AIG news dominates as deadline looms, Goldman, Morgan Stanley give earnings; plunging AIG dominates trading

By Andrea Heisinger and Paul Deckelman

New York, Sept. 16 - The demise of Lehman Brothers was fresh on everyone's minds in the investment-grade primary Tuesday as worries grew that American International Group Inc.'s downfall began to look inevitable.

By the time the market closed, there was news that that may not happen, with a possible Federal Reserve loan on the table.

"If nothing is announced tonight, they [AIG] are going to have to find funding by tomorrow morning," a source said, referring to the deadline the insurance company has, "which they don't have."

Lehman continued its liquidation, with Barclays agreeing to buy the so-called good half of the failed investment bank, or its capital markets business in the United States.

Topping off the day's news were third-quarter earnings announcements from Goldman Sachs and Morgan Stanley, both of which seemed optimistic in an otherwise negative environment.

In the investment-grade secondary market Tuesday, advancing issues trailed decliners by a ratio of almost two to one, while overall market activity, reflected in dollar volumes, fell 20% from Monday's pace.

Spreads in general were seen tighter, in line with generally higher Treasury yields; for instance, the yield on the benchmark 10-year issue rose by 7 basis points to 3.46%.

The debt of troubled American International Group Inc. and of such AIG subsidiaries as American General Finance Corp. and International Lease Finance Corp. dominated the secondary sphere. The debt of all three were seen sharply lower, and was being widely quoted on a dollar-price basis despite its still nominally investment-grade ratings, traders said, with spreads on most issues seen well over the 1,000 bps demarcation point denoting distressed debt.

There was also a fair amount of attention paid to the two remaining major investment banks, Goldman Sachs and Morgan Stanley, with each reporting quarterly earnings. But while Goldman showed a sharp fall off in profits, Morgan Stanley was one of the few bright spots on the market, with better-than-expected numbers. Even so, the bonds of both were seen trading at almost junk-like yield levels.

AIG news dominates

There were many bits of news floating around Tuesday which in normal conditions would have been the center of attention.

This was not the case as the drama of AIG continued to unfold a day after Lehman filed for bankruptcy and the stock markets saw their biggest fall since the first trading day after Sept. 11, 2001.

By Monday night, when both Moody's and Standard & Poor's downgraded AIG, it was unclear who exactly would bail the company out.

"People are still digesting and preparing for what they hear next," a source said of the tone Tuesday.

The end of Monday saw news that the Fed had asked Goldman Sachs and JPMorgan Chase to put together $70 billion in loans for AIG, refusing to loan the money itself.

After the ratings downgrades, it seemed an unlikely risk for the investment banks to get involved. This left the Fed.

"Everyone's just hoping for some resolution," a source said as he monitored headlines late Tuesday. "People are being constructive about things."

It seemed a general consensus that the Fed would have to intervene to stave off the second bankruptcy filing by a major financial institution in three days.

By about 6 p.m. ET, headlines were reporting that the Fed was looking to provide the $75 billion bailout loan itself, after initially saying it would not get involved.

This comes a little more than a week after government took over mortgage companies Fannie Mae and Freddie Mac after a severe financial crisis.

The Fed opted to stay out of saving Lehman over the weekend after the investment bank failed to find a buyer.

Barclays buys Lehman unit

Meanwhile Barclays agreed to buy a part of Lehman Brothers.

After backing off buying all of the failing Lehman over the weekend, the British bank was again approached and agreed to buy its capital markets business in the United States.

A market source said this was only a note on the day, as most people were focused on who would save AIG.

Fed leaves rate alone

The Fed met Tuesday and decided to leave its benchmark rate unchanged, citing inflation and financial weakness among its reasons. The rate remains at 2%.

Some had expected a 25 basis points rate cut, while others were not surprised to see no action.

When asked what effect this had on the investment-grade primary, a source said "It's tough to say."

