10/12 11:55 Corporate Debt Sags on Profit Woes (Update2): Rates of Return By Lee Theodoros

New York, Oct. 12 (Bloomberg) -- Loans and bonds to corporate America are losing value as profit warnings, rising defaults and declining stocks drive investors out of risky securities and threaten to shut some borrowers out of the market.

Some corporate bonds are now trading at levels not even seen in 1998, when the financial crisis triggered by Russia's debt default stunted all but the best-rated firms' access to funds and ground trading on many bonds to a halt.

The declines have dented bond returns and left companies in need of money with the choice of either paying up for funds or canceling financing plans altogether, a prospect that may slow the economy's record expansion. The drop has also made investors less willing to hold lower-rated debt.

``The market is in horrible condition,'' said Richard Stevens, who helps manage $12 billion of bonds at Colonial Advisory Services in Boston. ``People are looking at profit warnings and slower growth prospects for the economy -- that means we have to pick our credits very carefully.''

The average yield gap, or spread, between junk bonds -- the lowest-rated debt -- and U.S. Treasuries, has ballooned more than 2.5 percentage points this year to 7.16 percentage points, a Merrill Lynch & Co. index shows. That's the widest in almost a decade. Spreads on higher-rated bonds have grown by more than half a point to almost 2 percentage points.

No. 1 phone-equipment maker Lucent Technologies and No. 2 cell-phone maker Motorola Inc. earlier this week became the latest of a string of well-known firms to warn that sales or profit will miss estimates, sparking a drop in stocks.

Stocks

The Nasdaq Composite index -- two-thirds computer-related and telecommunications stocks -- is down more than 6 percent so far this week and about 25 percent since the start of September. That's led investors to avoid other risky securities such as corporate bonds, while fueling concerns losses may curb consumer spending and temper growth.

``Risk takers are now being punished in the bond market and on the equity side,'' said John Lonski, chief economist at Moody's Investors Service.

With the rise in yields, higher financing costs have forced companies such as wireless company MainStream PCS to shelve bond and loan sales for now rather than pay the higher interest rates investors are demanding. Junk-rated companies raised about $38.6 billion in the first nine months of the year, about half the pace for the same period of 1999, according to Thomson Financial Securities Data. Shrinking sales also eat into the fees Wall Street firms get for underwriting corporate debt.

Paying Up

Among companies that went ahead with borrowing plans, telecom firm Network Plus Corp. had to pay one of the highest yields on a syndicated loan this year to secure $250 million for expansion.

``In this market, you take the money where you can get it,'' said Robert Cobuzzi, chief financial officer at Network Plus.

Already, corporate bond defaults are threatening to rise to the highest levels since a decade ago, when the U.S. economy was in recession. Moody's predicts the default rate could reach about 8.4 percent by September 2001, the highest since the 10 percent- plus rates of 1990 and 1991. Among the lowest-rated companies, credit-rating downgrades have exceeded upgrades this year, marking the worst deterioration in junk-bond credit quality since 1989, Lonski at Moody's said.

Junk bonds, the worst performers of the U.S. bond market this year, handed investors losses of almost 2 percent since Sept. 1, compared with gains of more than 1 percent on two-year Treasuries, considered among the safest investments.

Telecom Slump

Telecom company junk bonds, in particular -- which have dominated high-yield issuance in recent years -- have been among the hardest hit, slumping more than 4 percent in the period, including price declines and interest, a Merrill index shows.

The drop in high-yield bonds led to some trading losses at Morgan Stanley Dean Witter & Co., and raised concerns that other firms also had losses on bonds.

Even some higher-rated companies are feeling the pinch. Xerox Corp., after issuing earnings warnings and seeing its debt ratings cut, earlier this week said it used its $7 billion credit line rather than tap its commercial paper, or CP, program. That's a move that typically only happens when a company can't access the cheaper and widely used CP market.

``The implications, beyond the negative credit perception for the company drawing down, would be that the cost of bank lines of credit would be driven up as banks become wary of draw-downs on what historically are rarely used facilities,'' said Peter Lyons, who handles more than $14 billion in money market assets at TD Waterhouse Asset Management.

Bad Loans

On the loan front, U.S. federal bank regulators this week pointed to a substantial increase this year in troubled large loans to corporate borrowers. Lucent, for instance, blamed its profit warning partly on higher reserves for potential bad debts stemming from loans to phone companies to buy equipment.

Also hurting buyers and borrowers are withdrawals from mutual funds that invest in high-yield bonds and loans. More than $5 billion was pulled from high-yield mutual funds this year, according to AMG Data Services.

So what will help the market? An interest-rate cut by the Federal Reserve, said some analysts and investors, though most see that possibility as remote with oil prices climbing and inflation on the rise in the U.S. Fed officials raised benchmark rates six times from June 1999 through May, and said after their most recent meeting that risks of faster inflation are still there.

Not Over?

Stevens at Colonial is among investors who are refraining from making any big purchases right now. Margie Patel, who manages the $10 million Pioneer Strategic Income Fund specializing in junk bonds, has steered clear of telecom bonds for the past year, favoring other companies in industries such as energy, electric utilities and semi-conductors.

``Things are becoming so cheap, but I think it might get even cheaper,'' said Patel. ``We're seeing signs of real distress.''

-- Carl Jenkins (Somewherepress@aol.com), October 12, 2000

Answers

All of this puts Greenspan in a box. He can't come up with an emergency, between meetings, interest rate cut this October, as he did in October, 1998, because of the election. The only thing he can do to ease the pressure is blow up the money supply. And, how can he do that with M3 now running at a 10%-12% flood rate?

About the last person on earth whose shoes I'd want to be in would be his, right now.

-- Wellesley (wellesley@freeport.com), October 12, 2000.

This is another great piece of reporting, Carl. I sure marvel at how and where you come up with this stuff.

-- Uncle Fred (dogboy45@bigfoot.com), October 12, 2000.

Although it was only two years ago, few remember that it was the big spread between oorporate junk bond rates and treasurys that had much to do with the big market malaise of Fall, 1998. I, too, had forgotten this, until I read this piece.

Thanks, much, Carl, for bringing it to our attention.

-- Billiver (billiver@aol.com), October 12, 2000.