Mortgage woes continues with ResCap, E-Trade; Aeroflex delays deal; funds see $275 million outflow

By Paul Deckelman and Paul A. Harris

New York, Aug. 16 - Mortgage-related names continued to take a beating on Thursday, particularly Residential Capital Corp., whose bonds were cut to junk by Moody's Investors Service and Fitch Ratings. Surprisingly, that was seen having little impact on ResCap's owner, GMAC LLC.

Thornburg Mortgage Inc.'s bonds - which had shot skyward on Wednesday, as the issue bounced back from a huge slide on Tuesday - were seen unable to sustain the comeback, retreating several points on the session.

And electronic banking operator E*Trade's bonds took a fierce pounding, after it revealed the depths of its exposure to the mortgage lending crisis which began with subprime lenders and which has now spread to other segments of the credit markets as well.

Sell-side sources said that junk ended the day flat after opening weaker on Thursday morning.

In the primary arena, the worsening credit conditions caused Aeroflex Inc. to postpone its proposed $370 million bond deal.

Meanwhile the primary market produced some news during the session that took at least some observers by surprise.

Amid the pulled deals and rugged executions witnessed in the primary market since late July, Sabic Innovative Plastics Holding BV smartly tightened up the price talk on its downsized $1.5 billion junk offering, which it expects to price on Monday.

Funds see tenth outflow

For the 10th consecutive Thursday, AMG Data Services of Arcata, Calif., reported that the high yield mutual funds faced redemptions over the previous seven days, according to a market source.

AMG said there was a $274.5 million outflow for week to Aug. 15.

It's the 10th consecutive outflow in a series of redemptions among the funds that report to AMG on a weekly basis, now totaling $3.415 billion. The smallest of those outflows was the $47.54 million seen for the week to July 11. The biggest was $502.45 million seen in the week to June 20.

The most recent outflow sends the weekly reporting funds deeper into the red, year-to-date: negative $1.812 billion.

Meanwhile the funds that report to AMG on a monthly basis remain in the black for 2007 to Aug. 15, having seen $4.454 billion of cash come in.

Hence the aggregate year-to-date flows, which tally both the weekly and monthly reporting funds, also remain firmly in the black at $2.643 billion.

The sudden shift over the last few weeks came about even though inflows have still been seen in 19 weeks out of the 32 since the start of the year, versus just 13 weekly outflows - because the inflows to date were relatively small in most of those weeks, while the recent outflows have been more sizable, some of them considerably so, as cautious investors pulled their money out of what were perceived to be risky asset classes that included high yield, heading for the relative safety of Treasuries.

The fund-flow numbers had started the year on a high note, as an aggregate total of some $862 million came into the funds in the first two months, according to a Prospect News analysis. That stretch run was then interrupted by a choppy four-week period in March, characterized by alternating weeks of outflows and inflows, none larger than $25 million. Over the next 11 weeks, though - through the week ended June 6 - with 10 inflows seen in that time, the funds had a net total infusion during that period of $786.9 million, according to the analysis. After that came the current downturn, which has plunged the year-to-date flows picture deeply into the red.

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 only comprise 10% to 15% of the total monies floating around the high yield universe, far less than they used to - because there is no reporting mechanism to track the movements of other, larger sources of junk market cash, such as insurance companies, pension funds and, most recently, hedge funds.

More mortgage carnage

Mortgage lending names - already hard hit over the last few sessions - continued to nosedive as the nation's biggest mortgage lender, Countrywide Financial Corp., announced that it had completely drawn down its $11.5 billion bank credit line to cope with the liquidity problems caused by the drying up of its access to short-term funding.

That was taken by the markets as a negative sign, since the company no longer has any availability.

Although the company remains nominally investment grade, its ratings edged closer to junk on Thursday, with Moody's chopping it down three notches to Baa3, Fitch dropping it two notches to BBB+, and Standard & Poor's lowering its credit one notch to A-.

