Bonds Market Looking Up

February 14, 2003
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GRAND RAPIDS — Analysts feel this year will be a better year than last for the corporate debt market. Not enthusiastically, mind you. They’ve said it almost has to be.

But they have also pointed out that a lengthy and costly war with Iraq could reverse their less-than-ringing endorsement.

In 2002, short-term notes and long-term bonds took hits from an economy that lost manufacturing jobs and investor confidence from the accounting scandals brought about by Enron, WorldCom, Qwest, Tyco and other alleged corporate cheats.

But as bad as it was, the year could have been substantially worse for the debt market if HSBC Holdings hadn’t acquired Household International Inc. in November.

Reasons for the somewhat hopeful view this year include a slightly growing economy and the fact that many corporations have made serious attempts to lessen their debt loads and restructure their balance sheets.

“We’ve had a lot of companies really using a lot of free cash flow to pay down debt and to build cash levels. That is good for a bondholder,” said Mitch Stapley, chief fixed income officer for Fifth Third Investment Advisors.

Bondholders like hearing that because when a company has less debt, its credit rises. It can also better withstand a downward business cycle, raise investor confidence in the firm, and is more likely to be able to meet its coupon payment dates.

Unlike stock transactions, which don’t compel a firm to declare dividends, a company is required by law to meet its debt payments. If a company fails to make one, a bondholder can push the firm into a bankruptcy filing.

“Companies have to make those payments,” said Stapley. “To the degree that companies are issuing less debt out there, that makes the value of the existing debt even more valuable.”

If companies issue less debt this year, then the spread should get better and that would be good news for bondholders. (See related story.)

As for specific debt categories, Stapley felt the telecom sector would remain pretty dicey this year because some competitive questions have to be answered — namely, who can be the low-cost provider. He said WorldCom could fill that bill, as it is operating without the heavy pressures of its debt load, and that Verizon and SBC could find higher ratings this year. Still, he felt the sector, as a whole, would struggle.

Stapley also thought automakers were facing a tough year due to pension liabilities and obligations. He wondered whether they could drive up sales without using zero-percent financing. GM is facing a dilemma with Fiat. Ford is losing domestic market share to GM. How well the F-150 series of trucks sell will go a long way to determining the type of year Ford will have.

“Autos are cheap,” said Stapley. “There is going to be a lot of scrutiny on their ability to execute this year. It’s really going to drive performance in that sector.”

Stapley said financials have a good chance of doing well if the economy continues to grow, even at a subdued rate. If the yield curve stays steep, regional banks should see profits. But the big ones, like Citicorp and Morgan, could be facing turmoil coming from brokers and lawmakers.

“Congress continues to look for scapegoats for the dot-com bubble and the banks keep coming under the microscope. But overall, their balance sheets are in pretty good shape, barring some really ignominious shock to the system,” he said.

Stapley felt that utilities would continue to struggle this year, as they are loaded with debt. Nor are these companies properly positioned in relation to their cost structures.

The federal deficit, pegged by the Bush administration at $304 billion for FY04, could put some upward pressure on interest rates due to increased government borrowing. But Stapley doesn’t think that the Federal Reserve will succumb to that pressure and raise interest rates, unless the economy bounces back a lot faster than anyone thinks it will.

But the Fed could change its mind in the long-term, he said, after the Treasury borrows for a few years, and if state and local governments do the same.

“We’re looking at a deficit that will be about 4 percent of the GDP. That will still be the lowest of any of the major G-7 industrialized countries, by a pretty long shot. It sounds like a big number, but you’ve got to realize you’re dealing with an enormous economy here,” he said. “It’s not as bad as it has been in the past, or as bad as other countries deal with.”

Bondholders weren’t alone in their suffering last year, as bond managers may have been wounded even worse. A top market draw like Ford, which has more cash than debt, traded like a junk bond that was 700 off in five years. Ford has rallied a bit, but was still trading at 390 off — not a historically strong position, but a better one than it had last year.

“That just shows you how bad it really was. Ford is the biggest issuer. Everybody and their uncle owns Ford,” said Stapley.

“Basically, the bids by HSBC for Household is what turned the market around last year. That showed that someone was willing to step in, buy a business, look at the fundamental value, and not wait until they entered bankruptcy and buy the assets on the cheap.”           

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