WaMu whacked on CDS auction; Level 3 outlook hurts; Q4 hope aids Smurfit Stone; funds up $72 million

By Paul Deckelman and Paul A. Harris

New York, Oct. 23 - The junk bond secondary market meandered mostly lower on Thursday, participants said, as the market once again followed the uncertain lead of the equity markets, where investors were once again running scared for most of the day - although shares ended mixed, helped off their lows by bargain-hunters.

Washington Mutual Inc.'s bonds were seen down around 5 or 6 points to the upper 50s, reflecting the outcome of the auction held to determine the settlement prices for the failed Seattle-based thrift operator's credit-default swaps contracts.

Level 3 Communications Inc.'s bonds were lower after the Broomfield, Colo.-based telecommunications infrastructure company released disappointing guidance - although the paper was not pulverized the way the company's shares were, helped by its narrower quarterly loss and the progress it has made in reducing debt.

On the other hand, Smurfit Stone Container Corp.'s bonds were solidly higher, helped by the packaging company's predictions that fourth-quarter results will be better than the third-quarter numbers.

Primary market activity meantime remained pretty much moribund.

Back in play

Bond and loan prices beaten down to levels that "easily" reflect traditional recovery rates have coaxed one high-yield mutual fund manager off of the sidelines.

"We've been putting more cash to work during the past two weeks," the investor said on Thursday afternoon.

"The percentage of our cash balance isn't as high as it used to be," the source added.

This investor is shopping predominantly in the leveraged loan market, buying loans in the 60s and 70s, and "getting more than equity-like returns, at the senior part of the capital structure."

The investor recently got into the HCA, Inc. term loan at 773/4. "It's trading today at 81½ bid, 82½ offered," the source added.

Other recent loan plays include TXU Corp. and US Oncology, Inc.

The investor is contemplating one bond play: the Sprint Capital Corp. 6.9% notes due 2019, priced at 48 to yield 25%.

"People think Sprint is going to spin off the Nextel business," the investor said.

"But that would seem to be pretty hard to do right now."

"The reason that the bonds are off so much is that people don't think that the company is guaranteeing them. But our belief is that the company is guaranteeing them."

Legging in

Even though the bonds and loans in question may be beaten down to levels that reflect traditional recovery rates this investor concedes that they may be subject to further price deterioration, simply because there is so much paper for sale to a dramatically reduced pool of potential buyers.

"The reason there are so many for sale is that the hedge funds are being forced to liquidate," the buy-sider said.

"The million-dollar question is 'When are they going to be done?'

"But a fair amount of the deleveraging has already happened.

"There is probably more to come, but I don't think it's going to last for the next year."

This money manager is mainly focused on names the fund already owns.

"We're not loading up the boat, right now," the investor clarified.

"But if you can leg in, you buy a little here and there.

"And if they come in a little more you buy a little more."

Funds rise by $72 million on week

As trading was wrapping up for the day, 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, $72.3 million more came into the weekly reporting funds than left them. That broke a string of five consecutive outflows, including the $590 million cash exodus seen the week before, ended Oct. 15.

Those five weeks, with outflows over that time totaling $1.706 billion, according to a Prospect News analysis of the AMG figures, represented a sharp reversal of the trend which had been seen in the eight weeks before that, from July 23 through Sept. 10. Inflows had been seen in seven of those eight weeks, according to the Prospect News analysis, totaling $632.366 million.

Over the somewhat longer term, although inflows and outflows have been evenly matched during the last 19 weeks, dating back to the week ended June 18, with nine inflows and 10 outflows, the funds have still lost a net of $1.797 billion during that time, according to the analysis, mostly due to the previous two weeks' large cash losses - $590 million last week and $471.7 million in the week ended Oct. 8 - and 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 $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 fourth quarter now well underway, inflows, after that slow start, remain ahead, albeit modestly, with 24 inflows versus 19 outflows seen in the 43 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 $117.5 million, up from $45.6 million 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 the total value of funds which report on a monthly basis, rather than weekly, was unchanged in the latest week; for the year to date, such funds show a net inflow of $3.062 billion.

On an aggregate basis, consolidating the year-to-date totals from both the weekly and the monthly reporting funds, there was a cumulative net inflow of $3.72 billion as of the week ended Wednesday.

