New MCI bonds may affect managers' strategies, Bear Stearns says

By Paul Deckelman

New York, May 4 - MCI Inc.'s emergence from Chapter 11 on April 20 and its issue of $5.7 billion of new bonds basis is an event that high-yield portfolio managers - and crossover debt players who dabble in higher-rated junk bonds - should take into account when studying the market and trying to strategize, according to a new report by Bear Stearns & Co.

The reason, the report says, is that the Ashburn, Va.-based telecommunications giant's issues constitute just over 1% of the junk universe in the company's weekly high yield index. In one fell swoop, MCI - the former WorldCom Inc. - became one of the 10 largest issuers in the index.

One percent doesn't sound like much, but for any one issuer to have that much concentration in a large, broadly based market index is unusual, so ups and downs in these bonds alone can alter the performance of the index, or at the very least, its always-volatile telecom component. Not many names can make that same claim.

"Usually, issuers coming out of reorganization don't have that kind of impact," says Bear Stearns analyst Michael Taylor. He added that companies issuing new bonds to finance their exit may issue "$100 million or $200 million. But $5.7 billion, obviously, is not just a blip on a radar screen."

MCI on April 21 announced that it had issued $1.983 billion of 5.908% senior notes due 2007; a similar amount of 6.688% senior notes due 2009; and $1.699 billion of 7.735% senior notes due 2014.

The new MCI bonds were not rated by Standard& Poor's and Moody's Investors Service, but rated or not, Taylor says, "they're trading on a crossover basis - and perhaps even investment-grade buyers are potentially looking at this credit, depending on where it might rate. Even without a rating, there's always room in some investment-grade [portfolios] for a small basket of speculative-grade rated paper."

Trading below par

As to whether portfolio managers and others might wait and see how the new MCI bonds do before deciding to jump in on them - they are currently trading slightly below par - Taylor says that "nobody is forced to buy the securities." With these bonds representing 1% of the universe of investable securities, "they're making an active decision on this if they don't invest in them, because they're essentially underweighted already, especially as these bonds come in at a lower cost-basis, since they trade at a discount to par. If they were at par, or at a premium [to par], I think there would be less incentive [for investors] to look at this for fear of underperformance."

Big as the new MCI issue is, the company still ranks only in the Top Ten out of 860 issuers who have outstanding nearly 1,700 dollar-denominated bonds tracked by Bear Stearns that are rated below Baa3 by Moody's and below BBB- by S&P - and not even in the top three, places occupied by, respectively, Charter Communications Inc., El Paso Corp. and Qwest Communications International Inc.

Charter now top junk issuer

In April, St. Louis-based cabler Charter vaulted past El Paso and Qwest, previously Number-1 and Number-2 in terms of total issuance tracked by the index, its $1.1 billion of new senior notes pushing its total debt included in the index to $13.9 billion.

Charter too - probably even more so than MCI, because of its much larger amount of debt in the Bear Stearns index - is one of those names that portfolio managers would not be able to ignore, because if it were to be omitted from their holdings on, say, a creditworthiness basis, it would be difficult to give the cable sector its proper market weight in a portfolio, since Charter makes up such a big portion of it.

Index down 0.33% in April

Commenting overall on recent performance in the high yield market, Taylor, who compiles the weekly index, noted that April total returns for the market gauge were down 0.33% on average, which lowered the year-to-date return to 1.67%.

The Bear Stearns High Yield Index - in line with indexes compiled by other investment banks - saw strong high yield performance in the opening weeks of 2004, carrying over the strong momentum seen in the robust last quarter of 2003, but a considerably more uneven result since then, rising and falling weekly more or less in tandem with high yield mutual fund-flow numbers.

One stabilizing factor, the analyst says, has been the low actual and expected default rates. But that's been offset by interest rate uncertainty - and Taylor said "that's likely to continue" in the coming months "until there's a little clearer picture of what the Fed intends."

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