Gridlock is gripping the bank bond market as jitters over second-quarter earnings put the brakes on the sector's 1991 rally.
After a stellar run-up that trimmed spreads hundreds of basis points and left many analysts scratching their heads, bond investors are again staring at bleak fundamentals from U.S. commercial banks.
But now, bank bonds are no longer the buy they once were. That has left many investors scrambling to take profits, only to find few willing buyers in the unsettled market.
The sector, blind-sided last week by a 94% slide in earnings at Wells Fargo & Co., got more bad news from California yesterday as First Interstate Bancorp announced a $295 million loan loss provision for the second quarter. That will leave the Los Angeles bank with an $80 million loss for the quarter.
While such news has battered equity players -- First Interstate's commons stock fell roughly 17% yesterday -- the bond market has barely shown a ripple.
First Interstate's 12 3/4s of 1997 were quoted at 112 to yield 9.98% late yesterday, down 1/8 point in line with the Treasury market.
"There's been some activity in the West Coast bonds, but in these markets, they just quit trading and dealers quote at much wider spreads," said one New York trader. "Going into these earnings reports, prices are going to start moving down -- a lot of names are very vulnerable. First Interstate is clearly going to shake some people's confidence."
Pressured by exposure to highly leveraged transactions and sagging real estate markets, some banks watched their bonds trade down 500 basis points last year. But as the sector cheapened -- and hopes of a rebounding economy washed over the financial markets -- bank bonds' high yields ignited a fierce rally.
"The market was trading well ahead of itself," said Anne McDermott, bank analyst at PaineWebber Inc. "Bank asset quality never turns at the same time the economy does."
But while the industry's outlook remains cloudy at best -- Ms. McDermott suspects second-quarter earnings will contain "a few surprises" -- investors are in a lurch.
"You've got investors that would like to take advantage of the run they've had and take their profits, but the question is, where do they then reinvest those profits?" Ms. McDermott said. "So people are holding thei bank bonds for lack of a better alternative."
For their part, traders say technical factors are helping keep the sector afloat.
While the equity market trimmed nearly $1 billion off the valuation of Wells, the company's bonds hardly budged. Many traders note that insurance companies, which had supplied many securities to short sellers as the bank bond market tanked last year, have all but gotten out of the stock and bond loan market. That makes it difficult to borrow bonds, inhibiting short sellers.
Michael J. Ross, vice president at Kemper Securities Group, said, "The entire market got caught up in 'We all want bank paper.'"
"I want to see second-quarter numbers," Mr. Ross said. "If they're disappointing, look for some banks to toss away this year as well. Everyone is saying New England, but I think it's something to be a little contrarian about -- we're looking out West to see how bad thing are."
The bank bonds' rally also opened the doors to the primary market for many institutions. That may change as earnings come in, players say.
According to Securities Data Co., commercial banks sold $8.5 billion of debt securities in the first half of 1991, up dramatically from the $2.6 billion they sold in the second half of 1990.
"I think the market's pretty much closed to banks until second quarter results are in, except for super-quality names like Republic New York," said Andrew Aran, fixed-income analyst at Alliance Capital Management LP. "People have to be reconsidering their bullishness, and have to be more selective.
Most investment-grade bonds slipped 1/8 point in light trading yesterday, matching Treasuries' losses. Junk bonds, meanwhile, finished flat to 1/4 higher.
In ratings action, Standard & Poor's Corp. downgraded American Express Co., citing lingering concerns about Amex's securities unit, Shearson Lehman Brothers Holdings Inc.
The agency cut American Express's senior debt to AA-minus from AA, affecting $9.6 billion of debt.
S&P Downgrades Hit Record
Corporate credit quality continued to deteriorate in the first half of 1991 as downgrades hit a record $408 billion, Standard & Poor's Corp. reported yesterday.
First half downgrades were just $100 billion short of the $500 billion of corporate debt lowered in all of 1990.
"S&P expects the number of rating downgrades to continue to exceed the number of upgrades -- at least through the balance of this year," said Leo C. O'Neill, chief ratings officer at the agency. "Even an early end to the ecession in unlikely to provide much relief for the many corporations and municipalities that have taken on substantial debt in recent years.
