Thursday June 28, 6:28 pm Eastern Time
Rate cuts spur bonds, underwriters in first half
(UPDATE: The following is one of a series of outlook pieces for the financial industry)
By Jonathan Stempel
NEW YORK, June 28 (Reuters) - For Wall Street bond underwriters, the heat wave of 2001 began on January 3.
That's when the Federal Reserve cut interest rates for the first time this year, igniting a bond boom as stocks struggled. Yields on many U.S. Treasuries slid as prices, which move in the opposite direction, surged.
``We've been off to the races,'' said Jim Merli, global head of fixed-income syndicate at Lehman Brothers Inc.
Companies have sold $364 billion of investment-grade and $50 billion of junk corporate bonds in 2001, according to Thomson Financial Securities Data, topping by about 50 and 160 percent the equivalent figures last year. Investment-grade issuance is certain to smash last year's $429 billion record.
Issuance of other kinds of bonds is also strong, Thomson said, with asset-backed, mortgage-backed and agency issuance totaling $173 billion, $80 billion and $216 billion, and issuance of securities convertible into stock nearing $49 billion. Those totals easily top first half 2000 totals.
After five more rate cuts, much of Wall Street now expects issuance of corporate and other non-Treasury debt to slow. Still, this year's race to sell bonds has helped investment banks boost bond underwriting revenue amid slowing business in stocks, mergers and initial public offerings.
FLEEING STOCKS
Why have bonds become so popular?
For much of 2000, bonds other than Treasuries were a wasteland. Investors bought quality amid jitters about defaults, corporate profits and the slowing economy. Treasuries, which are safest but yield the least, performed the best.
Though the Fed's rate cuts, including a 0.25 percentage point cut on Wednesday, haven't yet worked magic, bond investors clearly think they will. In 2000, short-term Treasuries yielded more than long-term ones, an odd condition often foreshadowing recession. Now, long-term Treasuries yield more.
``The market is believing we will avoid recession,'' said Steve Bohlin, who helps manage $2 billion for Thornburg Investment Management Co. in Santa Fe, New Mexico.
Yields are low, making companies comfortable selling bonds with what remain historically big premiums over Treasuries. Indeed, despite the supply those premiums are shrinking.
``You would think that all things being equal, a heavy calendar of supply would cause spreads to widen, but that doesn't factor in demand,'' said Merli at Lehman.
Lehman, according to preliminary data from Thomson has handled $32.2 billion of investment-grade bond sales in the first half, following leader Salomon Smith Barney's(NYSE:C - news) $82.8 billion, J.P. Morgan (NYSE:JPM - news), Merrill Lynch & Co.(NYSE:MER - news) and Morgan Stanley (NYSE:MWD - news).
Many companies have seen big demand for bonds. Among the year's big sales were WorldCom Inc.'s(NasdaqNM:WCOM - news) $11.9 billion sale in May, a record for a U.S. company, and Ford Motor Credit Co.'s(NYSE:F - news) $3.8 billion auto loan-backed offering in March.
``A lot of issuers got in the market earlier this year, where you got good executions,'' said Jeff Salmon, head of ABS research at Barclays Capital.
The same was true in mortgages. ``If we see further declines in rates, that could spark another round of refinancings,'' said Art Frank, head of mortgage research at Nomura Securities International Inc. ``If we stay at current levels and the refinance wave peters out, issuance will decline.''
Meanwhile, in agencies, Fannie Mae(NYSE:FNM - news), Freddie Mac(NYSE:FRE - news) and the Federal Home Loan Banks have sold debt to replace retired debt. ``It's all been driven by callable issuance,'' said Mukul Chadda, a Lehman agency strategist.
In contrast the junk bond market has been two-faced. Many companies are raising cash, but the door is shut tight to telecommunications companies. Those needing cash have sold convertible bonds, sold nothing -- or gone bankrupt.
``The market has a higher threshold for quality,'' said Prescott Crocker, a high-yield portfolio manager at Boston's Evergreen Funds.
According to preliminary data from Thomson, Credit Suisse First Boston regained its traditional lead as the biggest junk bond underwriter, with $7.8 billion of sales. Goldman Sachs & Co.(NYSE:GS - news), Salomon, Morgan Stanley and Banc of America Securities LLC(NYSE:BAC - news) followed.
Thomson said in ABS, Salomon leads the way, ahead of Credit Suisse, J.P. Morgan, Lehman and Deutsche Bank AG, while the top five for MBS are Credit Suisse, Bear Stearns & Co.(NYSE:BSC - news), Banc of America, Lehman and Salomon. For agencies the leaders are Morgan Stanley, Merrill, Credit Suisse, Goldman and Lehman, and in convertibles the top five are Merrill, Credit Suisse, Salomon, Morgan Stanley and Goldman.
SLOWDOWN
The outlook for non-Treasury bonds and underwriting remains good, experts said, especially if rate cuts rekindle America's love affair with stocks and the companies behind them.
But experts warned the bonds won't perform like gangbusters, especially if investors get more selective. And some issuance will likely drop to normal levels, they said, because many companies have sold the bonds they need to finance mergers, get rid of short-term debt, or prefund expenses.
Lehman's Merli likened the corporate bond market to baseball's Barry Bonds, the San Francisco Giant outfielder on pace to set a home run record.
``Barry Bonds isn't going to hit 90 homers this year, and I wouldn't expect $650 billion of investment-grade supply,'' said Merli. ``I would expect a fairly significant slowdown (as) investors become more cognizant of higher quality paper, in more defensive sectors.''
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