I wouldn't say things are humming, but at least the markets are alive," says one corporate finance banker about the state of the financing markets. That this is seen as an improvement over conditions that prevailed at the end of 2008 is a testament to just how ugly things got after Lehman Brothers Holdings Inc. blew up and plunged into bankruptcy in mid-September.
That singular event led almost every credit market to stall, and traditional metrics such as the TED spread, which measures the difference between three-month T-bills and three-month LIBOR, flashed signals of extreme distress for the entire system. After Lehman, other financial firms had to be saved (American International Group Inc.), sold off (Washington Mutual Inc., Wachovia Corp., National City Corp.) or bailed out (the banks that received money under the Troubled Asset Relief Program). Share prices slid, trade slowed and unemployment climbed as a crisis of the financial system swept into the real economy, not only in the United States, but in Europe and Asia.
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In the wake of a series of emergency government interventions around the world, the worst may have passed -- perhaps. Despite further problems at Citigroup Inc. and Bank of America Corp., the New Year brought some hope and some improvement, though in moderate amounts. "There's a lot less fear, but still a great amount of uncertainty," one debt investor says.
So where do we stand in early February? Many markets, particularly those trafficking in asset-backed securities and leveraged loans, remain moribund, with virtually no activity, while those dealing in commercial paper are being kept alive largely through government lifelines. However, there are encouraging signs that life is beginning to stir in some traditional bond markets, both investment grade and high yield.
The state of these markets, which are central to the short-term funding and long-term strategic needs of corporations, will continue to both reflect and drive economic conditions as the credit crisis and recession enter their second year of pain and dislocation.
What follows is a closer look at prospects, followed by a series of financings that succeeded. Consider one thing: These markets, for better or worse, can change rapidly, as high yield did at the end of January. What's presented here is a fever chart of very sick financing markets seeking a pathway to health.
The $1.7 trillion commercial paper market provides short-term financing to companies, helping the likes of General Electric Co., Gannett Co. and GMAC LLC raise money for terms as short as 24 hours and as long as nine months.
In normal times, the market is relatively staid, providing vast sums at low prices, but its importance to the day-to-day functioning of many corporations was sharply illuminated after Lehman's bankruptcy. Lehman's default of its CP obligations caused shares of one of the largest money-market funds, the Reserve Primary Fund, to drop below $1 and led other money-market funds, which are major buyers of CP, to stop lending short-term money and conserve cash.
The result: The U.S. economy almost ground to a standstill, with borrowers such as Gannett and electric utility Southern Co. forced to tap much more expensive bank credit lines to maintain daily operations.
The resulting fear and the potentially irreparable economic harm prompted the government to intervene with a guarantee of money-market funds through the Federal Deposit Insurance Corp. and a new Federal Reserve Commercial Paper Funding Facility. According to The Wall Street Journal, the Fed's CPFF bought approximately $350 billion of commercial paper on Oct. 27, about 21% of the market. That source of demand allowed CP rates for financial issuers (who make up the bulk of the market) to drop from as high as 3.74% in October to 2.14% by Jan. 28.
However, about $230 billion of the debt owned by the Fed was due to mature Jan. 31, and the market was waiting to see whether companies would be able to roll it over by traditional means. Expectations were that the CP market would absorb the new supply.
According to reports, the results were mixed, with less than half -- $102 billion, according to The Wall Street Journal -- refinanced in the private market at the end of January. That suggested a stable, if not exactly robust, market, symptomatic of many of the financing markets.
In fact, other data fed some doubts about the continuing health of the CP market. According to Federal Reserve statistics, U.S. CP outstanding for the week ended Jan. 7 rose 4.9%, or $83.1 billion, to $1.76 trillion. That was the highest since the week ended Sept. 10 -- just before Lehman fell. An increase in the amount outstanding suggests that borrowers and investors are returning to the market and issuers are able to roll over existing debt.
Since then, however, the amount outstanding has fallen $173.9 billion, to $1.60 trillion. More than half of that drop came in the last week of January, which experienced a $98.8 billion decline. Although the reasons for the fall remained unclear as we went to press, one market participant suggests that recession-wary companies are seeking longer-term funding sources to limit their refinancing risk.
Perhaps no funding source has been hurt more by the credit crisis than the asset-backed securities market, which includes debt backed by credit card receivables, student and auto loans and mortgages. According to data compiled by research firm Dealogic, global ABS issuance in 2008 plummeted 79%, to $455.6 billion, from $2.1 trillion a year earlier. Most of that drop came in the U.S., which experienced an 80% decline, to $311.2 billion in total issuance.
