Shabby Chic? Junk’s Fashionable Again

More than $3 billion in junk bonds issued last week; investment-grade debt also in demand. Elsewhere: Credit quality up slightly, and CA gets a subpoena. Plus: Why is Vivendi's ex-CFO in hot water?


The Borrowing Blizzard of 2003 intensified last week, with companies issuing $14 billion in new investment-grade debt and more than $3 billion in junk bonds, according to published reports.

The main reasons for this frenzy of debt? The lowest interest rates in decades and a seven-month low in yield spreads.

Investment-grade bonds now yield an average 5.044 percent, or 172 basis points more than comparably maturing Treasuries. Junk bonds, meanwhile, are now yielding 11.281 percent, or 798 points above Treasuries, according to Merrill Lynch & Co. Back in October, the junk premium topped a whopping 1,100 basis points.

The spread between junk and Treasury notes, while narrowing, is still great enough to lure plenty of investment money into high-yield funds. Indeed, lenders pumped $1 billion into junk-bond mutual funds in each of the first two weeks of the year. Those are the biggest weekly inflows since November, according to AMG Data Services.

Last week Georgia-Pacific Corp. brought out a $1.5 billion offering of below-investment-grade bonds, the largest issuance of junk bonds since May, according to Bloomberg. This was triple the amount the company had originally planned to raise.

No small feat, particularly since the forest-products company saw its debt rating cut earlier in the week.

Bloomberg estimates that more than half a dozen lower-rated borrowers plan to issue more than $5.7 billion of junk bonds in the next few weeks.

Several companies with credit ratings just a notch above junk also brought large issues to market last week.

For example, Tenet Healthcare Corp., the second-largest U.S. hospital operator, issued $1 billion of 10-year notes, twice as much as the company’s management had planned.

Impressive stuff, given that Tenet’s been caught up in a firestorm of controversy of late, In fact, a few months back, the company reported problems stemming from Medicare reimbursement and physician recruiting. Questions were also raised about the company’s doctors performing unnecessary heart surgeries.

Nevertheless, Tenet’s bond issue was rated Baa3 by Moody’s (the ratings agency’s lowest investment-grade rung) and BBB-minus by Standard & Poor’s.

And International Game Technology, the dominant maker of gaming and video lottery machines, raised $500 million in a private placement of 30-year zero-coupon convertible bonds. The offering was $100 million more than the company originally planned.

The underwriting took place just two days after Moody’s upgraded the company’s debt to investment grade.

Management at International Game Technology said it will use about $137 million of net proceeds to buy back common stock and the rest for general corporate purposes, including possible acquisitions or stock buybacks.

The bonds carry a 1.75 percent yield to maturity and are convertible into stock at a 45 percent premium.

The biggest debt sale of the week, however, was conducted by one of the original constituent stocks of the Dow Jones Industrial index.

General Electric Co. issued $5 billion of 10-year notes. On the same day, Standard & Poor’s affirmed the conglomerate’s Triple-A credit rating.

This was the first offering from the parent company in at least a decade. Generally most debt issues come from GE’s captive finance arm, GE Capital. Indeed, GE Cap has issued most of the company’s $264 billion in current outstanding debt.

“Very few companies can raise $5 billion in a single tranche in two days,” said Drew Ertman, co-head of syndication at Morgan Stanley, in an interview with Reuters. “It’s a sign that the corporate bond market is still extremely liquid, focused on buying high quality credits.”

Meanwhile, Citigroup Inc. issued $2 billion in five-year senior global notes on Friday. The offering was underwritten, of course, by Citi unit Salomon Smith Barney. Citigroup originally planned to raise $1.5 billion.

The notes, rated AA1 by Moody’s and AA-minus by S&P, were priced to yield 3.615 percent, or 80 basis points above comparable Treasuries.

A day earlier, rival J.P. Morgan Chase & Co. raised $1.75 billion in two-part global notes. The deal consisted of $1 billion in five-year notes priced at 117 basis points over comparable Treasuries and $750 million in an add-on to its existing 5.75 percent notes due in January 2013.

The total amount of the 10-year notes outstanding is now $1.75 billion, according to Reuters. The size of the 10-year tranche was increased to $750 million from an originally planned $500 million.

In addition, Chase Mortgage, a unit of J.P. Morgan Chase, sold $840 million in bonds backed by subprime residential loans.

Finally, AT&T offered to repurchase for cash $4.3 billion of its outstanding 6.375 percent notes due March 15, 2004, and 6.50 percent notes due March 15, 2013.

Credit Ratings Improving

One reason more companies are able to tap the debt markets: credit ratings are improving.