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 indicators lower

The widely followed CDX index of junk bond performance, which had fallen by about 2 points on Wednesday, lost another 3/8 point on Thursday, a trader said, quoting it at 80 bid, 80½ offered. The KDP High Yield Daily Index fell by 40 basis points to end at 53.65, as its yield widened out by 20 bps to 16.16%.

In the broader market, advancing issues trailed decliners by about a five-to-three margin. Activity, represented by dollar volume, fell by 3.4% from the levels seen on Wednesday.

A trader said that during Wednesday's session, "we seemed to be more resilient to the downside - [there were] less-anxious sellers, more bottom-fishers, people looking for value, where today, things definitely have a weaker tone again."

He opined that the junk market seemed to be continuing its recent trend - "every time guys get the courage to step in, they regret it. The market backs up within a day or two and trades below where they actually were."

However, a second trader thought that the market generally was "slightly weaker - but kind of status quo."

He saw some issues "hanging in there" - notably L-3 Communications Inc. and Nalco Co. "The crappier stuff is still getting beat up, but the better-quality stuff is starting to hang in there." L-3's 5 7/8% notes due 2015, for instance, were seen holding their own around the 80 bid mark Thursday, up nearly a point on the day. Nalco's 7¾% notes due 2011 continued to trade in a narrow range north of 90 bid.

But while some issues hung in within a narrow range, yet another trader exclaimed that the volatility he was seeing among some other issues recently was "just unbelievable. I've been in the market since 1973 - and I've never seen it like this. Nineteen-eighty-seven wasn't as bad as this. It was basically just a puke, and then they recouped. This is every day a puke."

WaMu slides on auction result

A trader saw Washington Mutual's bonds as "very active - a big mover to the downside," citing the news that the auction to determine the value of WaMu's credit-default swaps priced them at 57 cents on the dollar - considerably below the initial price of 63 5/8 cents set in the auction.

That, the trader said, was "not good news."

He saw WaMu's 4% notes due 2009 trading at a round-lot price of 59 bid, versus 65.5 on Wednesday, on busy volume of $38 million. He saw the company's other bonds moving in a similar context, with its 4.20% notes due 2010 at 58.125 bid, versus 65.25 on Wednesday, while its 5¼% notes due 2017 traded at 58, down from 66.

The cash settlement date for WaMu's credit default swaps is Nov. 7. There are some $90 billion of WaMu CDS contracts floating around. The 57 settlement price arrived at through the auction means that sellers of those CDS contracts, which insure against a bond's default, will pay buyers of the protection 43 cents on the dollar. At that kind of ratio, the $90 billion of notional value of CDS swaps would suggest that contract buyers would be due some $38.7 billion of payments, although analysts believe that the final payout amount will be well short of that.

While the final settlement number was less than expected, it should be noted that it is still a higher recovery rate than was widely expected a few weeks ago, when even WaMu's senior holding company bonds were trading in the 20s.

Those bonds subsequently shot up upon the discovery that the holding company had some $4.4 billion of cash now being held by J.P. Morgan Chase & Co., which bought WaMu's banking network for a song, relatively speaking, at the government-ordered fire sale several weeks ago, just before WaMu's Sept. 26 bankruptcy filing. Traders said that the money had been "earmarked" for paying down the holdco senior bonds, with any leftovers going to the holdco junior paper.

But while that was good enough to essentially double the price of the senior bonds, sending them into the 60s from prior levels in the 30s, another trader called the WaMu senior holdco bonds "down significantly" Thursday, adding that "they weren't at the beginning of the day."

He said the bonds had opened at a generic 64.5 bid, 67.5 offered, but then had fallen to 56 bid, 59 offered by day's end. He attributed the drop partly to the results of the auction setting the price for settling the CDS contracts, but also partly to what he called the "ongoing development" of the Federal Deposit Insurance Corp., which had brokered the sale of WaMu's far-flung network of local bank branches to J.P. Morgan, trying to recover the $4.4 billion.

Level 3 lower as it cuts guidance

Level 3 Communications bonds were seen lower after the company cuts its earnings and revenue estimates for the full year, citing the slowdown in its business caused by the generally weaker economy.

A trader saw Level 3's 12¼% notes due 2013 trading at a round-lot price of 66 bid - well down from 70.5 on Wednesday, in a busy $10 million of trading. He also saw its 9¾% notes due 2014 at 57 bid, down from 60.75, while its 8¾% notes due 2017 were likewise down about 3-plus points at 50 bid, versus 53.25.

