Qwest probe throws bonds, shares for loss; Oregon Steel prices slightly upsized issue

By Paul Deckelman and Paul A. Harris

New York, July 10 - News that federal prosecutors are investigating troubled telecommunications operator Qwest Communications International Inc. caused the beleaguered company's bond and stock investors to head for the exits Wednesday - while two of the three major ratings agencies responded with debt rating downgrades.

In the primary market, Oregon Steel Mills Inc. slightly upsized its offering of seven-year first mortgage notes and, while they priced at a discount, they moved up in secondary dealings.

And Oregon Steel's deal, which also came at the tight end of price talk, was just one sign of comparative vigor in the high-yield primary market - despite Tuesday's 3.1% decline in the Dow Jones Industrial Average, bringing it to its lowest close since Nov. 13, 1997.

Also o the new-issue front, Graham Packaging released details on the $100 million it figures to price in July, a eurobond offering emerged from the Parisian firm of Kaufman and Broad SA, and both Doane Pet Care Co. and Grief Bros. Corp. announced their intentions to bring new notes.

Trailing the wake of four downsized junk bond deals that priced wide of talk during the run-up to the Fourth of July holiday, Oregon Steel Mills' deal (B1/BB-) was raised to $305 million from $300 million and yielded 10¼% against talk of 10¼%-10½%. Goldman Sachs & Co. was bookrunner.

Louise Rieke, portfolio manager of the Waddell & Reed Advisors High Income Fund, told Prospect News Tuesday that she played Oregon Steel.

"Their end products are diversified and it's mini-mill," Rieke said. "They've got the pricing in their favor at this point.

"This company's been out there for a while," she added. "It's a known quantity and you have good things happening in the steel industry. It's one of the survivors at this point."

A sell-side source, not on the Oregon Steel syndicate, eyed the terms and said: "It looks like the market might be turning slightly to the issuers' favor.

"After the July Fourth week I wasn't sure if we'd need some kind of post mortem siesta to get things rolling. It's good to see a deal come in at the tight end of talk."

Beyond the high-yield primary, news from the capital markets Tuesday seemed to convey extremes, with the Dow closing at its lowest since late 1997 and the 10-year Treasury hitting its lowest levels for the year, 4.65%.

That news, combined with a continuing onslaught of massively negative corporate accounting revisions, comprises a recipe for fear and volatility, according to Rieke.

Prospect News asked her if the low yield on the 10-year Treasury could conceivably lead to reluctance on the part of the buy-side to get involved with the higher-tier speculative-grade credits.

"The double-Bs historically have tracked more closely with Treasuries but I don't know if that's true right now," said Rieke. "Right now fear could be coming into play.

"Today we started with a pretty good rally, closing that yield spread. Then we turned around and started tracking equities. The market is just so skittish right now you don't know what it's tracking because it changes its mind all the time."

Hearing this buy-side color, a source from the sell-side told Prospect News that he agreed with Rieke's take "100%."

"All bonds are affected by the interest rate effect, the equity effect and the market-risk premium," the source commented in a late-Tuesday e-mail message.

"In a normal market, the market-risk premium is stable and bonds behave as you would expect. Higher-rated credits are more sensitive to interest rates and lower-rated credits are more sensitive to the equity market. However, in times of market turmoil the market-risk premium increases and this affects all bonds (in their spreads).

"Right now, there is a lot of fear in the marketplace, evidenced by the equity markets being absolutely pummeled and Treasuries strengthening (due, in part, to a "flight to quality" from equities). The risk premium has clearly increased for all issuers and there is a strong negative equity effect. While normally a double-B name might tighten along with strengthening Treasuries, today the combination of the increasing market-risk premium and the negative equity effect is simply overpowering. Therefore, yields for all high yield bonds are blowing out along the entire ratings strata.

"We saw the same phenomenon during the emerging markets' turmoil in October 1998. Treasuries rallied, but absolute yields for high yield bonds widened and the equity market plummeted. By the beginning of 1999, everyone pretty much agreed that the market's reaction to the emerging markets turmoil was irrational and overdone, but that's what happens during a period of extreme fear. I can argue (and I hope) that we will all look back on the current period as an equally irrational overreaction."

In the face of Tuesday's resoundingly bad news from the rest of the capital markets, four issuers announced or clarified their intentions to bring new junk bond deals.

Brentwood, Tenn.-based private label pet food company Doane Pet Care announced that it is contemplating an offering of approximately $200 million of senior notes "in a private issuance during the second half of 2002, subject to market conditions."

Grief Bros. announced it would bring $300 million of 10-year senior subordinated notes.

Meanwhile, Graham Packaging, which told Prospect News on May 31 that it would bring $100 million, clarified its intentions Tuesday.

According to a filing with the Securities and Exchange Commission and syndicate sources, Graham Packaging Co./GPC Capital Corp. I will sell a $100 million add-on to its 8¾% senior subordinated notes due Jan. 15, 2008, bringing the deal as July business.

Deutsche Bank Securities Inc. and JP Morgan are joint bookrunners. Goldman Sachs & Co., Lehman Brothers, Morgan Stanley and ABN Amro are co-managers.