"People had expected a 25 bps cut, but oil is down and manufacturing is stronger."

He added that nearly everyone was more focused on the AIG outcome.

"It's hard to say how helpful a rate cut would be," he said, "or how much liquidity it would pump into the market."

Goldman, Morgan Stanley announce earnings

Another footnote on the day was third-quarter earnings announcements from Goldman Sachs and Morgan Stanley.

Both provided a relatively bright spot on an otherwise bleak day, as their earnings beat expectations.

Goldman announced a profit of $845 million for the quarter, a drop of 70% from a year ago.

Morgan Stanley saw its profit drop 7% from a year ago, but still beat expectations.

The bank earned $1.43 billion for the fiscal quarter.

"The Morgan Stanley news was good," a market source said. "People are looking at it as not all of the news out there is bad."

Market looks ahead

As negative headlines continued to pour out, the investment-grade market is looking ahead to when some normalcy returns.

"I think the sectors are more defensive," a source said of companies potentially looking at the bond market.

"They need a couple of days with no humongous headlines."

It will be a slow and cautious road to that point. No one is expecting any issuers this week, with the last day of solid issuance being Sept. 9.

A large backlog exists, and it will take some time and confidence for all of it to come out.

"People are looking at it [the market] and they are very cautious," a source said. "Everyone wants one or two deals to see how things go. It's a question of who wants to be first."

With the AIG resolution likely not fully worked out until Wednesday, it is assumed that next week could provide the first window of issuance.

"I can't imagine anyone jumping in this week," a source said. "People should be talking to issuers though, and getting them ready to issue."

By the end of the day Tuesday, as the flow of headlines continued, there were some hints of optimism.

"It was as good as the day could have looked," a market source said.

AIG angst roils market

The renewed beating which its New York Stock Exchange-traded shares took on Tuesday - they plunged as much as 73% at one point before finishing down $1.01, or 21.22% at $3.75 on incredible volume of 1.225 billion shares, some 20 times the norm, reflecting market concern over the insurance giant's increasingly perilous situation - was mirrored in the continued slide in its bonds, which for the moment are nominally still investment-grade instruments, but trading at badly distressed levels.

AIG's most active issue with over $200 million changing hands, its 5.85% notes due 2018 - which on Monday had tumbled about 20 points into the lower 50s - opened at 38 bid, a market source said, and then proceeded from there to gyrate wildly at mostly lower levels. The bonds swung from an early low point around 21 to as high as 66 later, where there were several big-block trades in a failed attempt to stabilize the price, and then cascaded back down into the 20s before finishing around the mid-30s.

A trader looking only at round-lot transactions as representative saw the bonds go as low as 35 before coming back to finish at 44.75 bid - still well below a closing price Monday of 57.

He saw insurer's 6 3/8% notes coming due in March get as low as 61 before closing at 65 - still well down from Monday's close at 79.625.

He said that over $100 million of the 5 3/8% notes due 2012 had been traded, with round-lot levels gyrating between 33 and 45 before finishing at 35, down from 67 on Friday.

Another trader, pointed out that AIG "did recover at the end of the day, at least a little bit," helped by news reports indicating that New York State and City officials and executives of other financial firms having exposure to AIG - which is most of them - had prevailed upon the Fed to at least take a second look at the idea of providing AIG a bridge loan that would buy the troubled Manhattan-based insurance behemoth some time to get its financial house in order. The Fed had initially nixed such a loan, instead urging AIG to borrow from a consortium of banks, but by Tuesday night, well after trading had folded up for the day, there were news reports indicating that the Fed would extend that life line. Some of the reports said that officials were thinking of putting AIG under a conservatorship, not unlike what the government did earlier in the month with troubled Freddie Mac and Fannie Mae.

Those signs that one way or another, AIG would not be permitted to slide into bankruptcy like Lehman - being considerably more important in the overall scheme of things than Lehman was - helped cut the shares' big losses down to a more manageable size and brought the bonds back from their day's lows.

