Look Back At The Decade: HY Closes Century On A Roller Coaster
January 3, 2000
The 1990s began on a decided down note for high yield, and it's ending in a slump as well.
In between was a wild ride with fortunes won and lost, sometimes overnight; new players emerging at the pinnacle of the market; new ways to communicate with people who, in some case, were complete strangers; and a whole new set of acronyms used to describe issuers that didn't exist in the 1980s.
A recession, a savings and loan crisis (in which junk bonds played a key role), skyrocketing default rates, and a desert war all hit the U.S. in the dawn of the decade, and they all took their toll on the financial markets. (See story on defaults below.)
Late in 1989, the junk bond market collapsed, but that was really just the beginning, as the following year saw less than $1 billion in high yield issuance. In February of 1990, high yield market maker Drexel Burnham Lambert filed bankruptcy and later that year, the firm saw its junk bond king Michael Milken get sentenced to 10 years in prison.
In 1991, Executive Life was seized by state regulators in California, which caused life insurers across the board to pull back from high yield. Merrill Lynch & Co. high yield strategist Martin Fridson noted that while all this was happening, the returns in high yield had never been higher. Indeed, in 1991, returns hovered between 35% and 41% depending on the index used.
He concluded that life insurers at the time pulled back more as a marketing strategy to their customers than from a genuine investment risk, but they nonetheless pulled back, creating a shortage on the buy-side.
One portfolio manager who has been in the business since the late 1980s said the outlook was bleak at the time, to say the least. "A lot of people thought our market was going to be dead... people were saying that there were a lot of greedy people in the 1980s and they leveraged companies up and took their underwriting fees," he said.
Instead, the market is now booming, he said. The advent of the Rule 144A market helped high yield immensely (see story and chart on page 3). In 1993, Rule 144A transactions had tripled their share of the overall high yield market to 15%, and by the middle of the decade, accounted for half the market. The new transactions helped ease the entry into the capital markets for issuers that before had relied on more traditional financing such as bank facilities and traditional private placements.
The biggest boon possibly was the deregulation of the telecom industry. It had only been in the 1980s that AT&T Corp. was broken up into the family of Baby Bells, but it wasn't until the 1990s that the frenzy began. Long distance, bundling, Internet, several different kinds of wireless and cable took root in the high yield market, and then they took over the high yield market.
This changed the issuer pool dramatically which, in turn, helped bring down the default rates, some portfolio managers noted.
In the early 1990s, steel, paper and retail companies made up a bigger portion of high yield. Those companies largely operate on low margins, so an economic downturn can have a severe impact, which means that a recession can result in high default rates.
The decade's other big boon in high yield was, of course, Europe. It began in the mid-1990s with a handful of issuers but then took it on the chin in the wake of Russia's 1998 default. That sent investors worldwide looking for safety above all else and in high yield, all but the benchmark names suffered.
But with an economy spurred on by the common euro currency, a growing leveraged buyout market, and a dire need to catch-up in communications technology, the European high yield market is well positioned, according to almost all market participants.
Throughout much of 1998, the European market was mostly a sellside beefing up to establish a presence and, hopefully, business contacts. But then the buyside also increased, albeit mostly from organizations with ties to the U.S. buyside and then the issuers came to the forefront.
The size of the market still pales in comparison to its U.S. counterpart, but it is indeed growing. Some predictions for the European high yield market are as high as $280 billion in outstanding paper by 2005. And some of the bigger names have become benchmarks, such as NTL and UPC.
So where does all of this leave the high yield market today?
Returns are fairly low, but still better than some other fixed-income assets classes and the default rate is creeping upward. But some market observers took the "glass is half full" approach and described the market as an attractive opportunity to buy.
The underlying economy is strong and the companies are better positioned and more efficient than ever before, the argument goes. And spreads in high yield still are not as tight as they had been in 1997, indicating room for price appreciation in the bonds. Furthermore, the high yield market is more diverse than in years past and some institutional investors have said that double-digit default rates are a thing of the past.
Kingman Penniman, president of KDP Investment Advisors echoed some of the positive notes, but remained cautious at the same time. "I'm just glad there are only five more days left in the 1990's," he said with a laugh last week.