Finally on Tuesday, from the opposite shore of the Atlantic Ocean, news emerged on a new eurobond offering from Kaufman & Broad SA, €125 million of seven-year senior notes via bookrunner Merrill Lynch.

The Paris-based single family housing developer will start its roadshow Thursday and expects to price its deal during the week of July 22.

Suddenly, after comparative torpor during the first half of 2002, the eurobond market now accounts for four deals on the Prospect News forward calendar totaling €675 million of new business.

Asked if such a build-up could in any way be related to the misfortunes of the stateside capital markets, one syndicate source told Prospect News "not likely."

"The two markets are really not correlated that much," this sell-sider said. "The reality is that the European market tends to be more chunky because it's a smaller market. So people have been working on deals for a while. And there are two very different investor bases."

Asked if - as has been reported in the American high-yield market - there is thought to be plentiful cash on the sidelines in the European market, the source said: "There has been because there hasn't been a whole lot of new issue supply in Europe for the past couple of months.

"The fact that there are all of these (euro deals) on the calendar is something that's partially opportunistic. These are deals that they have had in the pipeline and have been working. And it's just coincidence that they are all coming out at the same time.

"But if you look at market conditions two or three months ago when there was a real demand for new issue paper everyone clearly hit the gas pedal and started to try to bring deals. That's why you're getting a bunch of deals coming at the same time."

Asked how the investment banks quantify the amount of cash flowing into and out of high yield in Europe, this source said that in the absence of a counterpart to AMG Data Services, which reports the mutual fund flows in the US, intelligence on the amount of cash that needs to be put to work in European high yield tends to be generated within the investment banks.

"The European market really doesn't have fund flows as the US market does," this sell-sider said, adding that there are three distinct components of the market in Europe.

"There is bank investment, which basically was the way the market was started: a lot of proprietary desks started by all the European banks looking to invest, which is where the traditional eurobond market was, that had translated into high yield. Then you have the insurance companies which had set up small high yield funds. Finally you have the hedge funds and the US mutual fund business that invests periodically in the European market, depending on foreign exchange provisions.

"In comparison to the US, there is only a handful of investors in Europe so it's easier for us to track funds flows in and out of the market. There are a certain group of funds in Europe that drive the European market, and the premiere banks in Europe - Merrill Lynch, Goldman, Salomon and Deutsche - are basically the ones that have the relationships with the accounts to determine new issue flow."

When the new Oregon Steel notes were freed for secondary dealings, they moved as high as 100.75 bid from their 98.772 issue price earlier in the session.

Back among already established bonds, Qwest Communications held the spotlight, traders said.

"It was a complete piece of garbage," a disgusted trader declared, noting that over the previous couple of days, "Qwest had some decent upward mobility to it," including a rise of anywhere from five to seven points in Tuesday's session.

As Wednesday's dealings got under way, "it had gotten pretty well bid for across the board. Then they halted trading in the stock, and everybody was guessing that it was good news coming, based on the general undertone of the market," which over the past two sessions had seen some firming in the badly-beaten telecom and communications names.

As it turned out, "everybody" couldn't be more wrong. The Denver-based regional Bell operating company announced that it had been informed by the U. S. Attorney's office in Denver on Tuesday afternoon that the feds had begun a criminal investigation of Qwest - the latest major U.S. company to find itself on the hot seat. The company said that the prosecutors did not disclose to them the subject matter of the investigation, and it vowed cooperation with the probe. The federal criminal probe comes on top of an earlier civil investigation into alleged book-cooking initiated by the Securities and Exchange Commission, which is still going on.

News of the criminal probe was all it took to shatter the market's fragile confidence, and Qwest led the slide.

After the news, trading in the stock resumed, and the shares slid 83 cents (31.92%) to $1.77 in busy New York Stock Exchange dealings of 63 million shares, almost five times the normal turnover.

On the bond side, said the trader "that was the end of that [early firmness]. The Qwest holding company bonds proceeded to trade off," with the 7.90% notes due 2010, which had gotten as good as 56.5 bid/58.5 offered, careening downward to 45.5 bid/46.5 offered.

He said that Qwest's operating company debt "didn't get hit as hard" as the holding company paper, with its 6 5/8% notes due 2005 heard down about a point or so to the 78 bid/81 offered level.

A distressed debt trader noted - with considerable understatement - that the Qwest paper was "a little softer," by which he meant is off around 10 or 11 points on the bonds maturing in 2009-11.

"Obviously, even though guys sort of expected this, it still caused a lot of disruption," he said. But while the nominal change in the bonds' prices was pretty sizable, "the selling wasn't nearly as heavy as I would have thought. The buyers dropped their bids, and guys wanted to get out of the bonds, but activity-wise, it wasn't as hefty as you would have expected."

He said that in the previous several sessions - especially on Tuesday - "distressed guys were out there, jumping on them, buying them and bidding them up - and we were scratching our heads at the same time they were doing that, trying to figure out why. You always figure that someone may know something more than you do - but in this case they didn't."

