Financial troubles at Lehman Brothers led Standard & Poor's and Fitch Ratings yesterday to place a prepaid gas revenue bond issue linked to the bank on negative watch.
The rating agencies took the action on Georgia's Main Street Natural Gas, Inc. Series 2008A bonds, which are rated A by Standard & Poor's and A-plus by Fitch. The action followed the rating agencies' decisions Tuesday to place Lehman Brothers' ratings on negative watch amid questions about the bank's capital-raising ability.
Main Street issued the $709 million issue to fund a natural gas prepay transaction with Lehman Brothers Commodity Services Inc., which acts as the gas supplier. As Lehman Brothers guarantees the performance of Lehman Brothers Commodity Services, the rating action reflects Lehman Brothers' status as the "lowest-rated counterparty with obligations that are critical for the transaction to function as structured," according to Standard & Poor's.
In a prepaid gas transaction, the issuer sells debt and pays upfront for a long-term gas delivery contract, while also engaging in a swap transaction with a third-party. The gas supplier, usually a financial services firm, must either deliver the gas or reimburse the issuer for the cost of it, which is why the financial health of the counterparty can impact the rating on the bonds.
Lehman, which has seen its stock price battered this week, yesterday said it expects next week to report a loss of $3.9 billion in the fiscal third quarter. Lehman also plans to spin off of a "vast majority" of its real-estate assets into a publicly traded company, sell of a majority interest in its investment management division, and cut its dividend, it said yesterday.
Shares of Lehman have plummeted nearly 90% from its 52-week high as it continues to deal with fallout from the credit crunch. Shares of the bank plunged 45% on Tuesday after the Korea Development Bank said it had ended its discussions to invest in Lehman, which led to the rating agency actions.
The stock fell again in heavy trading yesterday, falling $0.54 to close at $7.25.
"The CreditWatch listing stems from heightened uncertainty about Lehman's ability to raise additional capital, based on the precipitous decline in its share price in recent days," said Standard & Poor's credit analyst Scott Sprinzen in a statement Tuesday night. "Although the ratings ultimately could be affirmed, we do not currently rule out the possibility of lowering the ratings by more than one notch."
Standard & Poor's holds a long-term rating on Lehman of A, while Fitch holds a rating of A-plus. Moody's Investors Service yesterday placedits A2 long-term debt rating on Lehman on review with direction uncertain.
Other prepaid gas deals have also seen rating agency action as a result of financial troubles at the counterparties involved in the transactions. In July, Fitch placed $2 billion in prepaid gas transactions on negative watch because of links to Merrill Lynch & Co.
The pressure on the financial services companies involved in prepaid gas deals has had a negative impact on the issues' themselves, according to Guy LeBas, a fixed-income strategist at Janney Montgomery Scott LLC.
"They're relatively illiquid, so it's hard to track the degree of the widening, but we have seen a high degree of correlation between the stresses on these financials and the spreads on these bonds," LeBas said.
