Interstate Bakeries trades at 85 on bankruptcy; Delta off; AMR warns after closing bell

By Ronda Fears

Nashville, Sept. 22 - Several bombshells pulled convertibles lower Wednesday, underscoring the sharp drop in stocks as oil prices continued to climb and fear of weak corporate earnings compounded the impact of the 25 basis point hike in interest rates.

With the convertible market feeling rather "stale" for the lack of any fresh paper, as one sellside trader put it, players were not entirely humorless despite the downdraft in the market.

Puns were flying in regard to several somber situations such as Interstate Bakeries Corp. filing bankruptcy, sandwiched between spiteful jabs at the maker of Twinkies and Wonder Bread.

Interstate Bakeries' bankruptcy threw its recent private placement convertibles into a tailspin, although traders said the bonds are likely to recoup par due to securities regulations about such matters. The blowup was speculated as perhaps the quickest on record, since the Kansas City, Mo., bakery just sold the convertibles on Aug. 12.

"You could say these bonds were moldy when they were sold, out of their 'best when eaten by' date," said a risk arbitrage trader at a hedge fund in New York.

A big chunk, some $55 million, of the Interstate Bakeries 6% convertible bonds due 2014, a $100 million issue, traded Wednesday at 85, market sources said. Traders pegged the issue anywhere from 60 to the mid-70s, but a sellside trader active in the name said those were levels were far too low.

Delta Air Lines Inc. hasn't landed in bankruptcy court, yet at least, but its bonds took a dive Wednesday as one of the Atlanta-based airline's vendors halted in-flight meals by refusing deliveries not paid in cash, a sellside convertible trader said.

"Even Delta can't get a free lunch," quipped a buyside market source.

Delta's two convertibles dropped 1 point each, and its straight junk bonds lost 2 points across the board, while the stock fell more than 4%. After Wednesday's close, however, Delta announced that a judge had ordered the vendor in question to resume catering services immediately.

AMR Corp. also took a dive Wednesday, which traders attributed to the spike in oil prices, as the two convertibles ended lower by 1 point each. Then, after the close traders saw more weakness as the airline disclosed in a Securities and Exchange Commission filing that it has had to get a waiver of immediate credit facility covenants and is seeking to refinance the credit facility to lower thresholds going forward.

BioMarin Pharmaceutical Inc. was lower on a warning of greater-than-anticipated losses, and Computer Associates International Inc. dropped on settling the SEC investigation of its accounting practices, which also resulted in the indictment of three former top executives. BioMarin's 3.5% convertibles traded down 3.5 points early Wednesday but ended the day off by just 0.625 point, a sellside trader said. Computer Associates converts were seen down about 1.5 points on its headlines.

Interstate convertibles at 85

Nearly ever since the Interstate Bakeries convertibles were sold at par of 100 in a private placement Aug. 12 they have been underwater, but the handful of buyers of the deal - about four or five hedge funds, mostly big players in the convertible market - have already made money on the issue and the bonds are expected to get a full par recovery in the bankruptcy.

"These are risk arb guys now, who have a fraudulent conveyance claim that basically is that this issue should have never happened," said a sellside trader at one of the major convertible desks. "A fraudulent conveyance claim is standard when a company files [bankruptcy] within 90 days of the issue, and these were sold, what, four or five weeks ago."

The Interstate Bakeries 6% convertible bonds traded at 85 on Wednesday after the news, which halted the stock on the opening bell at $2.05 - down 37.3% from Tuesday's close - and brought about a downgrade to the credit to D for default from CCC- by Standard & Poor's.

A buyside source saw a bid for a small slice of the issue at 79, which would be down from 83.5 bid a week ago seen by a sellside trader. Another sellside trader pegged the issue in the mid-70s.

A buyside trader said there was a bid for a small slice of the issue at 79, and a sellside trader at a boutique that traffics convertibles pegged the issue at 60. But a sellside trader active in the name said those were levels were off from the live market for the Interstate Bakeries bonds.

"That's too low," the sellside trader, at a major convertible desk, said. "I'd own them at 80, but there's a lot of hair on this, no doubt."

Interstate recovery seen

A risk arb source said indeed a par recovery is anticipated by holders of the Interstate Bakeries convertibles, because of the timing of the bankruptcy in relation to the bond sale. Besides, he said, the holders have already made money on the issue.

"These set up nice and lots of money has already been made, I'm sure, and they may even make more because of the legal issues," the source said, who pointed out that he does not hold any of the Interstate Bakeries convertibles.

Interstate Bakeries sold the $100 million issue of 10-year convertible senior subordinated notes at par with a 6% coupon and 12.5% initial conversion rate in a private placement on Aug. 12, but the placement agent was unknown at that time.

What is known is that proceeds of the bond sale were earmarked to pay down the company's senior credit facility with JPMorgan Chase and Bank of America. Sources contacted on the private placement teams at Bank of America were not available to comment; sources at JPMorgan were not reached.

