locations to Sears or Home Depot for about a billion dollars total.

Those real estate-related gains helped power the company to a third straight profitable quarter this past week, despite continuing declines in both revenues and same-store sales, the retailing industry's key financial metric.

Some analysts and commentators feel that Kmart's days as a retailer trying to compete against the Wal-Mart Stores Inc. juggernaut that drove it into Chapter 11 are ultimately numbered, with chairman Edward Lampert, whose ESL Investments controls a majority of its shares, seen by some as likely to transform the company into an investment vehicle, much the way Warren Buffett took underperforming textile maker Berkshire Hathaway completely out of the textile business and turned it into an investment powerhouse with interest in many, many businesses far removed from its roots. Kmart said in a recent Securities and Exchange Commission filing that Lampert has been given the green light to invest the company's excess cash pretty much as he sees fit.

Kmart, which used to have a load of junk bonds out before these notes were taken out via its restructuring, such as the old 9 3/8% notes due 2006, now attracts interest from fixed-income investors who use its structured paper as a real-estate play, and they drove those bonds solidly higher earlier in the year.

But now, he said, with some of the underlying real estate sold off, "even though earnings were decent [in the latest quarter], the properties look like they have been cherry-picked, so sellers are starting to come into the structured paper.

"The fact is there have been some writedowns, some cash payments, and I guess the feeling is that the juice is out of the paper, because the properties have been cherry-picked. So a lot of selling came into the market."

He saw Kmart's structured 8.99% notes attracting sellers in a 54-55 range, while its D-R structured 9.35% notes due 2019 "had a recent factor change, and sellers came into the market at 71.5-72.5." The company's 8.54% structured notes saw sellers in a range around 38, "so there are some liquidations by real estate holders from this paper."

The bloom, he said, is definitely "off the rose" in the once high-flying real-estate-backed notes, although he added "don't forget, they've had a pretty good run with that paper." But now, he said "there's definitely someone trying to take some money off the table."

He suggested, only half jokingly, that the Kmart secured-debt investors might be swapping out of Kmart and into Winn-Dixie Stores Inc.'s 8.181% and 7.803% notes, which pushed up slightly in response to the company's optimistic tone about its turnaround plans following Thursday's release of its fiscal fourth quarter and fiscal 2004 results. "At least they [Winn-Dixie] are still paying interest."

Summer slowdown

Generally speaking, activity Friday was lackluster, with several people blaming the usual culprit - mid-to-late-summer lassitude.

A trader said that "it's going to be slow right for the next two weeks [leading up to the Labor Day holiday break], I think. I mean, you never know [when something unexpected happens] - but generally, it's a very slow period of time."

Late in Friday's session market sources told Prospect News that the primary market produced no news.

"This must be what the place looks like on Sunday," observed one official on a high yield syndicate desk.

And don't waste your time looking for any real news until about the seventh of September, another source warned, adding that there are currently no junk bonds being marketed, nor are there any deals on the road.

Issuance may hinge on LBO activity

Twice during the Friday rounds Prospect News heard market observers forecast a reasonably healthy new issue market for the remainder of 2004 - as long as the market isn't disrupted by some unforeseen event.

"The new issue volume has been really strong," said one official who added that year-to-date issuance for 2004 tops issuance from the same time span in 2003. Prospect News figures have $95.1 billion so far this year compared to $91.8 billion at the same point last year.

"We think it will maintain a pretty good pace, absent some event that is capable of causing a severe disruption in the market place.

"Energy prices are high. And the Fed is going to continue raising the rate, which has more of an impact on the short end of the curve. The economy seems to keep turning out data that is toward the low end of expectations. The employment environment is still pretty soft.

"All things considered, though, if the LBO firms stay pretty active we should continue to see decent volume in the primary market.

"The LBO firms are going to be the driving force for the remainder of the year."

Business as usual, says Keefe

Pax World High Yield Fund portfolio manager Diane Keefe used a similar disclaimer as she predicted that, barring an unforeseen event, the post-summer primary market will be business as usual.

"You hear that the levels that issuers have had to pay during the summer are somewhat affected by how difficult it is to get a lot of buy-side attention, with vacations and people taking off," she said.

"Typically, if it was not an election year, and there wasn't the ambiguity that we have with the war in Iraq, and the fear of some terrorist attack between now and the election, it would be better to come in the fall than in the summer.

"That's because you can get the most efficient pricing when the most people are participating," Keefe added, noting that she herself has been working throughout the summer.

"But I think most people in our business are Republican and are optimistic that if anything happens it's not going to be big and it's not going to do a 9/11-kind of thing on the market.

"Given that, I think we're going to see business as usual."

Junk players may skip IDS

Given that the straight-up high yield market is not expected to produce much news in the fortnight to come, Prospect News asked one market source whether the dozen and a half (give or take) income deposit securities (IDS) deals thought to be in the market might steal the late August headlines.

The securities combine shares of common stock with bonds.

At least 18 companies have filed documents with the U.S. Securities and Exchange Commission announcing their intentions of selling IDSs. However to date only one, Volume Services of America, has actually priced such an offering.

Recently InSight Health Services Holdings Corp. cited market conditions as it withdrew its $675 million deal. And American Seafoods Corp., also citing market conditions, postponed its $450 million IDS offering - on the very eve of its expected pricing - only to bring the deal back with a subsequent filing.

In any case one high yield market source told Prospect News on Friday that the IDSs don't exactly seem to have junk players licking their chops.

"The reception out there isn't really that good with the institutional investors," the source commented. "They think the covenants are real sloppy.

"The big problem with the debt portion is that after four or five years the company is just as leveraged as when it started. So there just doesn't seem to be any exit strategy.

"People are thinking about these deals because they're talking about them. But no one seems too excited.

"Talking to accounts, it's hard to see where the demand is coming from. It's not coming from the high yield community."

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