Fed cut lifts high-grade market; financials strong with Lehman, Bear leading; Barclays prices $700 million

By Andrea Heisinger

Omaha, Sept. 18 - Pricing of investment-grade new issues was essentially put on hold Tuesday in anticipation of the Federal Reserve's decision about what it would do with interest rates.

Barclays Bank plc priced $700 million in two-year Fed Funds open plus 50 basis points global floating-rate notes at par.

Before it was announced that it would be a 50 bps cut rather than 25 bps, traders were speculating about which would be better.

"The consensus was it was going to be 25 basis points," a market source said.

After a mid-afternoon announcement, the market saw an upswing.

"The climate has improved, definitely, but how much is hard to say," one market source said. "The conversation is ongoing."

Another source said the cut didn't affect the Treasury market, but added that it will be good for the equity market, which was up 336 points in the wake of the announcement, as measured by the Dow Jones Industrial Average.

"It certainly won't hurt the new issue market down the road," the source said.

Issuers will like that the rates will stay low, one source said.

The source said he knew of a couple of potential deals and that there were probably more.

"There's a big backlog of deals," the source said. "It could all come rushing out of the gates tomorrow [Wednesday] with several new deals."

Some issuers who were advised to not enter the market Monday or Tuesday will likely come out Wednesday, the source said.

"There's definitely going to be more issuance across the Street in the latter half of the week," a market source said.

Terms of a $600 million Rule 144A issue from Rockies Express Pipeline LLC were given Tuesday after it priced late Monday.

The two-year three-month Libor plus 85 bps floaters priced at 99.73382.

The Royal Bank of Scotland Group plc announced an upcoming issue of non-cumulative dollar preference shares. An informed source said it was unknown when the issue would price.

Merrill Lynch, Pierce, Fenner & Smith Inc., RBS Greenwich Capital, Morgan Stanley & Co., Inc., UBS Investment Bank and Wachovia Capital Securities LLC are leading the transaction.

Fed move spurs financial rally

The Federal Reserve's surprising decision to cut its key federal funds rate by a full 50 basis points - something that most market players wanted but were not expecting, having resigned themselves to settling for a token 25 bps reduction - gave a jump start to secondary trading, particularly in the financial issues, whose spreads over Treasuries were seen to have tightened markedly, while the price of credit default swaps contracts used to hedge against a possible event of default also came down notably - the latter seen as a sign of increased investor confidence.

Among the major spread-tightening moves was Bear Stearns Cos. Inc.'s 5.55% notes due 2017, which tightened by 20 bps to 200 bps versus 10-year Treasuries.

Another big winner - and probably the most actively traded corporate of the day - was Lehman Brothers Holdings Inc.'s 6½% notes due 2017, seen 10 bps tighter, at 190 bps over Treasuries. The Lehman bonds were helped not only by the unexpectedly large Fed rate cut, but also by the news earlier in the day that the company's fiscal third-quarter earnings, though down versus year-earlier results, came in above Wall Street's expectations. That, in turn, gave some strength to other corporates in general and financials in particular in the early going, while market players waited for the Fed.

Among other big gainers among the banks and brokerages were Bank of America Corp.'s 6.10% notes due 2017, tighter by 5 bps at a 32 bps spread; Merrill Lynch & Co.'s very actively traded 6.40% notes due 2017, 10 bps tighter at 155 bps; and Merrill's 6.05% notes due 2012, 10 bps tighter on the day at 130 bps.

A trader said that "everything went up - there was a lot of good price action" on the day. "Everything rallied."

He saw the Lehman CDS contract's price tumble to a level of about 110/100 bps which he called "in like 15 or 20 bps on the day, and 35 bps from [recent] wides," while the Bears Stearns CDS price fell by 15 bps on the day to 115/110 bps, well under its recent wides at 165/155.

Among brokerages seen less affected by recent credit-market negativity than Lehman and Bear, Goldman Sachs Group Inc.'s' credit protection cost was seen down 4 bps to just under 50 bps, while Merrill Lynch's declined by 3 bps to about the 55 bps level.