Simultaneously with the convertible deal, Interstate Bakeries amended its senior secured credit facility, increasing the interest rate by 50 basis points on all loans, modifying the leverage and interest coverage covenants through the first quarter of fiscal 2006 to increase financial flexibility and prohibiting dividend payments until its senior bank debt is rated Ba3/BB- with a stable outlook or better.

Meanwhile, there was an investigation into the company's books, with an estimated charge of about $40 million to second quarter pretax income and a boost to its reserve for workers compensation claims by $40 million. That resulted in the company seeking up to a 15-day extension to file its form 10-K with the SEC and planning to restate second and third quarter financial statements.

Interest paid to the banks was bumped up again, meanwhile, with more flexibility to Interstate Bakeries, but Wednesday the company relented to financial pressures - a Sept. 26 deadline to meet certain conditions or receive waivers from its bank lenders to continue drawing on its revolver - with the bankruptcy filing. Chief executive James Elsesser also resigned.

The company said it has a commitment for $200 million in debtor-in-possession financing from JPMorgan Chase and has hired turnaround expert Tony Alvarez of Alvarez & Marsal Inc. as CEO and John Suckow as chief restructuring officer.

Delta skids, meal ticket jerked

Delta's meal ticket was effectively jerked when food and drink vendors refused to cater to its flights without cash payment for 30 to 60 days in advance, a sellside convertible trader said Wednesday.

The Delta convertibles dropped about a point each with the 8s at 33.5 and the 2.875s at 36.5. Delta's junk bonds also lost ground, by about 2 points, with the long-dated 8.3s at 24 bid. Delta shares lost 16 cents on the day, or 4.15%, to $3.70.

After the closing bell, however, Delta said in a news release that Fulton County Superior Court judge Stephanie Manis on Wednesday ordered Gate Gourmet to resume catering services on Delta flights, effective immediately.

Onboard service was impacted on some flights catered by Gate Gourmet on Tuesday afternoon and Wednesday, the airline acknowledged. In the interim, Delta said it used other suppliers for food and beverage service on the flights involved.

Meanwhile, after having reached a tentative agreement with union pilots to stem a wave of early retirements, wage concessions with that labor group are yet to be resolved.

The union agreed Monday to allow Delta to bring pilots out of retirement on a limited basis to deal with any shortages that threaten to ground flights. Earlier this month, Delta said it would cut 6,000 to 7,000 jobs over the next 18 months, plus "de-hub" its operations at the Dallas-Fort Worth airport.

AMR seen falling on warning

AMR said in an SEC filing after Wednesday's close, too, that because of weak revenues at its American Airlines Inc., rising fuel prices, hurricanes in the southeast United States, and other factors, it has busted covenants in its bank facility and is negotiating some refinancings. AMR said it expects it "mainline unit revenue" to drop in third quarter by 2.5% to 3.5% from a year earlier.

Also American Airlines raised one-way fares $5 and round-trip tickets by $10, which some onlookers saw as counterproductive amidst a decline in air traffic.

AMR's convertibles were quoted off about a point each before the news, with the 4.25s at 74 bid and the 4.5s at 68.5 bid. AMR shares ended Wednesday down by 26 cents, or 2.89%, to $8.74.

In an 8-K filing Wednesday, AMR said American has a fully drawn $834 million bank credit facility secured by aircraft that expires Dec. 31, 2005, with a liquidity covenant threshold of $1 billion of unrestricted cash and short-term investments and a minimum EBITDAR-to-fixed-charges ratio of 1.3-to-1.0 for the nine-month period ending Sept. 30, 1.4-to-1.0 for the 12-month period ending Dec. 31 and 1.5-to-1.0 for each of the four consecutive calendar quarters after Dec. 31.

"While American fully expects to comply with the liquidity covenant, American recently determined that, because of continuing record high fuel prices and weakness in the revenue environment, it might not be able to comply with the EBITDAR covenant as of Sept. 30, and it was unlikely to be able to comply with the EBITDAR covenant as of Dec. 31," the SEC filing said.

The company said it expects to end third quarter with a total cash and short-term investment balance of about $3.6 billion, including about $480 million in restricted cash and short-term investments.

To address the situation, on Wednesday, American obtained an amendment to the bank credit facility to lower the required EBITDAR-to-fixed-charges ratio to 1.0-to-1.0 for the nine-month period ending Sept. 30, and 0.9-to-1.0 for the 12-month period ending Dec. 31.

The required ratio remains 1.5-to-1.0 for each of the four consecutive calendar quarters ending after Dec. 31. Thus, the company said American is in active discussions to refinance its bank credit facility with one or more credit facilities or term loans in fourth quarter.

American has engaged Citigroup Global Markets Inc. and JPMorgan Chase to arrange the refinancing or replacement facility.

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