In line with what the first trader said, the distressed-debt maven pointed out that "the operating company paper hung in there very well, people seemed pretty comfortable owning it and making bets on the operating company stuff. But the holding company paper obviously was under a lot of duress."

In response to the federal probe, Moody's Investors Service dropped the rating on Qwest's senior unsecured bond debt three notches, to B2 from Ba2 previously, while Fitch Ratings lowered the company's debt all the way down to B from BBB- previously.

"While details of the investigation have not been disclosed," Moody's cautioned, it remains "concerned about possible adverse consequences on the company's near-term liquidity should asset sales or planned accounts receivable securitizations suffer any setbacks resulting from today's announcement."

Standard & Poor's meantime said that Qwest's BB long-term senior unsecured debt ratings (BB+ at Qwest Corp.) remain where they are for now, on Credit Watch with negative implications. But the criminal investigation "is a new development that could potentially materially weaken the company's financial and business profile and increase the likelihood that the ratings will be lowered," warned S&P analyst Catherine Cosentino.

A trader said that post downgrade, Qwest's 7¼% notes due 2011 had fallen to 47 bid. He pegged them down almost 10 points on the session.

Another trader, however, said the downgrades "happened a little late in the day" and really had little or no trading impact that he had seen. "I can't imagine that it was a major shock, given where these bonds had been trading."

He continued that apart from Qwest, "The market had felt like it had a relatively decent tone the last couple of trading sessions - mainly Tuesday - and we had some decent buying interest across the board. But the Qwest criminal investigation just stopped the market dead in its tracks."

He quoted VoiceStream Wireless' bonds - which had firmed on market speculation that the company, now a unit of Deutsche Telekom, would acquire rival AT&T Wireless - as coming off their highs. The VoiceStream 10 3/8% notes due 2009, which had ended Tuesday at 92 bid/93 offered, pushed as high as 97 bid in the early going Wednesday, before "backing off" those peaks to end at 95 bid/97 offered. He also saw Nextel Communications Inc.'s benchmark 9 3/8% senior notes due 2009 got as good as 57 bid before giving almost all of its gains back to close only marginally higher at 53.5 bid/54/5 offered. The psychology changed considerably."

The market buzz about a VoiceStream/AT&T Wireless combination - arising from a piece in Wednesday's Wall Street Journal which attributed its information to people close to the situation - pushed the VoiceStream 10 3/8% notes up to 96 bid from prior levels around 90, a market source said, while AT&T Wireless' bonds "were a little bit better," an observer opined. Still, he said, "I was very surprised" that the latter's paper wasn't up more; he quoted AT&T Wireless' 7 7/8% notes due 2011 closed at 81.5 bid, its 8 1/8% notes due 2012 at 82 bid and the 8¾% bonds due 2031 at 76 bid, "not much better than they went out on Tuesday" - specifically, about a point, unchanged and two-and-a-half points up, respectively.

But he pointed out that "in the previous sessions, these have been tightening, tightening and tightening - 25 basis points, and 25 basis points the day before that. We're seeing constant tightening in these bonds. Maybe this [deal speculation] has been factored into it."

The distressed-debt trader, meantime, said that Qwest's troubles and the continued slide in the stock market had a negative ripple effect elsewhere, helping to knock the bonds of WorldCom, Inc. down about two or three points on the session, for instance, with "some of the other phone guys down a point or two."

But actually, he added. "It was a pretty quiet afternoon, considering how bad equities were being killed. We didn't see a lot of panic selling, although the buyers obviously were knocking the bids down and withdrawing from the market place for a little while as the telecom market was selling itself out. It's an ugly little world out there."

WorldCom's debt had firmed Tuesday, aided by the overall better tone in the telecom and communications sectors (on the strength of AOL Time Warner Inc.'s scoring $10 billion in new funding and Level 3 Communications Inc. Lining up a $500 million investment, as well as its own reported progress in moving toward arranging a $3 billion credit facility with an as yet undetermined lender). But on Wednesday, dragged down by the Qwest-induced erosion among the telecoms, it was in retreat, its 7 3/8% notes due 2003 falling from a closing level Tuesday around 23 to about 17.5 bid/18.5 offered.

When the short end goes down, a trader ventured "that shows some level of market opinion that a bankruptcy is more imminent." The stricken Clinton, Miss.-based telecom giant said it would know in about three weeks whether it would reorganize though the courts or correct its financial problems some other way.

Outside of the communications world, the trader said that there was "a decent gain" in Allied Waste Industries bonds "after having been tarnished the last couple of sessions." He quoted its 10% notes "up a lot" at 95.25 bid/96.25 offered from 93 bid on Tuesday.

On the downside, Mail-Well Inc.'s bonds - which had fallen 10 points across the board Tuesday when the Englewood, Colo.-based printing company warned that it expects second- quarter earnings before restructuring and other charges to be below forecast results, largely as a result of lower-than-expected revenues - continued to retreat Wednesday.

Mail-Well's 9 5/8% notes due 2012 dropped to 88 bid from prior levels at 90, while its 8¾% notes due 2008 likewise ended down five points Wednesday, at 72 bid.

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