3 banks sold WorldCom debt despite doubts

Investors were never told of misgivings


Three big banks expressed misgivings internally about WorldCom Inc.'s financial soundness in early 2001, just months before they helped the company sell $12 billion in debt, according to documents filed in federal court in Manhattan yesterday.

But their doubts - and the basis for them - were not disclosed to investors who bought the debt 14 months before WorldCom filed for bankruptcy.

The role that banks may have played in papering over WorldCom's financial problems, which led to billions in investor losses, has not been determined.

But the new documents indicate that institutions close to WorldCom knew more than they let on to investors and that they acted to protect themselves from the company's shaky finances even as they sold its securities to the investing public.

Whether signs of the company's deteriorating financial condition should have been disclosed to investors will be up to a court to decide.

The documents were filed yesterday in connection with a class action lawsuit brought two years ago on behalf of the New York State Common Retirement Fund and other investors who bought WorldCom securities from 1999 to 2002.

Defendants in the case include Bernard J. Ebbers, WorldCom's former chief executive, who was indicted on fraud charges two weeks ago, the company's directors, and the banks and brokerages that sold WorldCom securities.

According to the documents, credit analysts on the lending side of three banks - J.P. Morgan, Deutsche Bank and Bank of America - saw increased risks at WorldCom and privately downgraded the company. In one case, an analyst recommended that the bank cap its loan exposure and not lend more to WorldCom.

In a February 2001 portfolio credit review of WorldCom, a Deutsche Bank credit analyst noted "performance concerns." Shortly after the bank analyst recommended no new lending to WorldCom, the bank effectively asked investors to lend the company money by buying the bonds.

"Per concerns/trends summarized above, WorldCom will be downgraded," the note said, adding "we seek a cap at the current level. Risk appetite reduced."

And J.P. Morgan Chase & Co., in an internal credit analysis dated Feb. 27, 2001, reduced its own rating of WorldCom because of "its weakened credit profile" and continued pressure on its long-distance business.

In the last 2 1/2 years, banks have come under increased scrutiny for their roles in the corporate scandals that began with the collapse of Enron Corp.

In July, J.P. Morgan Chase and Citigroup Inc. paid $300 million to settle charges without admitting wrongdoing that they helped Enron mislead investors about its financial position.

Back in early 2001, WorldCom badly needed to raise money. Documents from Citibank and Salomon Smith Barney, its brokerage unit, show how important the debt offering was to WorldCom and its lenders.

In a memo dated March 2001, relating to a $3.75 billion line of credit that WorldCom wanted to refinance, analysts at the bank recommended increasing the amount it was willing to lend the company, noting that the money was unlikely to be used.

Assuming the company was able to raise at least $10 billion from outside investors, the analyst wrote: "We believe the company will not face any liquidity issue to repay and finance its operations."

The Citibank memo also stated that the note deal would help cover WorldCom's negative cash flows for fiscal 2001, 2002 and 2003. In 2002 and 2003, according to the memo, WorldCom's negative free cash flow - essentially how much more it would spend than it took in - was expected to be $1.4 billion.

Securities laws may not have required the banks helping WorldCom sell its debt to disclose the cautionary views of their credit analysts to investors, lawyers said. One securities lawyer said, though, that a deterioration in WorldCom's financial position could be considered a big enough risk that it should have been disclosed in the offering document. It was not.

All the banks whose analysts expressed doubts internally about WorldCom played major roles in the company's 2001 note sale, the third-biggest debt offering in history.

J.P. Morgan Securities, the securities arm of J.P. Morgan, was a lead underwriter, along with the Salomon Smith Barney unit of Citigroup; each bank sold $3.24 billion in notes to U.S. investors.

Banc of America Securities, the brokerage unit of Bank of America, sold $1.1 billion in WorldCom notes, and Deutsche Banc Alex. Brown, the brokerage unit of Deutsche Bank, sold $808 million. All the firms sold additional amounts of the WorldCom notes to European and British investors.

Representatives at J.P. Morgan Chase and Bank of America declined to comment on the documents. A Deutsche Bank spokesman said, "We can't comment on matters in litigation."

The WorldCom bonds recently traded at about $350, down from an offering price of $1,000. As it turned out, the banks all ended up losing money they lent to WorldCom after it sought bankruptcy protection. The company, renamed MCI, is expected to emerge from bankruptcy next month.

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