The downward trend continued in January with only $2.6 billion of global issuance, $1.1 billion of which was from U.S.-based issuers.
Given the size of the market (global issuance totaled about $2.8 trillion in 2006, of which U.S. companies issued $2.1 trillion) and its importance in keeping rates down for student loans, auto loans and credit cards, the Fed created a $200 billion Term Asset-Backed Securities Loan Facility to support the market.
As the Fed put it when it created TALF in November, "The ABS markets historically have funded a substantial share of consumer credit and [Small-Business Association]-guaranteed small business loans. Continued disruption of these markets could significantly limit the availability of credit to households and small businesses and thereby contribute to further weakening of U.S. economic activity."
Under terms of the TALF, the New York Fed will lend money to holders of AAA-rated ABS paper in the hopes of drawing investors back into the marketing by providing them with liquidity. Market sources say TALF is set to begin auctions to take eligible paper in February, which could encourage some issuance. "Those markets are starting to come alive," says a source in one corporate finance department, "but we're a long way from healthy."
The most encouraging signs that the markets may be reawakening have come from the investment-grade bond markets, where issuance in January exceeded expectations. "Issuance had been on life support, following the collapse of Lehman Brothers," Moody's Investors Service economist Ben Garber says.
In fact, the freeze began even earlier. According to Dealogic, investment-grade bond offerings raised only $38.6 billion last June, a 65% drop from May's $111.2 billion. The decline continued through the summer, sagging to $24.8 billion in July, $25.1 billion in August and $15 billion in September.
But the outlook improved in December, when companies raised $108.1 billion, and then followed with roughly $64.4 billion in January.
The last two numbers are slightly misleading, however. Much of December's total came from financial firms taking advantage of yet another government support program. Specifically, about $74.5 billion of issuance came from banks, most of them using a loan guarantee from the FDIC.
The plan, called the Temporary Liquidity Guarantee Program, is meant to give investors confidence that the government would back any money loaned to the banks.
But since most of the largest banks took advantage of the program late last year, issuance volume dropped to $19 billion for January, indicating nonfinancial corporations have begun to gain investor interest.
Ross Junge, a portfolio manager with Aviva Investors, says investors with cash on the sidelines have had to come back into the market as the Fed lowered interest rates to near 0%. "There was a tremendous amount of cash built up," Junge says. "And investors are getting paid to take risk."
As Junge says, buyers of investment-grade corporate debt have been seeking liquidity premiums, which has pushed spreads of corporate bonds to around 5 percentage points greater than Treasuries.
Even companies as strong as discount retailer Wal-Mart Stores Inc., which has high double-A credit ratings, are paying the premium. When the retailer sold $500 million of five-year bonds in mid-January, it paid 175 basis points over comparable Treasuries. That compares with a 160-basis-point spread in April, when Wal-Mart last sold such bonds, according to Bloomberg News. Another $500 million offering of 10-year bonds was priced at a spread of 200 basis points.
Nonetheless, while these spreads were historically wide, the absolute rates are still low, considering that five- and 10-year Treasuries were yielding around 1.7% and 2.7%, respectively. As one bond market issuer says, "You'll never be blamed for issuing 3% paper, regardless of the spread. That only matters when rates are high."
Not all issuers were received as kindly as Wal-Mart, however. Chemicals company Lubrizol Corp., for example, had to price its $500 million offering of 10-year bonds at a spread of 675 basis points, while R.R. Donnelley & Sons Co. had $1.5 billion of 10-year notes priced at a spread of 904 basis points.
Still, the bond market was encouraged further when Pfizer Inc. received committed financing of $22.5 billion to fund its $68 billion cash and stock acquisition of Wyeth. The underwriters, Bank of America Merrill Lynch, Goldman, Sachs & Co., J.P. Morgan Chase & Co., Barclays Capital and Citigroup, agreed to fund the deal with an initial bridge loan that will be converted to bonds.
"There's a significant amount of cash available for the right companies," says one banker close to the transaction, adding that Pfizer has a lot of cash flow and its high double-A rating gave banks enough comfort to commit precious space on their balance sheets to the deal.
Although there's no short- or even medium-term prospect that banks will return to underwriting leveraged lending, which remains closed to borrowers such as private equity shops, Aviva's Junge is taking the most encouragement from a revival in high-yield bond markets. Those markets are on pace in late January for the most issuance since last July. "Investors started with high-quality, A-rated names, and now they're in their first high-yield issues," he says, adding that the move from low to higher risk suggests a rational progression that indicates increasing comfort with the state of the markets.
"The markets were priced on fear and emotion, and now we're returning to more traditional measures."