In fact, Moody’s reported late last week that there might be a slight reprieve from the high number of credit downgrades experienced in the past year.

Of course, at first blush, the overall credit cycle would still seem to be negative. Four out of five companies on Moody’s Watchlist at year-end 2002 are being considered for downgrade rather than upgrade.

But Moody’s points out that a smaller total number of companies are under review than there were at the end of the previous quarter. One out of every 17 Moody’s rated issuers was on review for downgrade at the end of 2002, compared with 1 out of 13 three months earlier.

Approximately two-thirds of all reviews are ultimately resolved in the direction in which they are initiated, the rating agency said.

“While most sectors are likely to experience at least some pressure in a still-tough economic environment, there are still really just a handful driving what may be perceived as a broad-based credit deterioration,” said Richard Cantor, managing director of Moody’s Ratings Research & Analysis.

For example, telecoms and utilities account for more than a third of companies (36 percent) now on negative review, after accounting for 25.9 percent of all downgrades in 2002.

Not surprisingly, airlines currently face the highest rate of negative rating actions, with one in five on the Watchlist for downgrade, Moody’s said. During 2002, about 40 percent of the industry was downgraded.

On the other hand, things may be looking up for the insurance industry. One out of four life-insurance companies was downgraded during 2002, as were 40 percent of the rated providers of other types of insurance (property and casualty, among others).

By the end of the year, however, less than 4 percent of life insurers and 6.8 percent of the nonlife-insurance providers remained on review.

Former Vivendi CFO under Attack

Questions have been raised about the exercising of share options by Vivendi Universal SA’s former chief financial officer Guillaume Hannezo, ex—chief executive Jean-Marie Messier, and one other staff member, according to an article in the Wall Street Journal. The article cites a person familiar with a memo from Vivendi’s audit committee.

All three exercised large amounts of stock options on December 28, 2001, the source told the paper.

The option exercise came weeks before the company sold 55 million of its own shares on January 7 in an attempt to cut debt.

TheJournal reported that Messier’s lawyer, Olivier Metzner, confirmed Messier had exercised the options, but said Messier did not immediately sell the shares he obtained.

Hannezo, however, could be in hot water, since he sold the shares obtained from exercising options. He netted a E1.3 million profit on the sale.

The paper said a person close to Hannezo confirmed details of the trades by the then—Vivendi CFO

The third person named in the memo is Micheline Clerc, whose position at Vivendi at the time is not known, according to the paper, citing the person familiar with the memo.

The memo, dated August 1, 2002, reportedly states: “At least three people have exercised [their stock options on] the same day, was it a coincidence?” It adds: “Some may wonder if those people did not benefit from specific information.”

A person close to Hannezo confirmed to Dow Jones that Hannezo had made a E1.3 million profit before taxes by exercising stock options and then selling the shares in December 2001. The person close to Hannezo reportedly said the trades had been driven by tax considerations.

“In December 2001, Hannezo exercised stock options that were due to maturity after five years,” the source told Dow Jones. “He exercised them after being recommended to do so by legal advice.”

The person close to Hannezo reportedly said the CFO asked his banker to sell the shares on December 21. This was executed on December 28. That person said Hannezo did not know about the Vivendi share sale operation of January 7 at the time.

Hannezo resigned after Messier was replaced by Jean-Rene Fourtou last July.

CA Receives First Subpoena

Are federal investigators stepping up their investigation of Computer Associates’s accounting practices?

The company last month confirmed it received its first subpoena, according to Newsday.

As you may recall, managers at CA were reportedly upset because the Securities and Exchange Commission and the Department of Justice had subpoenaed 10 of its clients. Apparently CA asked investigators to approach the company rather than its clients for information about past contracts.

Hence, the question is whether the subpoena CA received in December was the result of that request—or a stepping-up of the year-long investigation into the company’s accounting practices.

“We approached the government after we heard about [customer subpoenas] and invited them to ask us instead of our customers for whatever additional information like this they need to continue their investigation,” said chairman and chief executive Sanjay Kumar on a conference call with analysts last week. “So in response they have formally asked us for this additional information, and we are gathering up the contracts and documents, and will continue to provide the government with any additional information they want.”

CA spokesman Dan Kaferle told Newsday: “We don’t see the issuing of the subpoena as an indication of any finding or determination in the investigation.”

In November Charles Wang abruptly resigned as chairman, handing the title to Kumar, his handpicked successor. Kumar had been serving as the company’s chief executive since 2000.

Wang, who founded the company more than 26 years ago, was given the role of chairman emeritus, a largely ceremonial title, and has no role on the board of directors.

Interestingly, he also wasn’t given a severance package, unusual in this age of multi-million-dollar separation agreements.

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