Primary activity halts as market watches Lehman; Lehman, WaMu down again in trading

By Andrea Heisinger and Paul Deckelman

New York, Sept. 11 - News from Lehman Brothers Holdings Inc. continued to weigh on the investment-grade primary market Thursday as companies opted to wait out the negative market conditions.

"It's looking like no one's going to do any [new issues] until next week," a source said.

Some in the market have commented during the last couple of days that it would be irresponsible to advise a company to issue in the current conditions.

In the investment-grade secondary market Thursday, advancing issues continued to trail decliners by a ratio of seven to six, while overall market activity, reflected in dollar volumes was up 19% from Wednesday's pace.

Spreads in general were seen little changed, in line with generally steady Treasury yields; for instance, the yield on the benchmark 10-year issue remained at 3.63%.

For yet another day, Lehman Brothers' bonds remained the most actively traded issues, deteriorating badly in line with a sharp slide in the troubled investment bank's shares as market sentiment rose that Lehman would have to be rescued from its current financial jam by a larger, more-stable institution. Its officials were reported to be in talks on a potential sale with their counterparts from other large financial players, with Bank of America Corp. being the most oft-mentioned name.

Troubled Washington Mutual Inc.'s bonds also remained on the slide, especially as it announced intentions to up its loan-loss provisions - and Moody's Investors Service dropping its senior unsecured ratings two notches to junk status.

With the troubles of Lehman and WaMu the major focus in the secondary market, not much else was seen going on, although Aetna Inc.'s new bond issue was seen hanging in at the sharply better levels to which those bonds had moved following their Tuesday pricing.

Lehman sale increasingly possible

By the market close Thursday, media reports said Lehman Brothers was in talks with at least one major bank, Bank of America, for a possible sale, leaving those in the primary market glued to TV and the internet.

One source said that the news developed about the time the market closed, and that he and almost everyone else was closely monitoring the Wall Street Journal site and other sources for the latest developments.

The news was already having an effect, he said, with both Lehman and Bank of America's stock "surging up."

Until this news broke, the market was quiet with nothing in the way of new issues to watch.

"It was a pretty uneventful day," a source said. "The story about Lehman developed throughout the day, and that was about all [that was] going on."

"It was literally within the last half hour that this all came out," the source said about a half hour after the market close.

The primary has been sensitive to negative headlines in recent months and even more so in the last couple of weeks. Fannie Mae and Freddie Mac's rescue by the Treasury Department, and the threat of Lehman's demise were the major downers for the investment-grade primary.

"There's been the usual craziness over the negative headlines," a source said of the market tone Thursday.

Adding to the negativity, although to a far lesser degree, were the continued headlines of Washington Mutual's difficulties and the fall of its stock price.

Companies and traders "take those things into perspective," a source said, adding that it was overshadowed by the Lehman news.

What Friday will bring is up in the air.

"It's really hard to say at this point," a source said. "At the market close, people were viewing the B of A news as good news."

Forward calendar eyed

The week has not turned out as some had expected.

On Tuesday, after the Fannie and Freddie news had time to settle, the view was that volume would pick up.

"We thought it would get busy, and it did for a day," a source said. "You had Halliburton and Aetna come in and get deals done."

Then the negative news from Lehman and Washington Mutual began to intensify and issuers shied away from the market.

"There was a real full calendar coming in, market wise," a source said of the post-Labor Day volume.

"There was expected to be $80 [billion] to $100 billion [in September]. That was the market talk for the month."

Although some activity has materialized, it hasn't been nearly as much as anticipated.

"The market is poised for a meaningful supply calendar, but that hasn't been able to happen," a source said.

A potential resolution to the Lehman troubles, either on Friday or over the weekend, could boost volume in the second half of the month but will not relieve the market of its backlog that has been building in recent weeks, sources said.

"I don't think people were expecting all of this negativity at once," a market source said.

The tone may even improve enough by Friday's open for a couple of issues to sneak in yet this week, depending on what happens tonight, a source said.

"It's really hard to guess what's going to happen," he said. "It's all talk and speculation at this point."

Lehman still leading object of interest

A trader said that Lehman Brothers bonds were again sharply wider, in line with yet another disastrous fall in the investment bank's shares.

"Lehman dominated it," he declared. "The senior paper is what people focused on the most." He noted that some of the issues were trading around 8 to 10 points lower on a dollar-price basis - many of the Lehman issues now trade at well above 1,000 bps off comparable Treasuries, the typical mark of a distressed issue and are being quoted on a dollar-price basis at various desks - but said that "we'll see what happens with the rumors about Bank of America and other people looking at them."

A market source saw Lehman's 6.50% notes due 2017 trading at a spread over Treasuries of 850 bps - well out from the 601 bps at which those bonds were trading at on Wednesday. They had widened out from 499 bps on Tuesday and out further still from the 457 bps at which they had traded on Friday.

The source also quoted the actively traded 6.875% notes due 2018 at 636 bps over, versus 510 bps on Wednesday.

Easily the busiest issue, with over $100 million of paper changing hands, was the 5 5/8% notes due 2013, which was seen swinging wildly between a high around 86 and a low just under 71, before finally settling in at the 78 bid level.

A number of other Lehman bonds easily traded up in the tens of millions of dollars, volume-wise, with a trader seeing the 6 7/8s "really active" - well over $60 million - finishing the session at a final round-lot trade of 81, well down from its end Wednesday at 88. That spread was 636 bps.

Also in big-block trading, he saw the company's 5½% notes due 2016 at 74 bid, or about 700 bps over, a 10 point fall from late Wednesday, while its 5¼% notes due 2012 swooned to 78 from late levels Wednesday near 87. The spread ballooned out to over 1,100 bps Thursday.

