High-yield bonds underwritten by commercial banks could carry wider spreads than those handled by investment banks, a recent Merrill Lynch & Co. study concluded.
Martin Fridson, Merrill's chief high-yield strategist, set out to identify factors that cause spread to vary for high-yield bond offerings.
He found that "all things being equal, a high-yield offering will carry a larger risk premium if it is a 144a transaction, a new name in the market, or a bond underwritten by a commercial bank."
That's worrisome news for banks' securities units like J.P. Morgan & Co., BT Securities, and Chase Securities that are fighting to take an increasing share of the junk bond market. Meanwhile, more newcomers, including BankAmerica Corp., First Union Corp., and BankBoston Corp., are also trying to get a piece of the action.
The Merrill study looked at 19 variables seeking to identify the strongest determinant of spreads. A sample from Securities Data Co. of 428 issues floated during 1995-1996, both public and rule 144a bonds, was examined.
At the top of the list were credit ratings from agencies such as Moody's Investors Service and Standard & Poor's, a bond's callability, and whether it was a 144a transaction.
Next were an issue's zero-coupon status, whether it was the issuer's first time to market, and the type of underwriter handling the deal.
"To the extent that institutional investors cannot derive completely objective prices for a newly floated noninvestment grade bond, the quality of the issuer's execution will depend at least partly on the underwriter's effectiveness in presenting the deal to analysts and portfolio managers," the study said.
Jeff Cooke, who manages a high-yield fund for Strong Capital Management, Menemonee Falls, Wis., said there's "no question" that underwriter type has an impact on new issue pricing.
If an underwriter "has no extensive sales and distribution capability in high-yield, people will demand a premium for concerns about liquidity, sales and distribution, and reaching the whole market in terms of the buy side," Mr. Cooke said.
"We would definitely demand a premium to get involved with an issue led by a second- or third-tier underwriter that didn't have a first-tier underwriter as a co-manager," he added.
Bankers said that in the early days differences between the way commercial and investment banks handled junk bonds certainly existed. But for some commercial banks, those days are over, they said.
There's now "enough history with BT, J.P. Morgan, and Chase that execution is pretty much the same," one commercial banker in the junk bond business said.
"A number of professionals at commercial banks came from securities firms, so essentially you have the same people executing the deals," he added.
Art Penn, head of global fixed income at BT Securities Co., said the concern is not what kind of underwriter an issuer uses, but how much experience the underwriter has.
"If you go with a major underwriter-whether it's an investment bank or a commercial bank-by and large, you get good execution," he said.
Ed Mally, director of high-yield research at CIBC Wood Gundy Securities added that it may be the quality of the company that pushes a wider spread.
"The higher-quality companies tend to get the better underwriters, so firms that are stretching to do business reach for companies whose credit ratings are not as high," Mr. Mally said.
"There's a correlation between the quality of the company and the quality of the underwriter they attract," he added.
