Sagging stocks, short session still junk market

By Paul Deckelman and Paul A. Harris

New York, Nov. 8 - A shortened trading session that essentially was over almost as soon as it had begun, and an easier stock market where weak corporate earnings remain the main focus combined Friday to mostly freeze the high-yield market in its tracks.

At the recommendation of The Bond Market Association, junk desks officially called it a day at 2 p.m. ET ahead of Monday's Veterans' Day holiday, when the debt markets would be completely closed. But the reality was that long before that official deadline, whatever little trading was to be done, had been.

The paucity of real trades, or traders (some shops operated with skeleton crews), produced little in the way of market reaction to the news that high-yield mutual funds, considered a key barometer of overall junk world liquidity trends, had received a whopping $1.104 billion of new money in the week ended Wednesday, according to statistics released after Thursday's close by AMG Data Services of Arcata, Calif.

It was the fourth straight week in which more money had flowed into the funds than left them - a good omen for both a pickup in high yield new issuance and for a continuation of recent secondary market strength, with fund portfolio managers (and, by extension, other large investors as well) now flush with cash and looking for some place to put all of it. A Prospect News analysis of the AMG figures shows a cumulative net inflow of $2.41 billion over the last four weeks; the cumulative net inflow on a year-to-date basis - counting only those funds that report weekly and excluding distributions - is $5.784 billion, the highest it's been all year.

Even though Friday's was a relatively quiet session, it gave primary market desks plenty to talk about.

Ali Balali, senior high yield strategist for Banc of America Securities, told Prospect News on Friday that this latest inflow is solid evidence that the buy-side has cash to put to work - especially on repeat issuers with credit stories that are familiar to investors.

As examples Balali pointed to a pair of deals that priced during the week of Nov. 11: Owens-Brockway Glass Container Inc.'s upsized $450 million of 10-year senior secured notes (B2/BB) that priced Nov. 5 to yield 8¾%, at the tight end of price talk of 8¾%-8 7/8%, and Chesapeake Energy Corp.'s $50 million add-on to its 9% senior notes due Aug. 15, 2012 (B1/B+) that priced at 104.25 on Nov. 6 for a yield to maturity of 8.531%.

"I think these repeat issuers are being told that by their high-yield capital markets bankers that people have money to put to work," Balali said.

He added that as of Friday morning the market was up 2.5% for the week of Nov. 11, and was "up tremendously since Oct. 10."

War worries and volatility in the equity markets remain concerns, Balali added.

"The junk bond market has to a great extent been linked to the performance of the equity market, and the correlation between the volatility in the equity markets and the performance of our market has picked up quite significantly in 2002," he said.

"I'm sure there is going to be some nervousness about war with Iraq," the strategist added. "But it depends what happens to the outlook for economic performance. High yield companies are levered. They need to service their debt. If suddenly war pushes us into a recession it's not going to be good."

Another sell-side source who spoke Friday with Prospect News also said that high yield appears poised to open strong at the beginning of 2003, but that war is an X-factor. A short war with a positive outcome for the U.S. could ignite a formidable rally in equities - and the junk bond market would be surfing in the wake. A protracted conflict, complete with the kind of grisly news of a kind that is almost completely unknown to an entire generation of Americans, would be another matter entirely, the source said.

"It has become pretty apparent over the past four weeks that the accounts have cash," this source said with regard to the above-mentioned inflows.

"You still will need a little bit more oomph in the market though," the source added. "Nobody in the market is jumping up and down to bring a B3/B- deal right now. While you may be able to get it done it will probably come at an egregious level where you're hamstringing the company.

"And really you're only six weeks away from the turn of the year, in terms of business weeks: Thanksgiving week is a non-event and the weeks before and after Christmas are non-events. In my opinion the high-yield primary market is going to be substantially better on Jan. 2 than it is today, barring a major catastrophe."

But the good news in the fund flow numbers went essentially unnoticed as far as price action was concerned, with no one around to trade on it. Ironically, much the same thing had occurred on Friday, Aug. 30 - a huge inflow number ($1.556 billion) but virtually no one around to react to it due to abbreviated session ahead of a Monday holiday, in that case Labor Day.

"There was a $1.1 billion inflow - and that about sums up the whole week," a trader quipped Friday, astonished and amused that anyone would even be asking whether anything would actually be happening on such a day.

"Beyond that - I didn't see [anything] happening today. We sat here, and just talked about what we were going to do with our weekends."

About the biggest trading story in the corporate bond world Friday was happening just over the fence that separates high yield from high grade, with troubled Tenet Healthcare Corp.'s bonds and shares tumbling badly in the wake of the sudden departure of two key executives from the Santa Barbara, Calif.-based hospital company - and its chief executive admitting that the company's Medicare pricing policies may have been too "aggressive," although not illegal.

