The Bond Market's Still in the Doldrums

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Alan Greenspan

, but no thanks.

The euphoric reaction in the stock market to the

Federal Reserve's

recent rate cut hasn't been matched in the fixed-income market. Even though the trading "sentiment" in corporate bonds has improved in the last couple of days, the spreads between corporate bonds and Treasury bonds have continued to widen. Financing opportunities remain limited for the companies that need it the most.

The Fed's noble goal was to inject liquidity into the bond market with its surprise Oct. 15 rate cut. But the systemic risk caused by the mass selling by hedge funds of all fixed-income assets has caused a drag that will not be alleviated until investors feel comfortable buying the bonds of risky companies. Once that happens, companies may be able to sell new bonds.

"You cannot with any confidence state that the Fed interest-rate cuts have accomplished their objective," said John Lonski, senior economist at


. "It seems we've had a little more in investment-grade bond issuance; that's trickling in a little more briskly."

High-yield issuance slogs along

High-yield issuance certainly isn't moving briskly. Since the junk market's virtual shutdown at the end of July, only six companies have financed deals, four of which are rated one notch below investment grade. Leveraged activity, which accounted for about 25% of the buying in this market (and frequently bought the most speculative names), has moved to the sidelines. Therefore the buyers who would purchase bonds that hedge funds sold are looking at the particular companies as long-term investments. There isn't much evidence that they're willing to buy those bonds just yet.

The spread, or difference in yield, between Treasury bonds and Moody's high-yield index has widened from 560 basis points, or 5.6 percentage points, to 642 basis points, or 6.42 percentage points, as of Tuesday. Bonds of speculative companies such as



, which priced a $400 million issue last December at 11.5% near 100 cents on the dollar, are currently trading at 75 cents on the dollar, yielding 16.98%.

"I don't think we're going to see continued improvement in spreads because there is still a lot of secondary supply overhang," said Margaret Patel, manager of the $10 million

Third Avenue High Yield

fund. "The leveraged players that added so much liquidity in helping absorb the huge

issuance calendars aren't going to be nearly as much of a factor" as they were.

What this means is that the appetite for risk among high-yield investors has not yet been tested. Once the spread between Treasuries and high-yield narrows, speculative companies will begin again to finance their activities.

But this will likely not begin to happen until 1999. "It's going to take time to gradually absorb the securities, and two, as we get into 1999, we have to get some feeling as to how much our economy is going to slow down," Patel said. "I think we'll get more Fed easing and it will make yields of the survivors look more attractive."

When junk companies begin to issue to the market again, they may find the terrain somewhat different from the smooth pavement they encountered in 1997 and early 1998. Generally, high-yield companies, since they are less well-known, go on road shows to drum up interest in their financing needs among investors. In the frenzy of 1997 and early 1998, companies weren't even bothering with this formality, instead conducting conference calls and then pricing the deals a few hours later. As one investor said, "Junk


have a road show."

In addition, the companies that attempt to finance through a junk-bond offering won't include start-ups, or firms that investors refer to as "an idea." A company such as

Level 3 Communications


falls into this category. This telecommunications concern financed $2 billion in the market just to build out its network. To Level 3's credit, it already had several billion dollars' worth of holdings in various industries.

The most risky companies were usually forced into including warrants for a portion of the company's equity, a practice that disappeared in the spring. More than likely, new companies will be forced to entice investors with equity again.

One factor currently operating against a new company is fear. If the average high-yield bond is trading at 12%, and a company is so desperate to get money at 13%, then "you've got to wonder why they're selling in this market," said one banker.

Investment grade is slow but steady

While investment-grade trading declined during August and September, the companies that needed money here didn't stop issuing bonds. During the first seven months of 1998, $795 million in investment-grade domestic bonds were priced per business day. In August that figure fell to $143 million a day before recovering to $346 million a day in September and $316 million per day in October.

That translates to two medium-sized or one large deal per day, in comparison to about four deals per day earlier in the year.

According to Moody's, the spread between Treasury bonds and Moody's corporate bond index before the Fed's September rate cut was 149 basis points. The spread as of yesterday was 173 basis points. The spread was even tighter at the beginning of the year, closer to 110 basis points.

Lonski said investment-grade issuance remained consistent from January through June even as spreads widened. Most of this is attributable to the rally in Treasury bonds, exacerbated by the flight from emerging markets and other risky assets.

Since investment-grade bonds, by their nature, carry a certain level of risk, investors didn't turn tail on these products. The prospects in this sector for the rest of 1998 are stronger than in the high-yield sector. Investment-grade bond registrations, which averaged $41.3 billion a month from January to July, averaged $58.5 billion a month in August and September.

In comparison, high-yield registrations dropped from $16.3 billion during the first seven months of the year to $10.8 billion in August and September. Since many high-yield deals are sold prior to registration, it is worthy to note that the forward calendar, or expectation of new deals, hovered around $8 billion in the spring, but currently stands at $1.5 billion.

"The sudden jump in M&A announcements are a positive development as well," said Lonski. "Perhaps a healthier attitude toward risk is returning for investors."

Generally, an investment-grade issuer has existing debt, has no problem meeting their obligations and, well, makes money, more than can be said for recent high-yield issuers.