The trader said that the company's 5.45% notes due 2017 had been trading near the low 30s earlier in the day, "if they were even that good," but had risen to 42 bid, 44 offered, "and I think most of the paper went out like that.

"The sub debt was down in the low 30s and it recovered by the end of the day to being in the low-to-mid-40s, depending on the issue, and by mid-40s, I mean maybe 45, not above that level." Even with the bounce off the lows, the AIG paper was "definitely down."

American General, International Lease sink

Among the AIG subsidiaries, American General Finance's 5.375% notes were seen by a market source to have fallen 14 points, ending at around 27 bid, while its 4.875% notes due 2010 were down 13 points, also to the 27 level.

The bonds of ILFC - considered one of the most valuable and profitable of AIG's properties and likely to fetch a handsome premium should it be put up for sale - were nonetheless seen sharply lower Tuesday along with the rest of the AIG capital structure.

Its 5.625% notes due 2010, which had finished at around 90 bid on Monday, lost fully half their value in intraday action, nosediving down to below 45 bid, before finally bouncing off those lows to end at 70, still down 20 points on the day in heavy trading of over $40 million.

The aircraft leasing unit's 3.50% notes due 2009 also dropped well down into the 40s but came back up to finish at 79, down about 9 points.

But its 6.375% notes due 2009 had the wildest gyrations of all, plummeting all the way down to the around the 30 level before finally coming back to end around 60, down nearly 20 points on the session.

Morgan Stanley, Goldman yields rise

A trader said that "not that Morgan Stanley was trading that fantastically to begin with, but we knew that Morgan Stanley and Goldman would be 'toss it on the pile' kind of names."

The trader saw a piece of three-year Morgan Stanley paper being offered at 81 - "for a piece of Morgan Stanley paper at almost a 16% yield," repeating incredulously "for a three-year piece of paper!"

With that kind of yield for a piece of paper issued by a well-regarded company like Morgan Stanley, the trader asked rhetorically, why even bother with regular junk bonds, supposedly high-yielding instruments? The catch, of course, is that "the problem [with this sector] is that you don't know. We don't know what's in there? What do they have? What are [any financial firm executives] not telling us? You just don't know any more. The whole sector is a little scary at this point."

The trader saw "a lot of bid lists out on Goldman to start the day." One issue which seemed to stand out was the Goldman 6.65% notes due May 2009, which traded in a 96-97 neighborhood, "on either side of 13% [yield]."

The Goldman 5.95% due 2018 saw turnover of $5 million at a bid yield of 8.49%, an offered yield of 8.36%, "either side of +500 [bps] - and that's pretty good, compared to their peers."

The trader said that Wachovia Corp. paper "has been depressing for a while. It seemed like Goldman and Morgan Stanley were just joining the party today - but Wachovia has been having issues for a while."

The trader said that the North Carolina bank's 3.625% due February 2009 were trading at a dollar price of 92-92.5, "and that's a 25% yield. So if they make it [past the current financial crunch], fantastic - but if they don't - oh, my."

Wachovia's 5.60% notes due 2016 were being offered at 71, which translates to an 11.50% yield, while its 5¾% notes due 2018 "traded on pretty decent size" in a dollar-price range of 66-68, the trader said, for a yield of 11.875% down to 11.375%..

Financial CDS costs widen out

In the credit-default swaps market, debt-protection costs of investment-bank paper widened out sharply amidst the continuing turmoil gripping the financial sphere.

Merrill Lynch's debt-protection costs - now sharply lower since it is to be bought by Bank of America - still widened out to 470 bps bid. 500 bps offered from 315 bps bid, 355 bps offered on Monday.

Morgan Stanley's CDS cost ballooned out to 765 bps bid, 795 bps offered from 450 bps bid, 470 bps offered on Monday. Goldman's CDS cost also widened out to 460 bps bid, 490 bps offered.

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