Against a backdrop of federal auditors looking over the second-largest U.S. hospital operator's claims for Medicare outlier payments - that is, payments which Medicare makes for patients whose care costs far more than the average - Tenet had announced on Thursday afternoon that 17-year company veteran Thomas Mackey, the chief operating officer since 1999, had retired, while David Dennis, Tenet's chief financial officer since 2000, had resigned.

Tenet shares swooned $13.05, or 46.69% Friday, to close at $14.90. New York Stock Exchange volume of 115 million shares was more than 17 times usual daily turnover.

On the debt side, Tenet's bonds - which had actually been junk-rated until last year, when the company was doing well enough to merit an upgrade to investment grade by the major agencies - teetered precariously on the fence after the latest events, in danger of ignominiously returning to their former lowly status. Standard & Poor's lowered ratings on Tenet's $3.6 billion of unsecured debt a notch to BBB- late Thursday - the last stop before a return to junk (Moody's currently rates the bonds at an almost-junk Baa3). S&P also put the debt on CreditWatch with negative implications, meaning a further downgrade - back to junk - is possible.

The ratings agency warned that its moves reflect "the substantial, but currently unquantifiable, impact on the company's earnings and cash flow from:

-- A probable future reduction in Medicare outlier payments,

-- Potential costs relating to alleged physician misconduct at one of its hospitals,

-- Damage to Tenet's reputation from these issues,

-- Management changes, and

-- Litigation relating to the unfolding events."

S&P further cautioned that "recent disclosure of excessive revenues derived from Medicare's outlier payments is accompanied by the likelihood that potential actions to bring these payment levels more in line with industry averages will have a significant effect on profitability."

Recent well-publicized problems at the company - including a raid last month on a Tenet hospital in Redding, Calif. in which FBI agents and Medicaid investigators swooped down on the facility to examine heart-surgery billing records of two doctors there, a probe said to be unrelated to the current Medicare audit - have caused Tenet shares to fall 70% since mid-October, while its bonds widened out sharply. A market source saw them having gone from spreads over comparable Treasury issues in the 160 to 170 basis point range (the equivalent to trading north of par) "before all of this began last month," to spreads around 300 basis points over by mid-week.

The latest news sent that debt tumbling even further, and had market participants quoting the bonds in dollar-price terms, as though Tenet was already back to being a junker. Tenet's 6.5% notes due 2012 retreated to 84 bid Friday from prior levels around 98 bid. A junk trader quoted the company's 2011 bonds around 81 bid/83 offered, and its 2006 paper at 84 bid/86 offered, both down substantially from prior levels in the 90s.

On a conference call Thursday afternoon in which skeptical analysts and investors peppered Tenet CEO Jeffrey Barbakow with pointed questions about just what was going on, Barbakow denied that the timing of executives Mackey and Dennis' abrupt departure was related to the federal Medicare scrutiny; he said they left in the wake of a management reorganization which happened to be going on anyway.

According to news reports, Barbakow also conceded that the company's Medicare pricing policy - which resulted in a higher-than-average number of special payments for costly procedures, such as heart surgeries - was "aggressive," and "not the way I want to do business," - but he stopped short of saying that they were improper, and said that moves he was making to form a new management team "and to take a fresh look at our approach to pricing are not a signal that our fundamental strategy is flawed or the result of any impropriety."

Tenet has justified the higher-than-average rate of outlier claims on the grounds that many of its 113 hospitals have costlier open heart surgery and teaching programs.

Although Tenet's bonds were on the slide Friday and the trader allowed that it might once again become a junk bond, he saw little in the way of fallout from the Tenet situation Friday for actual high yield healthcare names, owing to the generally very quiet status of the junk market.

"I didn't see that [any sector slide] today. I think they'll be under a little pressure, just in sympathy as a whole, but if there's no real problem with those names, you won't see them [continue to] trade down. They'll stabilize or they'll trade back up. But I didn't see it today, no."

At another desk, meantime, Triad Hospitals Inc.'s 8¾% notes due 2009 were quoted down nearly two points at 104.75 Friday, while HCA Inc.'s 7¼% notes due 2008 were a point lower at 106.5 bid. Both are Tenet competitors. However, Healthsouth Corp.'s 10¾% notes due 2008 were a point higher at 70 bid.

Apart from dealings in healthcare, not a lot else was seen happening.

