Despite Problems, Refco's Lenders Keep Ties

[HenryTo]

The bonds closed at 76.25 cents on the dollar yesterday - near the levels of a distressed company. Stock is down another 25% in before-hours trading as I am typing this:
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Banks and Trading Partners
Continue to Finance Operations;
Firm's Stock, Bonds Slide Again
By ROBIN SIDEL, PETER A. MCKAY, AARON LUCCHETTI and JONATHAN WEIL
Staff Reporters of THE WALL STREET JOURNAL
October 13, 2005; Page C1

Despite Refco Inc.'s critical problems, its lenders and trading partners have so far continued to finance its daily operations, avoiding a rush for the exits that could bring down one of the biggest futures brokerages and disrupt global financial markets.

Banks that provided critical financing to Refco last year haven't as yet pressed the company to revise loan terms, people familiar with those relationships say -- even though those loans were predicated on financial statements from Refco that are no longer reliable.

Wall Street's hesitancy to act against Refco stems at least partly from self-interest: Refco's lenders, trading partners and investors stand to lose if the company's financial position becomes more perilous. Refco is a financial-services firm with few hard assets, so its cash flow from daily operations is key.


And, in an another example of how Wall Street plays multiple roles in the world's financial markets, the same banks that have lent money to Refco and recently earned big fees for taking it public also have sizable commodities businesses. That means they are potential trading partners with Refco, which is a leader in brokering commodities trades, and could be hurt badly if Refco's ability to transact suffers.

Although there is no "counterparty" risk in a trade of an exchange-listed futures contract -- the exchange essentially guarantees both the buyer and seller's sides of that transaction -- that's not the case in other Refco transactions. Like many brokers, Refco does much of its business in privately negotiated contracts in which the parties must trust one another's ability to make good on the trades. Should one side of that trade fail, the other is on the hook. Refco has more than $4 billion in customer accounts, trading with banks, hedge funds and companies that use futures and other derivative contracts to offset exposure in commodities ranging from pork bellies to cows and financial instruments such as Treasury bonds.

For its part, Refco has couched the week's developments as an in-house governance snafu that doesn't affect customers or trading. "We remain a financially strong brokerage firm," the company said in a letter sent to customers on Monday, the same day that it disclosed that an investment firm controlled by Chief Executive Phillip Bennett had owed the company $430 million. Mr. Bennett, now on indefinite leave, repaid the money this week, but Refco said that as a result of Mr. Bennett's dealings the company's financial statements dating back to 2002 "should no longer be relied upon."

Despite those assurances, the situation at the big brokerage remains tenuous. At the New York Stock Exchange, officials were discussing the possibility of "delisting" Refco stock -- which was just listed Aug. 10 -- or at least halting trading while waiting for more information, according to a person familiar with the situation. Big Board rules hold that companies that make inaccurate disclosures can get booted from the exchange. "We're watching it very closely," an NYSE spokesman said.

The Federal Reserve has asked about Refco in the course of its routine, daily conversations with Wall Street firms but isn't taking any action, according to a trader at one firm.

Refco stock, which lost more than half its value over the previous two days, slid another $3 a share, or nearly 22%, yesterday to $10.85. Refco's bonds also continued to swoon; they were down 16% to $76.25 per $100 face value, according to data from the National Association of Securities Dealers. That's down from about $91 on Tuesday. At their current prices, the high-yield bonds are approaching levels typically associated with companies in distress.

It's too late for the Refco initial public offering to be rescinded, as happens occasionally when an unexpected event occurs in the first days after trading starts, legal specialists say. But investors could have strong claims to recover the losses they've suffered from buying shares in the IPO if they prove "material misrepresentation -- and that doesn't look very hard at this point," says John Coffee, a securities law professor at Columbia University. Another legal issue is Wall Street's liability in selling the shares to the public. That type of case or a case involving accountants or directors would hinge on whether the problems with Refco's finances "could have been discovered and weren't," says Tamar Frankel, a Boston University law professor.

So far, firms that trade with Refco appear to be taking a cautious approach. One consultant who works with energy traders in New York said he was studying alternatives for three concerned Refco brokerage clients who called him yesterday. He said he's going to recommend that those customers maintain accounts at multiple firms, but not necessarily that they close their Refco accounts.

Meanwhile, Refco's lenders may already be entitled to start pressuring the company about its outstanding loans. Last year, Bank of America Corp., Credit Suisse Group and Deutsche Bank AG arranged an $800 million loan and $600 million debt offering for Refco as part of a large investment made by Thomas H. Lee Partners LP, the Boston-based private-equity firm that helped bring Refco public and remains a major shareholders.

The banks declined to comment on whether they would seek to revise loan terms. Refco and Thomas H. Lee Partners executives, board members and spokesmen also declined to comment yesterday.

Under its lending agreements, Refco must comply with a series of financial covenants -- maintaining certain levels of earnings relative to debt, for example. But without reliable financial statements, Refco's lenders at some point could take the position that there's no way to know if Refco is in compliance with the requirements under its covenants and hold Refco in default. Lenders have the option to waive covenants or renegotiate them. A covenant violation could give Refco's lenders additional bargaining power to extract concessions from the company, including higher interest payments on the loans.

In a securities document filed in conjunction with its bond offer last year, Refco said that, should it have repay its debt faster than expected, the company could be overwhelmed financially: "We cannot assure you that our assets would be sufficient to repay in full," if debt payments were accelerated by bondholders.

--Randall Smith contributed to this article.

Write to Robin Sidel at robin.sidel@wsj.com, Peter A. McKay at peter.mckay@wsj.com, Aaron Lucchetti at aaron.lucchetti@wsj.com and Jonathan Weil at jonathan.weil@wsj.com

[HenryTo]

Stock halted once it opened this morning. Here is a new, updated press release from the company. Refco just announced a 15 Day Moratorium on Customer Withdrawals at Refco Capital Markets, Ltd.
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Refco Hires Advisors
Thursday October 13, 11:29 am ET
Reaffirms Regulatory Capital at Refco LLC and Refco Securities LLC
Announces a 15 Day Moratorium on Customer Withdrawals at Refco Capital Markets, Ltd

NEW YORK, Oct. 12 /PRNewswire-FirstCall/ -- Refco Inc. (NYSE: RFX - News) today announced that it has retained Arthur Levitt, formerly Chairman of the Securities and Exchange Commission and Chairman of the American Stock Exchange, and Eugene A. Ludwig, formerly U.S. Comptroller of the Currency, and currently Chief Executive Officer of Promontory Financial Group LLC, and Promontory Financial Group LLC as special advisors to its board of directors.

Refco also announced today that it has retained Goldman, Sachs & Co. as its financial advisor.

The Company stated that the regulatory capital and excess regulatory capital of Refco, LLC, its regulated Futures Commission Merchant, and Refco Securities, LLC, its regulated Broker Dealer, have been substantially unaffected by the events of this week. The business at these subsidiaries is being conducted in the ordinary course including customer deposit and withdrawal of segregated funds.

In light of recent events, the liquidity within the Company's non regulated subsidiary Refco Capital Markets, Ltd., which represents a material portion of the business of the Company, is no longer sufficient to continue operations. The Company has therefore imposed a 15 day moratorium on all activities of Refco Capital Markets, Ltd. to protect the value of the enterprise.