Wall Street Journal - 09/04/98
By GREGORY ZUCKERMAN and PATRICK MCGEEHAN Staff Reporters of THE WALL STREET JOURNAL
NEW YORK -- With Wall Street firms and hedge funds still reeling from heavy losses in emerging markets, the focus of concern about red ink is widening to include several domestic fixed-income sectors, including corporate bonds and mortgage-backed securities.
Lehman Brothers Holdings Inc. Thursday became the latest of the major financial institutions to reveal how badly it has been hit in the recent market turmoil. The firm took the unusual step of forecasting
third-quarter earnings of $151 million, down from $197 million a year earlier, in part because of a $60 million after-tax loss caused by the volatile emerging-markets sector.
Separately, famed hedge-fund manager Leon Cooperman's Omega Advisors LP has incurred substantial losses of its own, investors close to firm said. Omega's Overseas Partners fund shed 22.3% of its value, or $446 million, in August, according to these investors. The fund is down 14% through Aug. 31, but retains substantial cash balances and hasn't experienced any margin calls.
"August was generally a bloodbath for hedge funds with emerging markets or Russian exposure," said Lois Peltz, of MAR/Hedge, a hedge-fund tracking firm.
But even as word was spreading about the latest emerging-markets problems, some analysts and others were calling attention to potential damage much closer to home.
"Broadly for the Street, the story is broader than emerging markets," said Guy Moszkowski, an analyst at Salomon Smith Barney. "The impact of the increase in [yield] spread on corporate, high-yield and
other domestic bonds is probably more important for many firms than what happened in emerging markets."
The corporate-bond market has tumbled in recent weeks amid investor fears that a recession may be looming. And mortgage-backed securities have also been weak, as falling interest rates spark worries
that higher mortgage refinancings will cripple mortgage-backed bonds.
Adding to concern is the way many firms try to protect their corporate-bond and mortgage-backed-bond portfolios against a move in interest rates by selling Treasurys securities short, or selling borrowed Treasurys in the hope of profiting by buying them back at a lower price. The strategy has worked wonders in recent years because corporate bonds and Treasurys have moved more or less in unison.
Not lately, however. Treasurys have rallied in the last six weeks, amid a global flight to quality, but other, riskier bonds have weakened. As a result, many Wall Street firms have suffered losses from their bond holdings, which have fallen in value, and their Treasury short positions, which have also lost money.
"In the last couple of weeks almost all trading desks have been damaged by both widening spreads and a simultaneous Treasury rally," said Mark Patterson, head of corporate bonds at Credit Suisse First
Boston. "It's been a double whammy."
"To say it's been hard to hedge would be an understatement," said Grant Kvalheim, global head of debt capital markets at Deutsche Bank Securities Inc.
Industry talk points to losses in the tens of millions of dollars at most bond houses on Wall Street. Much of the speculation has centered on Merrill Lynch & Co., the firm with by far the biggest position in the corporate-bond market.
Merrill has repeatedly declined to talk about any trading losses, even as the firm's stock price has sunk about 40% since mid-July. Merrill's silence, while most investment and commercial banks have
announced losses caused by all the turmoil, has fueled questions about the firm's experience.
Some Wall Street executives have suggested that Merrill may be hoping to recover some of the losses they assume it has recorded before announcing results for the quarter.
A Merrill spokesman reiterated Thursday that the firm has a policy of not discussing its results "intra-quarter."
Some analysts are estimating the impact on Merrill's earnings by extrapolating from other firms' announcements. Mr. Moszkowski last week trimmed his estimate of Merrill's third-quarter earnings by
19% to $1.05, from $1.29 a share. That translates to a hit of more than $80 million, but Mr. Moszkowski says the real impact "might be bigger."
One of Merrill's major competitors, Morgan Stanley Dean Witter & Co., said earlier this week that the damage in its fixed-income businesses will shave about $110 million off its net income for the quarter
that ended Aug. 31. Some of that came from corporate and junk bonds, but a big chunk came from leveraged investments in emerging markets made by the firm's asset-management unit.
The trading losses at many Wall Street firms have been so substantial that many are suddenly reluctant to quote reasonable prices, or make a market in corporate bonds, say some institutional investors. This
has reduced liquidity, sending the corporate-bond market into its worst crisis in years.
"Wall Street brokers are extremely reluctant to take on additional inventory," said Greg Hopper, a portfolio manager at Bankers Trust Global Investment Management. "It's not unusual in bad markets, but
it hasn't been this bad since 1990 and 1991, and it frustrates me."
"There's been an improvement in liquidity in the last day or two, but the adjustment in the corporate market in the last two weeks has been more severe than that of the stock market, and in many cases
Wall Street was caught with too much on their books," said Brad Tank, director of fixed income at Strong Capital Management.
Indeed, the $183 billion in corporate bonds issued this year is already a record, according to First Boston, as is the $251 billion in government-agency issuance.
Because brokerage firms usually feel an obligation to make a market in bonds they underwrite, many have been forced to buy back bonds amid the market's sell-off, traders say.
"Standing by a bond is your calling card to investors and future issuers, and it hurts your reputation if you don't make a bid for a bond as the market plunges," said a trader. "But this means losses,
especially if your hedges don't work."
Treasury Securities
U.S. Treasurys posted moderate gains on another weakening in stocks.
In late trading, the benchmark 30-year bond rose 17/32 point, or $5.3125 for a bond with $1,000 face value, at 102 29/32. The bond's yield, which moves in the opposite direction of its price, fell to 5.297% from 5.332% late Wednesday.
As in recent sessions, the bond market followed the stock market's gyrations.
A speech by the San Francisco Federal Reserve Bank's president, Robert Parry, was generally seen as neutral for Treasurys. Mr. Parry said recent declines in U.S. stocks will likely slow the economy and rein in consumer spending, and reiterated that global financial turmoil still poses a threat to the U.S. economy.
Friday, investors and traders will scrutinize the Labor Department's latest monthly report on growth in U.S. nonfarm payrolls, looking for evidence that wage pressures may be increasing.
A Dow Jones-CNBC survey of economists shows that August payrolls are expected to have risen by 375,000, up from a 66,000 gain in July. Unemployment is seen declining to 4.4% from 4.5% in July.
In other credit markets:
Municipal bonds finished a lifeless session 1/8-point higher but continued to underperform U.S. Treasurys.
U.S. brokerage paper widened in the corporate bond market on news of sector losses due to the Russian economic fallout.
Mortgage-backed securities inched up 2/32 in thin trading.
In the Eurobond market, Fannie Mae reopened its global benchmark program to offer $2 billion of five-year notes. |
