Morgan Stanley falls, AIG gyrates as financial carnage continues; ILFC takes flight

By Paul Deckelman

New York, Sept. 17 - Investment-grade financials on Wednesday continued to be on the receiving end of the ongoing beating doled out by investors nervous about whether the financial models that those companies have operated under is broken amid the suddenly changed environment.

Among the big losers was Morgan Stanley, being pushed by powerful but panicky market forces into the same kind of shotgun marriage to a commercial bank - probably Wachovia Corp. - that Morgan Stanley rival Merrill Lynch & Co. ended up in.

American International Group Inc.'s recently battered bonds were meantime on a dizzying ride, first shooting up as investors digested the news of the $85 billion bailout of the troubled insurance giant by the Federal Reserve, but then coming back down from those heights after the initial euphoria about the company being saved from bankruptcy began to wear off.

However, the bonds of AIG's valuable aircraft leasing division, International Lease Finance Corp., which had fallen Tuesday along with the rest of the AIG capital structure, were seen having bounced back smartly, on the assumption that the lucrative business will be sold for a sizable premium.

The until-recently active primary, meantime, remained in a standstill mode as participants waited for the current financial sector shakeout to subside.

In the investment-grade secondary market Wednesday, advancing issues continued to trail decliners by a ratio of almost two-to-one, while overall market activity, reflected in dollar volumes, rose 5.5% from Tuesday's pace.

Spreads in general were seen wider, in line with generally lower Treasury yields; for instance, the yield on the benchmark 10-year note declined 5 basis points to 3.41%

A trader said that "Morgan Stanley, AIG and Goldman Sachs have been the focus."

International Lease Finance Corp. "is trading better because they feel its stronger and they're going to spin it off," he added.

He noted the Morgan Stanley-Wachovia rumors - in the context of Lehman Brothers Holdings Inc. selling a substantial chunk of its domestic business to Barclays plc and, overseas, HBOS agreeing to combine with Lloyds TSB. "Things are all over the place."

He said that Morgan Stanley and Wachovia are being quoted on a dollar-price basis - the latter's bonds, he said "are like 800 [bps] over in some instances." He said that Goldman "for the most part" was still being quoted on spread."

Morgan Stanley falls as Wachovia beckons

Morgan Stanley's bonds and shares - the latter hammered down some 24% in heavy trading - were pushed lower Wednesday as the Number-Two independent investment bank, once considered well-run and solid as a rock, became the latest target for short sellers and for nervous investors worried about the viability of its business model in the suddenly - and radically - changed landscape.

A trader saw $83 million of its 3.875% notes due in January 2009 closing on a round-lot basis at 74.75 - a yield of 111%. "Again, this is a bond that's maturing 1/15/09, and Morgan Stanley is A1/A+. This pretty much gives you the picture of what went on today."

He also saw $177 million of the company's 6.625% notes due 2018 making a final round-lot level of 64.5, for a 13.25% yield. However, another market source saw the bonds finishing the day at 75, down 3 points, after having bounced around from the mid-50s to the mid 70s. At one point, the spread over comparable Treasuries on the bonds had pushed out to some 1,114 bps - a full 367 bps wider than on Tuesday.

Its 5.50% notes due 2017 meantime lost over 3 points on the day to finish at 62, after having first fallen as low as 55.

Late in the session stories circulated that Morgan Stanley had been in talks with Wachovia Corp. on a possible combination. However, Wachovia has also had its share of mortgage troubles - its $25 billion purchase of Golden West Financial Corp. in 2006, at the height of the housing boom, exposed it to large mortgage losses. Reports said that the two companies might negotiate a transaction more along the lines of a merger of equals than a rescue such as Bank of America's transaction with Merrill Lynch.

AIG all over the place after bailout

As has been the case all week, American International Group's bonds were being actively traded around - including in the junk bond markets as well as the more traditional investment grade desks, even though they technically remain investment-grade instruments, at least for now.

The bonds swung wildly as investors grappled with Tuesday night's news that the Federal Reserve had reversed its earlier opposition and will loan the staggering New York-based international insurance powerhouse $85 billion - in return for taking a nearly 80% ownership in AIG. The deal buys AIG time to sell off some of its businesses in order to come up with $14.5 billion of additional collateral made necessary by credit-agency ratings downgrades. Federal officials feared that letting AIG follow Lehman Brothers Holdings Inc. down the tubes and into bankruptcy would create a shattering domino effect on world financial markets, given the wide exposure that banks and other financial companies have to AIG.

A market source saw AIG's most widely traded issue, its 5.85% notes due 2018, gyrating around on heavy volume of almost $60 million, although that pales next to the over $200 million of those same bonds that changed hands on Tuesday. The bonds were seen having opened at 58 bid, well up from the levels at which they finished on Tuesday and then popped as high as the mid-60s, before coming down from that peak to stabilize in the mid 40s - about unchanged on a round-lot basis from where the bonds had gone home on Tuesday, though still about 10 points above the levels at Tuesday's close, which saw a bunch of smallish trades in the lower 30s.

Another trader quoted the bonds going out at 43, versus the prior day's 44.75, and said that the bonds had popped higher "the first thing in the morning" on a couple of big-block trades of over $5 million, before coming back down. The bonds were yielding 19.21%.

The trader also saw AIG's 4.625% notes coming due next May 15 trading at 65, and noted that works out to a yield of 85%. $30 million of the bonds were traded.

While the bonds seemed to get a boost, however short-lived, from the news the company would be spared bankruptcy by being taken over by Washington, AIG's already badly decimated NYSE-traded shares plunged as much as 47% in the early going before finally stabilizing only slightly above that low, to finish at $2.05, down $1.70, or 45.33%, on volume of 546 million, more than six times the usual turnover.

International Lease bonds rebound

The one exception to the generally dismal picture in the financials was International Lease Finance's bonds. The AIG aircraft-leasing unit's paper had fallen on Tuesday along with the rest of the capital structure -AIG's corporates and the bonds of its American General Finance Corp. subsidiary.

But on Wednesday, those aircraft-lease bonds were seen gaining altitude, on the assumption that the valuable unit - considered one of AIG's crown jewels - can be sold for a hefty price and thus freed from being associated with the faltering AIG.

ILFC's 6.375% notes due 2013 were seen by a market source to have recovered almost all of Tuesday's losses, up some 17 points on the day at just over 79.

Another source saw ILFC's 4.875% notes due 2010 having jumped some 25 points over its Tuesday levels to the 75 mark.

Its 6.375% notes due 2009 finished at 82 bid, a 9 point improvement.

And its 4.15% notes due 2015 had improved to 87 bid.

Primary shut for now

In the primary market, it was generally agreed that investment-grade issuers may be skittish - and with good reason. A market insider told Prospect News Wednesday as the Dow Jones Industrial Average plunged almost 450 points, that "absolutely nothing is getting done and I don't expect anything to get done all week.

The sell-side source added that "issuers are taking a good, hard look at the market right now and it's going to take a while for things to adjust. There's lots of stuff to price, but no one wants to get out there now. I would imagine once the dust settles and we have a sort of normalizing period, things will pick up again. In fact, I'm sure we'll have a big influx of stuff all at once, probably as early as next week."

Sheri Kasprzak contributed to this report.

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