Another trader, while seeing the company's 9¼% notes due 2014 "a little weaker" at 58 bid, 60 offered, down 3 points, saw the 121/4s down about 1½ points, not 3, at 67 bid, 69 offered, versus 68.5 on Wednesday.

Still another trader said that there had been "a lot of movement in Level 3, all day long, back-and-forth. Up a point, then down 2 points, then up ½ point."

While the bonds traded within about a 3 or 4 point range, the company's Nasdaq-traded shares lost as much as half their remaining value at one point, before ending the day down 39.43%, or 49 cents, at 75 cents. Volume of 162.1 million shares was over six times the norm.

Level 3 said that it was changing its previously announced full-year EBITDA guidance to range of $980 million to $1 billion from $950 million to $1.1 billion - implying a new midpoint of $990 million versus $1.025 billion previously.

It also said it now expects 2008 core communications revenue to grow by 7.5% versus its 2007 level. That's well down from the previously issued guidance calling for a growth in a range of 8% to 13%.

But while Level 3 had bad news on the guidance front, its news was not all negative. The company said that its third-quarter loss declined to $120 million, or 8 cents per share, from a loss of $174 million, or 11 cents per share, in the year-ago quarter. Wall Street was expecting a loss of 9 to 10 cents per share.

Revenue meantime rose to $1.07 billion from $1.06 billion a year ago - also beating consensus analysts estimates of essentially flat revenues versus the year-ago period.

Level 3 further announced that it had reduced its debt by $179 million following the close of the quarter.

Smurfit Stone better on improved outlook

Financial results were the catalyst for a rise in Smurfit Stone Container's bonds. A trader saw its 8% senior notes due 2017 push up by 2 points to 50.5 bid, 52 offered, while its 8 3/8% seniors due 2012 were up 1½ points at 51 bid, 52 offered.

The Chicago-based packaging manufacturer not only reported favorable third-quarter earnings, but predicted sequentially better fourth-quarter results. It said that earnings "will benefit from higher selling prices and moderating commodity costs due to lower freight and recycled fiber prices. Furthermore, our transformation program will drive incremental savings. We are taking the necessary steps to ensure sufficient financial flexibility given turbulent financial markets and uncertain economic conditions."

Affinion bonds bounce back

Elsewhere, one of the larger gainers on the day was Affinion Group Inc.'s 10 1/8% senior notes due 2013, which pushed up to around the 73.5 bid mark on several large trades, versus the 64 level at which those bonds had finished up on Wednesday. However, a market source noted that the bonds had traded at around that same 73 area earlier in the week, dismissing the 9-point drop to 64 on Wednesday as pretty much a fluke.

There was no fresh news out on the privately held Norwalk, Conn.-based provider of membership-based organization affinity products and services that might explain the bonds' movement. Its other issue, the 11½% senior subordinated notes due 2015, last traded earlier in the week at 60 bid.

VeraSun seen mixed

Another name which was seen coming off the lows hit Wednesday was VeraSun Energy Corp.'s 9 7/8% notes due 2012, which were seen by a market source up more than a point, north of the 52 mark; they had been quoted around 5 points lower at 50 on Wednesday.

The bonds had slid on Wednesday on investor fears that the battered ethanol industry - already reeling from sharp shortage-induced rises in the price of corn, its key raw ingredient - may be further hurt as energy prices fall, decreasing demand for alternative fuels.

But another market source called the Sioux Falls, S.D.-based company's '12s actually a bit lower on the day at 49 bid, down from Wednesday's 51.5. The source also said its 9 3/8% subordinated bonds due 2017 - which had dropped badly on Wednesday down to 17 bid - continued to fall on Thursday, dipping down as low as 12 bid, before recovering a little to finish at 14.

VeraSun's NYSE-traded shares remained under pressure - down 10 cents, or 6.49%, to $1.44.

GM leads auto names lower

A trader saw General Motors Corp.'s benchmark 8 3/8% bonds due 2033 open at 27 bid, 29 offered, and then fall to 23 bid, 25 offered. He also saw GMAC LLC's 8% bonds due 2031 open at 38 bid, 40 offered, but then retreat to 36.5 bid, 38.5 offered.

Another trader saw GM's '33s at 25 bid, 27 offered, down 2 points, while domestic arch-rival Ford Motor Co.'s 7.45% bonds due 2031 finished down 2 points at 26 bid, 28 offered.

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