Western Wireless Corp. 10 ½% notes due 2006 were being quoted at 53.5 bid, up as much as seven points in the past two sessions, although on light trading, after the Bellevue, Wash.-based wireless service provider reported at mid-week that it had lost $15.9 million (20 cents a share) in the third quarter. That was not only much smaller than its year-ago loss of $66.8 million (85 cents a share) - it was a smaller loss than the 33 cents per share Wall Street had been expecting. Revenues for the third quarter were up 6.1% from a year ago to $315.9 million, beating the Street's $299 million consensus estimate. While its shares had surged more than $1 on Thursday to close at highs above $6, they were off 97 cents (15.37%) Friday to end at $5.34.

But mostly, "it was incredibly slow," said a trader. "Nothing was going on."

He did see United Airlines bonds heading earthward after the troubled carrier's debt had been flying high for much of the week, propelled partly by positive sentiment in the wake of its having made the Nov. 1 coupon payment on its 10.67% notes due 2004 - something not everyone had expected United to do. UAL had also been boosted by its having successfully rescheduled $500 million of debt slated to come due this month and next, thus easing its liquidity situation, and by its having gotten its powerful pilots' union to agree to $2.2 billion of wage-cost concessions over five years, which could help get the other unions to get on board for the airline's cost-cutting plans.

But after having enjoyed a rise in its bonds which saw the 10.67s get as high as 42 bid by mid-week, around a 20-point gain from where they had been trading before all of the good news started showing up, UAL had been quoted Thursday as having eased, with the 10.67s dropping back to about the 37 bid/39 offered level, probably due to profit-taking. The trader saw that trend continuing Friday, with the 10.67s retreating to 31.25 bid/32.25 offered, down about nine or 10 points over the two days. He saw the air carrier's 9¾% bonds due 2021 offered at 27, down from 35 a couple of days ago.

He attributed the erosion to a combination of profit-taking after the heady gains seen earlier in the week as well as some lingering investor suspicion that the good news still doesn't mean that the ailing Number-Two U.S airline's troubles are over yet.

United has repeatedly said that if it does not receive a $1.8 billion federal loan guarantee so it can borrow $2 billion it will likely file for bankruptcy - and some observers expect it to make an emergency landing in Chapter 11 sooner or later anyway, like smaller rival U.S. Airways Group did earlier this year.

Elsewhere on the airline front, Continental Airlines Inc.'s 8% notes due 2005 were quoted as having dipped a point, to 56.5 bid, but Northwest Airlines Corp.'s 7 7/8% notes due 2008 were at 60 bid, up from prior levels in the mid-50s.

The trader noted the activity going on in the investment-grade area, including the troubles of Tenet, and El Paso Corp.'s decision to quit the energy trading business, but said that hew hadn't seen much impact from either story in junkbond land. "It's hard to make heads or tails of anything because it's just so dead," he declared.

He saw Levi Strauss & Co. "giving a little bit back - they're off a couple of points from their highs." Levis' senior bonds had recently firmed into the high 90s and its subordinated debt into the mid-80s after the San Francisco-based apparel company said it anticipated having a refinancing plan for next year's debt maturities in place by the spring and would sell a new, lower-priced product line through the vast Wal-Mart store chain next year.

Other than that, he said, "the market seems to be softer with stocks, a quarter-point, a half point, across the board." The major stock indices eased on Friday on investor concerns about corporate earnings, after McDonald's Corp. and Safeway Inc. said their earnings will come in lower than estimates, and Walt Disney Co. reported lower profits at its media unit.

A trader saw The Gap bonds "a little softer, down about a point" because of a lack of flow, with no one stepping forward to continue the big push which saw the San Francisco-based apparel retailer's bonds firm smartly on Thursday after it reported its first year-over-year rise in monthly comparable-stores results in 2½ years. Gap's 6.90% notes due 2007 ended a point lower Friday at 92 bid/94 offered, while its 8.80% notes due 2008 were also off, closing around 103.5 bid.

"Beyond that, nothing of any consequence happened in our market, any big moves up or down that we saw," he declared. "Everyone went home early. It was just a non-event."

In the primary, little news leaked out Friday from the investment banks that toil in the high-yield market.

Sources said that Constar International, Inc.'s $200 million offering of 10-year senior subordinated notes (B3/B), which had been scheduled to price late in the week of Nov. 11, is now expected to price Wednesday. The deal, via Salomon Smith Barney and Deutsche Bank Securities Inc., was talked at 10¾%-11% on Nov. 6.

The source also confirmed that the IPO, scheduled to price Tuesday, saw the share price range lowered to $12 to $15 from 15 to $18.

In addition to Constar, two other deals are parked on the forward calendar as business to be transacted during the four-day market week of Nov. 18: National Waterworks' $200 million of 10-year senior subordinated notes (B3/B) via Goldman Sachs & Co. and JP Morgan and Cummins Inc.'s $200 million of eight-year senior notes (Ba2/BB+/BB-) via Salomon Smith Barney and JP Morgan.

Both transactions are expected in the latter part of the week.

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