Bear Stearns anticipates 15-20% junk return in '02; new deals may hit $100 billion

By Paul Deckelman

New York, Jan. 9 - Bear Stearns & Co. projects that high yield bonds as a class will provide a total return somewhere in the 15% to 20% area in 2002, and that new issues will at least match 2001 levels and could hit as much as $100 billion.

The investment bank made its predictions in a new start-of-the-year research note by High Yield Strategist Michael Taylor.

The company's weekly Bear Stearns High Yield Index, which tracks almost 1,450 issues from across a broad spectrum of industrial sectors, maturities and credit-rating as a proxy for the overall high yield market, rose 5.41% in 2001, its best showing in four years.

Taylor wrote that for the upcoming year, "we believe high yield could be one of the favorite asset classes among fixed-income investors as well as equity investors with the ability to invest in high yield (i.e., equity income funds)."

However, one factor which he cautions could temper the anticipated 15% to 20% gains is the yield on Treasuries. Unlike 1991 (when the High Yield Index returned 44% as the economy began to head out of recesssion) "yields are already relatively low, and have been moving higher," Taylor wrote.

In 1991, he continued, the 10-year Treasury bond "tightened about 100 bps and still ended the year about 200 basis points higher than it is currently. Furthermore, market expectations for a rate cut on January 30 have diminished," although the analyst does believe it "unlikely" that the Federal Reserve would be forced to reverse policy and raise rates.

Looking ahead to anticipated new-issue activity, Taylor predicted that total high yield issuance this year "will be no less than 2001's [$77 billion, nearly twice the 2000 total of $40 billion], perhaps reaching $100 billion."

Taylor noted that in 2001, new-issue credit quality drastically improved, with BB-rated issuance jumping to 39.33% of the new-issue pie from 26.99% in 2000. With B-rated new deals essentially holding steady as a percentage of primary-market activity (56.61% vs. 57.22% in 2000), all of that extra BB issuance had to come from somewhere - namely the lower-rated new deals. While deals rated CCC or below totaled 8.47% and non-rated deals accounted for 7.32% of the new bonds in 2000, the appetite for such shaky credits "all but disappeared" in 2001, dwindling to 3.18% for all of the C-rated deals and 0.89% for the non-rated deals.

"The quality of new issuance increased last year in large part due to demand for higher quality from investors," Taylor wrote. Looking ahead, he estimated, "this year's new financing quality level may be driven by the large amount of debt that is coming up to its first call date."

Bear Stearns estimated that $41 billion of debt will be come callable in 2002, with another $54 billion first callable in 2003. It also pointed out that a small amount of deferred-interest paper is scheduled to step up to become cash-pay, as well as become callable this year.

After seeing net flows for high yield mutual funds increase by $10 billion in 2001, Bear Stearns is also anticipating that this trend will continue, at least for the present. The report noted that the $678 million of outflows seen over the last two weeks of 2001 probably did not represent the start of a negative trend. In the first week of 2001, fund flows were once again positive, as the investment bank had anticipated, increasing to the tune of $216.5 million.

"Retail inflows, as well as larger institutional allocations (such as Calpers' recent vote to invest up to $1.5 billion in high yield through five external managers) should make demand stronger at the start of the new year and help high yield spreads tighten further," Taylor wrote. Including the mandate from Calpers (the massive California state employees' pension and retirement system), Bear Stearns added, "over $5 billion of new money from just a few large pension funds may be invested in the high yield market."

End

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