Financials continue to fascinate junk market; better tone seen as stocks recover; funds lose $178 million

By Paul Deckelman and Paul A. Harris

New York, Sept. 18 - For yet another day, fallen financials remained the fascinating focus in the high yield market, which busily traded the bonds of such companies as Lehman Brothers Holdings Inc. and Washington Mutual Inc. - formerly investment-grade institutions recently reduced to junk - as well as Morgan Stanley and American International Group Inc. - still nominally investment-grade rated companies for the moment, whose bonds have been knocked down to junk-like prices and yields.

However, unlike the previous three days of the week, which saw massive blood-letting in those issues amid the financial markets' acute anxiety attack about the soundness of the banks, broker-dealer companies and insurers trapped in the credit crunch, Thursday saw an overall better tone, encouraged by a strong rebound on Wall Street, where the Dow Jones Industrial Average surged more than 400 points after a report that the federal government is considering creation of a repository for banks' bad debt - the sore spot that has been dragging all of those institutions lower.

Activity in more traditional junk names remained muted overall. While junk market bellwether General Motors Corp.'s bonds moved higher, in line with the equity rally, GM's financing arm's bonds were going the other way. The same was true of the securities of its domestic arch-rival, Ford Motor Co. and its own auto-loan arm.

Funds fall by $178 million on week

As trading was wrapping up for the session, market participants familiar with the high yield mutual fund flow statistics generated by AMG Data Services of Arcata, Calif. said that in the week ended Wednesday $178 million more left the weekly-reporting funds than came into them. That broke a string of three straight inflows, including the $130.303 million cash infusion seen in the previous week, ended Sept. 10. Up through that prior week, seven inflows had been seen over eight weeks, according to a Prospect News analysis of the AMG figures, totaling $632.366 million.

However, over the somewhat longer term, although there have been eight inflows seen during the last 14 weeks, dating back to the week ended June 18, against just six outflows, the funds have still lost a net of $342.05 million during that time, according to the Prospect News analysis, mostly due to the massive $651.2 million outflow seen in the week ended June 25. Before that had come a run of 11 consecutive weekly inflows, stretching from early April through mid-June, during which time some $3 billion of inflows were recorded, according to the analysis. Prior to April, outflows had been recorded in most weeks, with net outflows totaling around $1 billion.

But with the calendar third quarter now entering the homestretch, inflows, after that slow start, remain solidly ahead, with 23 inflows versus 15 outflows seen in the 38 weeks since the start of 2008, according to the analysis. According to market sources, net inflows from the weekly-reporting funds since the start of the year, excluding distributions but including previous retroactive adjustments and revisions, are now estimated at $1.574 billion, down from $1.751 billion the previous week. At its peak, the 2008 net inflow totaled $1.933 billion in the week ended June 11, the final week of the 11-week run of straight inflows.

A market source meantime said that funds which report on a monthly basis, rather than weekly, were unchanged in the latest week, which followed an inflow of $106.976 million in the Sept. 10 week. For the year, the net inflow of such funds stands at $3.445 billion. On a year-to-date aggregate basis - consolidating the net inflow totals of the weekly- and the monthly-reporting funds - some $5.019 billion more has come into those high yield funds since the start of the year than has left them.

The flow of money into and out of the junk bond funds is seen as a generally reliable market barometer of overall high yield market liquidity trends - although they comprise considerably less of the total monies floating around the high yield universe than they used to - because there is no reporting mechanism to track the movements of other, larger sources of junk market cash seen in recent years such as insurance companies, pension funds and hedge funds.

Market barometers mixed

The widely followed CDX index of junk bond performance, after easing ½ point on Wednesday, rose 1½ points on Thursday, a trader said, quoting it at 90½ bid, 903/4, although the KDP High Yield Daily Index fell by 23 basis points to end at 67.81, as its yield rose 7 bps to 11.35%.

In the broader market, advancing issues trailed decliners by a not-quite two-to-one margin. Activity, represented by dollar volume, jumped by 57% from the levels seen on Wednesday.

"What a difference a day makes," remarked a trader, who noted the vast change in sentiment among the junk players in line with the big stock market comeback late in the session.

Another trader described the session as "exhausting." He added "I can't wait till Friday - I'm glad it's actually finally here. You turn around and you're down 200 on the Dow, turn around and you're up 200 on the Dow. It's just very numbing."

He said that in the morning "things were better bid for, obviously, with all the liquidity news, and we continued to see some better selling into strength. But today was actually the first day in about a week in which the bids were living after trades. Up until now, it's been like 'bid hit, leaves offered, bid's down 2 points.' Today, it was 'bid hit, next bid's a quarter-point down, but good for 3 to 5.'"

He said that "things were definitely holding in a lot better than we've seen in the past [week]," even though "accounts were still looking to lighten up."

When the Dow dropped about 150 points around mid-day, as the initial optimism following the big central-bank liquidity injections faded and was replaced by renewed uncertainty about whether those measures would do the trick in calming market fears, "some of the bids got a little shaky - but you didn't see the rush to unload that we'd seen in previous days."