According to Standard & Poor's Leveraged Commentary & Data, a flurry of offerings late in January -- there were three until the last week of the month, when another six suddenly emerged -- including ones by energy companies Inergy LP and Chesapeake Energy Corp. and satellite manufacturer Intelsat Ltd., added $1.5 billion to the month's total, pushing it above $5 billion.
But the sense that the future remains dangerously murky tempers even that tentative recovery. "There's still a feeling that things will get worse before they get better," one investor says.
Adds Kingman Penniman, president of high-yield research firm, KDP Investment Advisors Inc.: "If you look at it, the high-yield market has opened up, but it's opened up pretty selectively." Penniman says issuers in energy and industrial companies, such as MetroPCS Wireless Inc., are finding buyers but adds that every one of the nine deals that were priced in January were done on a best-efforts basis, at steep discounts. This means that underwriting banks did not commit financing, and the issuers themselves had to swallow the cost of the discounted selling.
Also, S&P said the offerings came with an average 115-basis-point new-issue premium. This suggests that even though traditional bond investors are starting to come back into the market, they are only doing so when deals are sweetened.
Some market participants, in fact, feel that indicators suggest more pain to come. "The market would indicate that things are bad and getting worse," says one debt capital markets banker, who adds that secondary prices for high-yield bonds suggest default rates much higher than the current level of around 4.5%.
Diane Vazza, head of fixed-income research at S&P, predicts that default rates could hit 13.9%, while Martin Fridson, CEO of Fridson Investment Advisors LLC, says rates could go even higher, approaching 20% by year's end.
It's unclear whether those expectations have been built into the market, but Penniman argues that about 84% of the market trading at distressed levels makes it clear that things are far from rosy in investors' eyes.
Demand for debtor-in-possession loans, provided to companies in bankruptcy, is continuing to rise, which is no surprise given the rising pile of Chapter 11 cases. Unfortunately, lender willingness to provide DIP financing has not kept pace.
In fact, General Electric Capital Corp. gave notice in October that it was exiting the DIP market entirely, and remaining lenders have shown a distinct unwillingness to provide struggling companies with the lifelines they need to continue operating and restructuring while in bankruptcy.
Data from Thomson Reuters shows that DIP loan volume has dropped about 35% during this recession, compared with volume in 2002, the last time bankruptcies spiked.
And prices have increased. According to The Deal's Bankruptcy Insider, the average price of DIP loans between July 2007 and the end of January is LIBOR plus 623 basis points. That compares with LIBOR plus 344 during the tech and telecom bust of 2001 and 2002 -- a significant increase.
According to one distressed-debt investor, lenders are willing to finance companies in bankruptcy, but only in select industries such as chemicals, where LyondellBasell Industries AF SCA unit Lyondell Chemical received $3.2 billion in new money as part of an $8.5 billion package that included existing debt. "The auto sector is something you'd want to stay away from," he says.
Most of the media is ignoring it, transfixed as it is by the wider economic crisis, but some of the financing markets in Europe are showing signs of life. Credit is tight, to be sure, but nothing like the days after the fall of Lehman Brothers. On Sept. 30, the three-month sterling LIBOR rate, for instance, stood at 6.3%. By the beginning of February the rate had fallen to 2.17%.
The corporate loan market in Europe is definitely alive, though not lively. It would be a mistake to see meaningful "green shoots of recovery" in a handful of big, high-price deals, especially as there is very little underwriting available. Yet it is still significant that companies such as German utility RWE AG, Norwegian telecom group Telenor ASA and Spanish food group Grupo SOS are able to fund billion-euro acquisitions with debt and that even some of the most hard-pressed U.K. banks have been lending. For the most part, however, these loans are short term and based on the assumption that corporations will be able to refinance them in the investment-grade bond markets. It is also worth noting that Telenor, which has decided not to opt for a rights issue, had faced months of uncertainty about its financing, and Grupo SOS experienced delays because of the fallout from the demise of Lehman.
The European high-yield market, which had lain buried for 18 months, resurrected itself in January courtesy of German medical equipment company Fresenius SE. The issuer came out with a euro-denominated bond of €275 million ($351 million) and a dollar-denominated bond of $500 million. Fresenius is something of a special case, though, since the sector in which it operates is expected to benefit from government spending. Also, with a BB rating, it is close to investment grade.
More robust is the European commercial paper market. It has continued to function through the crisis, without the equivalent of the Fed's Commercial Paper Funding Facility.
Volumes are down, but bankers believe that the market is working well and that there is no reason for the Bank of England to intervene, as it has indicated it might, to buy up commercial paper to boost liquidity.
-- Neil Sen in London contributed to this article.