A trader saw the credit default swaps contracts used to hedge against a possible bond default as having widened out as far as 700/730 basis points during the session, although that price did drop substantially later in the session to 540 bps, "so it had a relief rally. It rallied back [off the CDS highs], but didn't rally back to where it had been," around 455/485 bps on Wednesday.

Countrywide's beleaguered bonds were being quoted at some desks in dollar-price terms, like junk bonds, rather than on a spread versus Treasuries basis, since they are already trading like distressed junk, a trader said.

Its 6¼% notes due 2016 were seen trading as low as 68 during the session, before bouncing back towards the end to finish at 78 - still down more than 3 points on the session.

Its 4¼% bonds due 2009 likewise dropped into the lower 70s before firming a bit off those lows to close at 80, still down nearly 5 points on the day.

Residential Capital meanwhile started the day as a shakily investment-grade credit - but ended it as a junk bond, as Moody's and Fitch both cut the company's debt ratings to speculative grade.

That made ResCap's 6 3/8% notes due 2010 a big loser on the day, seen down more than a dozen points in heavy trading, to around the 70 level - and for a while, the bonds were the mid-60s.

Its 6½% notes due 2013 were also trading down into the 60s and finishing in the low 70s, although their loss was only 3 points on the day.

However, that was not seen having a negative impact on GMAC bonds, even though GMAC owns ResCap and has had its earnings negatively impacted by the troubles of the mortgage sector.

A trader quoted the GMAC 8% notes due 2031 about unchanged to only off a little at 87 bid, 88 offered. He noted that "there were a lot of buyers" in GMAC.

Thornburg bounce fizzles

Thornburg Mortgage - whose 8% bonds due 2013 got hammered early in the week, before bouncing back smartly on Wednesday, up some 20 points - "didn't do all that great" Thursday, failing to sustain the upside momentum generated Wednesday and ending down 5 points at 65.5 bid.

Another trader pegged the bonds down to 63 bid, 64 offered from prior levels at 71.

Elsewhere on the mortgage scene, a trader quoted E*Trade as having "dropped like a rock" after the electronic banking company outlined what the trader called "its huge mortgage portfolio.

"The stock got hammered, and the bonds did as well," he said, quoting its 8% notes as having fallen from recent levels above par to a 91 bid, 92 offered opening level, finally ending at 91.75.

Delphi gets dumped

Outside of the mortgage area, a trader saw a 12 point drop suffered by the bonds of Delphi Corp., whose 6.55% notes that were to have come due last year slid to 91 bid, 93 offered from opening levels around 103 bid, 105 offered.

He said that "everything else" in the capital structure "was all down about the same" in a 10 to 12 point range.

He saw no fresh negative news out about the bankrupt Troy, Mich.-based automotive parts maker, which on Thursday actually announced some favorable news - it had received approval from the U.S. Bankruptcy Court for the Southern District of New York, which is overseeing its restructuring, for the sale of assets related to its global original equipment and aftermarket catalyst business to Umicore Group for $75 million.

The court also okayed Catalytic Solutions Inc. as the alternate bidder, and authorized Delphi to make a deal with Catalytic Solutions should the transaction between Delphi and Umicore not close.

Judge Robert Drain also signed off on four more settlements between the company and its labor unions, leaving only the United Steelworkers union, which represents about 1,000 Delphi employees, still to reach an accord. The accords with the other unions are similar to the pact Delphi reached with its biggest union, the United Auto Workers, approved by the court last month, which provides cost-cutting measures the company says it needs in order to emerge from bankruptcy, remain competitive and preserve the unionized jobs.

Sea Containers bonds derailed

Sea Containers Ltd.'s bonds were a train wreck on the news that Britain's transportation officials had selected another company to take over the running of the lucrative rail service between London and Edinburgh, Scotland, starting in December.

A trader saw its 10¾% notes that were to have come due in 2006 plunge to 68 bid, 70 offered, from prior levels at 80 bid, 82 offered, while its 10½% notes due 2012 were likewise down a dozen points, at 67 bid, 69 offered. Its 7 7/8% notes due 2008 were off 10 points at 66 bid, 68 offered.