That having been said, he noted that when stocks again turned north later in the day and ended with the Dow up 400 points and other indexes up as well on news reports that Treasury secretary Henry Paulson was considering setting up a government entity to sop up the toxic loans bedeviling the banks, the way the Resolution Trust Corp. was used to overcome the savings-and-loan crisis in the 1980s, "I don't think our positive tone at the end of the day was equivalent to a 400-point run up." He said that he didn't know whether it was because "people just don't believe it's real, or they're waiting for the next down-trade tomorrow, or if offerings were just pulled and there was nothing there to lift, which didn't allow the market to get to where it should be."

All eyes on distressed

Consistent with color imparted on Tuesday by an investment banker, a money manager whose portfolio includes stocks as well as high-yield bonds said on Thursday that most of the activity now taking place in the secondary market is focused on the distressed sector.

"You see names like Charter [Communications, Inc.] down 5 points a day, for several days," the money manager said, adding that lately Freescale Semiconductor, Inc. has "really caved in."

"That's all hedge fund trading," the investor said, "trading the tape, or reacting to what is going on in the equity market, when there is no news.

"And you're seeing much more selling. Just as you're seeing hedge funds having to liquidate on the equity side, you're seeing the same thing on the high-yield side, with structured products and the lower-tier names where they operated."

This source also sees the hedge funds and structured products entities at play in the volatile financials, in names such as AIG and Morgan Stanley.

"If you look at Trace for AIG, over the past couple of days, any particular bond had a low price of 40 and a high price of 80," the investor said, adding that hedge funds may be counted upon to show up when there are markets as wide as that.

More profitable dealers

The money manager also asserted that the present wave of consolidation among the dealers - the marquee moves being Bank of America's acquisition of Merrill Lynch & Co., and Barclays Capital's planned acquisition of the investment banking business of Lehman Brothers Holdings Inc. - is well suited to present circumstances.

"If, as expected, a lot of hedge funds close their doors, you're going to have a lot less secondary trading in the high yield," the investor said.

"That's because well over half the trading in the high-yield market is really done by hedge funds," the source asserted.

"As you reduce the number of hedge funds, and thereby reduce that volume of trading activity, it's very helpful to have the dealer base consolidated because the remaining dealers will be a little more profitable."

Debt plan buoys financials

Reports of the RTC-like plan - an idea which has been endorsed by, among others, former Federal Reserve chairman Paul Volcker - gave the bonds of faltering financials companies some new zing, in line with a rebound in most of their share prices.

A junk trader said that once again, Lehman Brothers' newly junked bonds were the most actively traded issues in high yield.

He saw Lehman's 6 7/8% notes due 2018 "actually improve as the day went on," after trading as low as 12, ending with a round-lot level of 16, not too far off from Wednesday's round-lot finish at 17, on $81 million of the bonds traded.

Another market source - taking into account all of the trades in the issue rather than just the big-blocks - noted some wild gyrations that took the bonds as high as par - a phenomenon seen with several Lehman issues - and as low as 12 and change, before they finally closed out the day just above 17, which the source saw as up slightly on the session.

That source also saw the bankrupt investment bank's 5 5/8% notes due 2013 jumping around wildly like the 6 7/8s did before finally ending up nearly 2 points at just over 19 on busy trading of $58 million bonds.

However, the first trader, looking only at the round-lot deals, saw the bonds going home at 14.5 - admittedly up from its lows around 12, but still off from Wednesday's close at 17.

Lehman's subordinated bonds, like its 6½% notes due 2017 moved up to 1 - double their closing fractional level Wednesday.

WaMu, Morgan Stanley better

A trader saw Washington Mutual's 4% notes due 2009 gain 7 points on the session to end at 55 bid, 59 offered, helped by both the idea of an RTC-like solution to the bad-debt problem and the possibility that the struggling Seattle-based thrift might find a deeper-pocketed partner. WaMu's 5.65% notes due 2014 did even better, seen up more than 12 points at the 44 level.

Among the still nominally investment-grade issues that have been trading around the junk precincts over the past few days, Morgan Stanley's bonds were seen better. Besides the news reports of the New York-based investment bank's talks with Charlotte, N.C.-based commercial bank Wachovia Corp., other reports said that Morgan Stanley chief John Mack was pursuing other avenues as well, including putting out feelers to large global banks such as HSBC, and was sounding out China's investment arm about possibly upping its current 9% stake in the Wall Streeter.

A trader saw Morgan Stanley's 3 7/8% notes due 2009 having moved up to a round-lot close at 84 - he noted the 65% yield - well up from 76.5 previously. He also saw the company's 5.30% notes due 2013 enjoy "a nice pop" up to a round-lot close of 68, versus 59 on Wednesday, with $63 million of the bonds being bought and sold.