Lehman earnings a helpful factor

The Fed move helped to intensify the sector's early gains, which followed the announcement of Lehman's earnings. In the early going, spreads on cash corporates were seen generally to have tightened by roughly 3 to 7 basis points after the company reported its results, while the main high-grade CDS index tightened 3 basis points to 64.5 bps.

Lehman reported that fiscal third-quarter net income fell 3.2%, as the New York-based investment firm took more than half a billion dollars in writedowns for troubled fixed-income securities - but it still beat Wall Street's expectations. The company earned $887 million ($1.54 per share) in the three months ended Aug. 31 - off from the $916 million ($1.57 per share) it made a year earlier, but better than the roughly $1.47 per share that analysts were looking for. Lehman's revenues in the quarter rose 3% year-over-year to $4.31 billion, up from $4.18 billion a year ago, and better also than the $4.3 billion it was expected to report.

On a morning conference call with analysts and investors following release of the numbers, Lehman executives said that the worst of the credit correction is over - barring any unforeseen circumstances - although they acknowledged that there are issues in the asset-backed commercial paper market which must still be resolved.

Analyst: 'could have been worse'

Gimme Credit analyst Kathleen Shanley, in a research note Tuesday, said that Lehman's consolidated results "are not as bad as they could have been," and noted that earnings "were buoyed by strong results outside the U.S., which accounted for over half of net revenues in the period. Investment management and equities were also strong."

However, the analyst noted the 47% drop in the companies results from fixed-income capital market, and a "meaningful" rise in its net leverage ratio to 16.0x versus a mid-13x figure a year ago.

Overall, Shanley wrote, Lehman's "strong track record of managing risks in the volatile brokerage sector is being tested as it navigates the current credit crunch. Growth in non-U.S. revenues has helped so far to mitigate the impact of the mortgage downturn in the U.S."

Non-financial names gain modestly

Outside of the financial names, investment-grade industrial credits were also better, though to a somewhat more moderate degree than the banks and the brokerages.

Anheuser Busch Cos. Inc.'s 6.45% notes due 2037 tightened by 10 bps to 140 bps over Libor, while Daimler Chrysler's bonds were about 10 bps tighter across the board, the big automaker's 4 7/8% notes due 2010 at 140 bps versus the three-year note and its 5 7/8% notes due 2011 and 6½% notes due 2013 at 132 bps and 150 bps over the five-year note, respectively.

Home Depot's 5.40% notes due 2016, on the other hand, were just 2 bps tighter at 185 bps versus the 10-year, and McDonald's Corp.'s 5.30% notes due 2017 were unchanged versus the 10-year at 111 bps.

Strategist is hopeful

Max Bublitz, chief strategist at San Francisco-based SCM Advisors, which manages $12 billion of fixed-income assets, most of it investment-grade paper, said that "one of the most important things that the Fed started to do on Aug. 17," when the central bank cut the discount rate by 50 basis points and announced other measures aimed at calming the jittery markets, "was to say 'look, we've been in a kind of wacky credit environment' - one that the Fed had not been comfortable with, with risk spreads say too tight - 'and we're going to transition now into a brave new credit world and we're not quite sure what that's going to be'."

He said that the initial jump from the old, "risk-oblivious world" into the new "risk-obsessed world" was "kind of emotional" - but since that time, "what I have seen over the last four weeks is the Fed has done a great job of at least trying to take emotion out of the price-discovery process."

At this point, he said "who knows where prices are going to settle? Who knows how the markets are going to react in a shipwreck [that hit the credit markets earlier in the summer] as more bodies float to the surface?"

But he said that having taken a walk around his firm's trading room earlier in the day, "corporate bond markets are a little bit tighter, things are trading better. The CDX markets are a bit tighter. Swap spreads have come in today."

The strategist said that "it's a little bit early, but my sense is that we're probably going to be a little more comfortable buying bonds - this whole price-discovery process, instead of dipping toes in the water, I think people will be jumping in up to their knees.

"I don't think anyone is totally comfortable that we've put this completely behind us. But it is clear that more and more people are participating in the process - to try and figure out what the new world is going to look like."

He concluded that "obviously, they're going to do that with the investment grade credits first."

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.