A market source said that the Lehman bonds began cascading downward in line with a steep fall in its New York Stock Exchange-traded shares, as equity and debt investors expressed their disappointment with the package of "key strategic initiatives" to cut risk and generate cash which the company had hoped would calm market nerves inflamed anew by the nearly $4 billion second-quarter loss reported on Wednesday morning. It didn't, with analysts and commentators noting that the measures - including the sale of some British mortgages, the spin off of commercial real estate assets and the sale of a majority stake in Lehman's asset management business - were not definite, and there was no solid commitment by anyone to buy anything or make any kind of sizable investment in Lehman.

Analyst Kathleen Shanley of the Gimme Credit investment research service derided Lehman's much-touted strategic plans on Thursday as not being ready "for even an off-Broadway run. In particular, the proposed spin-off of $25 to $30 billion of commercial real estate assets won't close before the first quarter of next year, which Lehman is still exposed to losses on the portfolio."

Moody's Investors Service also starkly laid it on the line, saying Lehman's financial flexibility "has become more limited as its stock price has fallen to near all-time lows and the firm is experiencing a crisis of confidence. Although Moody's believes liquidity remains firm and has not shown signs of material erosion, the potential for rapid franchise impairment in this environment remains a significant rating concern."

It noted that while the sharp reduction in market confidence had led Lehman's management to consider all strategic alternatives - even including the possible sale of the firm - Moody's said the heightened level of market stress on Lehman has increased pressure on the firm to consider this latter option, warning that if a strategic transaction with a stronger financial partner were not to materialize in the near term, Moody's would have no choice but to downgrade the ratings, kicking them down to the Baa level.

In the credit-default swaps market, the cost of protecting Lehman debt initially jumped out to 790 bps over, a 210 bps widening from Wednesday, but then pulled back to about 650 bps. By late in the day - spurred on by the possibility that the company could be sold to a more financially stable buyer who would redeem, assume or guarantee Lehman's debt, the CDS costs had shrank further to about 500 bps, a market source said.

Lehman's shares - which on Tuesday had plunged nearly 45%, and which had then failed to rebound on Wednesday after the release of its strategic plan, gyrating around and ending moderately lower - resumed their nosedive on Thursday as different analysts weighed in on its plan as being a case of 'too little-too late." By day's end, that stock had collapsed by another $3.03, or 41.79% to end at $4.27, on volume of 471 million shares, over seven times the norm. The stock was trading down another 9% in after-hours trading on Thursday night.

During the session various reports popped up indicating that Lehman had taken the market criticism to heart, and would look to sell the firm. Lehman executives were reported to be in talks with representatives from several large banks on a possible sale; one name being bandied about was Number-Two U.S. lender Bank of America Corp., although there was no immediate confirmation by any of the parties involved. The Financial Times late Thursday also mentioned banking giants Barclays of the United Kingdom and Nomura of Japan as potential buyers, although this speculation was also unconfirmed.

The Wall Street Journal said late Thursday that the Federal Reserve and the Treasury Department "have been working with Lehman to help resolve the bank's troubles, including talking to potential buyers." While the Journal said that although prospective buyers "would likely want the U.S. government to help shield them from future losses from any such transaction," as happened in March, when J.P. Morgan Chase & Co. absorbed the faltering Bear Stearns Cos. and Washington agreed to absorb as much as $29 billion in potential losses, the paper said that the feds - sensitive to the political implications of another such move just two months before the elections - are not expected to structure any Lehman bailout along the lines of the Bear transaction or this past weekend's direct governmental rescue of mortgage giants Fannie Mae and Freddie Mac.

WaMu also watched - but not as much

The first trader said that apart from Lehman Brothers, "the other ones being talked about were WaMu - but it still just paled in comparison."

A trader quoted its 7¼% notes due 2017 as having been beaten down to 25 bid 30 offered, which he called a loss of 15 points on the day.

WaMu finally officially fell to junk status at Moody's late in the day, as the ratings service lowered the company's senior unsecured debt rating two notches to Ba2, from Baa3 previously, with a negative outlook.

That followed WaMu's announcement that it would increase its reserves for bad loans by $4.5 billion, although the company said it has sufficient capital.

Moody's said the downgrade resulted from WaMu's "reduced financial flexibility, deteriorating asset quality, and expected franchise erosion as the bank continues to face adverse performance across its asset base. Its ability to deal with this issue is constrained by prospective earnings that are inadequate to restore or attract capital. This has complicated WaMu's ability to access external capital. Further, as a result, its funding sources have become more concentrated."

Moody's vice president and senior credit officer Craig Emrick said that WaMu's limited financial flexibility "makes it more difficult for it to replenish capital and preserve diversified and stable funding sources. Both issues are critical to restoring the strength of the institution."

Moody's also expects WaMu to report future quarters of large losses. "This could exacerbate negative market sentiment and lead to franchise impairment," the ratings agency warned.

WaMu debt remains for the moment at a BBB level at both Standard & Poor's and Fitch Ratings

New Aetnas hang in

Apart from those twin financial disasters, a trader saw the new Aetna 6.50% notes due 2018 as remaining at a spread of about 277 or 278 bps over, unchanged from Wednesday but in from the initial secondary levels of 290 bps bid, 285 bps offered at which the bonds traded on Tuesday, and well in from the 295 bps level at which the upsized $500 million issue had priced earlier Tuesday.

In the CDS market, a trader saw brokerage paper debt-protection costs anywhere from 25 bps to 85 bps wider, while big-bank CDS costs were about 7 bps out.

However, he saw WaMu's debt-protection costs "off the charts" at an up-front level of 40% to 43%, out from the mid-30s on Wednesday, plus 500 bps annually.

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