However, he saw the company's busiest issue, the 6 5/8% notes due 2018, with $246 million traded, ending lower at 70 bid, down from 71.5

Another source saw those same bonds actually 7 points lower, ending at 68, but saw the 5.30s going out 13 points better on the day at 67.

And a trader saw AIG's 5 3/8% notes due 2009 at a last round-lot price of 62, up nearly a point from Wednesday, while its 5.05% notes due 2015 rose to 46.5 bid from 42 the day before.

He saw the insurance giant's International Lease Finance Corp. aircraft leasing unit's 6 3/8% notes due 2009 rise to 87 from prior levels at 85.5.

Rest of junk world mostly steady

With all of the attention being focused on the fallen-angel financials, a trader said, "traditional high-yield names came in pretty much unchanged to maybe a quarter-point better." He said a lot of issues "hovered right around that unchanged [level], up or down a point at different points of the day, when the equities were whipping around."

Overall, "a lot of the real show was over in the finance sector," particularly AIG and Morgan Stanley. He noted that those badly beaten down credits are trading off some high yield or even distressed-debt desks, despite their nominally investment-grade ratings, but his was not among them - yet.

Among traditional high-yield credits, "in gaming the usual suspects were out there - MGM [Mirage] and whatnot, which opened up unchanged and finished a little better maybe half a point or a point. Other than that, you had the usual Freescales of the world, but even that was very much market-driven - it was almost like the whole tide going up or down. Very few news events were pushing anything one way or another."

Rouse lower

An exception to that rule was Rouse Co.'s 8% notes due 2009, which "got beat up pretty good."

He noted that the Columbia, Md.-based commercial and industrial real estate investment trust's corporate parent, General Growth Properties Inc., saw its NYSE-traded shares fall "a couple of bucks," amounting to fully one-third of their value - although they later recovered and only ended down 2% on the day, helped by the a conference call explaining that the company had obtained additional mortgage facility funding.

The bonds were offered at 97.5, with no bid, down "at least 1½ points, and it probably could be 2 [points] or more.

"For 2009 paper, that was a pretty big move, [especially] for a BB credit."

Of course, he said, "I guess you can throw all of those rules out the window with Lehman - a single-A credit going straight to D. We're in a whole new world here - it feels like its 2001 all over again. I feel like I'm [again] talking to you about WorldCom - the last time I saw moves like this."

GM joyrides - but not GMAC

Elsewhere, a trader saw General Motors's benchmark 8 3/8% bonds due 2033 up 1 point at 50 bid, 51 offered, while Ford Motor's 7.45% bonds due 2031 were also a point better at 51 bid, 52 offered.

Another trader saw the GM long bonds up 2½ points on a round-lot basis at 52.5, with $39 million bonds traded. The Ford long bonds, he said, were "very active," with $31 million changing hands at 52, up from 50.5 on Wednesday.

Among the shorter automotive issues, he said that GM's 7.20% notes due 2011 were also "very active," with $30 million traded. The trader pegged those bonds 1¾ points higher at 69.75.

A market source saw GM's 7 1/8% notes due 2013 up 1½ points on the day to just under 61 bid, while its 8¼% bonds due 2023 were 2½ points better at 49.5.

But while GM and Ford were cruising higher, their respective financing subsidiaries were spinning their wheels. A trader saw GMAC LLC's 8% bonds due 2031 lower at 49.75 versus 50.5 on Wednesday, on volume of $12 million. GMAC's 6 7/8% notes due 2012 were down more than 4 points at around the 52 area, while its 6 7/8% notes due 2011 dropped more than 5 points to 55. Ford's auto-loan arm, Ford Motor Credit Co., saw its 7% notes due 2013 lose 4 points to close just under 70.

Finlay Jewelry not such a gem

A trader said that Finlay Fine Jewelry Corp.'s 8 3/8% notes due 2012 had been "quoted in the mid-20s the last couple of days," but "it is lower" now. He saw "a real odd-lot market" at 16 bid, 20 offered, "down a couple of points" and "considerably" down from levels in the 30s that the bonds held a week ago. He said it was "only on a small piece" - but added that that particular name "always traded in bits and scraps, from what I remember."

A second trader saw the bonds having finished at 19 on Wednesday, which he called down 18½ points than where they had been trading for a while, and down at least 10 points from levels around 30-32 at which they had traded just two days earlier.

He saw no news on the New York-based jewelry marketing company, which runs leased jewelry counters in a number of well-known department stores, but suggested that "hedge funds shorting weak credits" might be a factor in the fall.

Another trader saw the bonds at 19 bid, 21 offered, which he said was unchanged on the day, although he noted they had fallen 7 points on Wednesday. He saw no news out on them but said they were 'just down with the market" on Wednesday.

Nothing doing with Nortel

A trader saw Nortel Networks Corp.'s 10¾% notes due 2016 - which had plunged a dozen points on Wednesday after a warning the Toronto-based telecommunications equipment manufacturer would have lower-than-previously expected sales for the third quarter and the year - were unchanged at 75 bid, 77 offered.

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