NEW YORK-The huge outflows of capital from mutual funds that followed the late October drop in equities markets involved “primarily profit takers, who will be back in a few months,” said Martin Fridson, chief high-yield strategist for Merrill Lynch & Co.
During the weeks of October preceding the market crash, there was about $9 billion in high-yield corporate bond issuance. “The market was already seeing some signs of fatigue and then, over the weekend, was hit with a one-two punch,” said Jack S. Mann, managing director in charge of Merrill Lynch’s high-yield bond underwriting syndicate.
Fridson and Mann took part in a panel discussion, “The Surge in High-Yield Bonds,” sponsored by The Bond Market Association, New York, late last month.
“Goldman Sachs (& Co.) lost some money in the bond business but more in investment grade. High-yield investors were relatively calm. And no one wants to sit on cash for too long,” said Lawrence Buchalter, a partner of the firm that is in charge of its high-yield corporate bond underwriting syndicate.
“Our market has outperformed equities and (investment grade) corporates. That’s one reason why demand for high-yields is so strong.”
High-yield bond mutual funds, which came into existence in this country in the early 1970s, likely will close out 1997 with nearly $100 billion invested in them, up from $65 billion a year earlier, Fridson said.
High-yield bonds account for about 25 percent of all outstanding corporate debt, Mann said.
“These are not just failing companies on their last legs in this market but very prominent, market-leading companies in the world.”
In fact, there is an inadequate supply of high-yield issues available relative to investor demand. “Evidence of this is the concentration of issuance, about 40 (percent) to 50 percent in the telecom/media sector,” Mann noted.
Despite the industry sector concentration, investors are snapping up the securities. “There is nothing wrong with these companies, but a basic principal of a money manager is to diversify his portfolio,” Mann said.
A dearth of available high-yield bond investments has played to the advantage of issuers with such debt outstanding, Buchalter said.
“The most interesting thing from where I sit is the event-related story,” he said. “There are triple-C credits trading (in secondary markets) at low yields because someone expects WorldCom to buy them, for example, so these (companies) are enjoying an arbitrage capability of sorts.”
Triple-C is a low-tier speculative grade rating on corporate debt. Issuers of low-rated debt typically have to offer investors the inducement of high yields during the initial offering of these securities. Arbitrage is akin to what a homeowner does when he or she takes out an equity loan at a lower rate than outstanding credit card bills and uses proceeds from the equity loan to pay off the credit cards.
However, Ron Lee, a principal of high yield capital markets for BT Alex. Brown & Sons Inc., said he believes recent market gyrations will compel some companies to increase yields offered and/or reduce the size of the debt issues they bring to market.
Overall, however, it remains a seller’s market for high-yield issuers. The kinds of deals brought to investment banks for high-yield bond financing these days are another atypical result of this role reversal, which has resulted from a scarcity of new issues relative to demand, Buchalter said.
“We’re working on a deal for Alex Mandl’s Teligent, and we’re being asked to evaluate a business plan, not a credit. It’s questionable if it’s a bond financing or whether it’s a venture capital financing.”
Lee termed that kind of development “integration” and said it is likely to become more prevalent.
“In the application of high-yield issuance for technology companies, we’re beginning to see a move away from traditional cash flow issuer access to what we feel is almost a proxy for equity,” Lee said.
“There is an increasing level of interest by high-growth, high-tech companies in using high-yield (debt) as a substitute for equity or convertible capital, not just to grow the company but also to couple that with an acquisition strategy.”
Another emerging trend is that the high-yield corporate bond market “has become almost exclusively a 144A market with registration rights,” Mann said. Securities and Exchange Commission Rule 144A, also sometimes called a private placement, allows issuers to sell securities without formal SEC registration, provided the sales occur through a broker. Buyers, which tend to be large institutional investors, typically may not resell those securities for at least two years and then only in small increments in each succeeding three-month period.
Besides a concentration of new high-yield bond issuance in the telecommunications and media sectors, about 20 percent of all high-yield bond issuance this year to date also has been concentrated in various kinds of companies in emerging markets, Fridson said.
“The availability of long-term capital at a fixed rate is very valuable, especially in countries that don’t have it,” he said.
Today, the United States is virtually the only country with a developed high-yield corporate bond market, although Canada launched one this year.
Government regulation and “other kinds of artificial restraints” have kept high-yield bond markets from getting started outside the United States so far. Besides the recent debut of a Canadian high-yield market, “there is quite a bit of movement in the [United Kingdom] and Europe can’t be far behind,” Fridson said.
“I look forward to the day when issuers can sell in any country. There should be a high-yield market everywhere.”