The InterCity East Coast Franchise had been the crown jewel in the holdings of Sea Containers' GNER rail unit in the U.K., which had operated the franchise since 1997, most recently winning a 10-year contract service contract in May 2005. But when the Bermuda-based parent company went into bankruptcy last fall, leaving it unable to pay the government the required £1.3 billion in premiums for the privilege of running the prestigious service, it was made clear to GNER that it would only operate as a caretaker until a new operator was found.

Sea Containers did not give up all hope - it teamed up with two other transportation operators, Virgin Rail and Stagecoach, to submit a joint bid, in hopes of hanging on to at least a piece of the pie. But as had been expected by most industry-watchers, the authorities announced on Wednesday that GNER rival National Express will take over.

Sabic tightens talk

Sabic Innovative Plastics Holding lowered price talk for its downsized $1.5 billion offering of eight-year senior unsecured notes (B1/B+) to 9½% at par.

Previously the notes had been talk to price at a discount to yield 10¼%.

Meanwhile the planned registration rights for the Rule 144A notes have been withdrawn; the notes will be issued via Rule 144A for life.

Pricing is expected on Monday.

The bond deal initially came to market as a $2.765 billion equivalent offering of eight-year notes in tranches of $1.95 billion and €590 million. The proposed euro-denominated notes have been withdrawn.

With the downsizing of the bonds, the bank deal has been upsized to $6.65 billion from $5.4 billion.

An informed source told Prospect News on Tuesday that much of the demand for both the bond paper and the loan paper is from Middle Eastern institutions, with European accounts and a smattering of U.S. accounts also expected to be in the deal.

Citigroup, ABN Amro, GE Capital, HSBC and JP Morgan are joint bookrunners.

Proceeds will be used to help fund the acquisition General Electric's plastics business by Saudi Basic Industries Corp. (Sabic) for $11.6 billion including the assumption of liabilities.

With the price talk being tightened and registration rights withdrawn, Prospect News suggested to an informed source that these were characteristics of an offering of bonds that would be placed in "strong hands," and that the sharp sell-offs in some of the issues priced last Spring do not seem to be factoring to the calculations of the prospective Sabic investors.

The informed source said that this assertion seemed "fair enough."

Not a benchmark

Sources roundabout the high yield sell-side are cheering for a tight execution on the Sabic deal.

However sell-siders more or less seem to agree that Sabic is a special case, with very few of the bonds expected to end up in the portfolios of U.S. investors.

"It's a good deal, and it should go well," said one sell-sider not involved in the Sabic bond offering.

"But I doubt that it will be a benchmark for the condition of the primary market," adding that when Sabic clears the present myriad difficulties in the credit markets will still remain to be dealt with.

Falling knife

The primary market produced one other negative news nugget on Thursday.

Aeroflex Inc. postponed its $370 million 10-year senior notes deal due to unfavorable market conditions.

The Goldman Sachs led deal was launched in mid-July to help fund the LBO of the company by Veritas Capital.

In place of the bonds the underwriters will supply bridge financing.

In light of this and other postponed deals, as well as the above-mentioned outflows and a host of other travails that presently beset the credit markets (most related to what has come to be known as the "subprime mess") Prospect News has been surveying high yield syndicate sources as to what kind of September to expect in the new issue market.

A schism has emerged, with some sources pointing to volatility in the secondary market and in equities, and forecasting a mostly quiet to extremely quiet September, while others anticipate a busy post-Labor Day primary market.

One syndicate source who is focused on both the high yield bond market and the leveraged loan market expects a busy September.

"I think a lot of people are going to try to push deals through," the source said, but added that if proposed September issuance plays to poor reviews from the buy-side, and it appears that deals will continue to struggle, the underwriters won't hesitate to fund the bridge loans.

This source added that for any kind of primary market to develop in the Fall investors will need to be reasonably certain that the bottom is in sight, with respect to the junk market.

"No one is going to want to go out there and stand under a falling knife," the official said.

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