Commercial banks have finally arrived at the junk bond party-but the festivities appear to be winding down.
The Federal Reserve Board's decision last month to raise interest rates has spooked investors in high-yield bonds. Indeed, outflows from high-yield mutual funds in recent weeks have hit their highest levels since the bond debacle of 1994.
That has caused many junk bond issuers to postpone their deals or pull them from the market. In the first week of April, at least eight planned junk issues were delayed. Five of those deals were to have been led by the securities units of commercial banks, according to KDP Investment Advisors, Montpelier, Vt.
But banks, which have spent millions of dollars in recent years building high-yield bond businesses, say they are prepared to weather the storm. They say the market's turbulence is part of a larger, "healthy" rationalization of all the capital markets that was long overdue. And they say they have no plan to move out of the business.
"We view this as a correction in the marketplace, as opposed to the threshold of a protracted bear market," said William Sacher, head of high- yield finance at NationsBanc Capital Markets, Charlotte, N.C., a unit of NationsBank Corp. "The underpinnings that have created a robust environment for high-yield are still firmly in place."
NationsBanc postponed a $75 million high-yield bond offering in early April for Radio One Inc. However, a week later, it priced four high-yield deals, two of which it led, Mr. Sacher said.
Nearly 40 commercial banks have piled into the junk bond business in the last six years, hungry for the roughly 3% fees that lead underwriters typically receive. The past two years have been especially active, with many banks hiring high-priced investment banking talent and aggressively pursuing and winning underwriting mandates.
The number of issues commercial banks have had to yank from the market in recent weeks is a sign of their hunger for deals, investment bankers said. But no one expects them to leave the market. For one thing, many banks have signed multiyear employment contracts with the high-profile investment bankers they have lured to their fledgling junk shops.
For another, at many commercial banks, emerging as a one-stop shop for corporate clients is a "strategic imperative" that goes beyond the economics of the junk bond business, said Mark Patterson, head of high- yield finance at Credit Suisse First Boston Inc.
Indeed, Bank of Boston Corp. is forging ahead with plans to enter the high-yield bond business.
"We are confident in the market and see some of this volatility as an opportunity for a new entrant to add some value," said Steven Schenfeld, head of high-yield securities at Bank of Boston, which has been hiring high-yield talent since the bank gained section 20 powers last year.
"The high-yield product is still fundamentally sound," he added. "While there have been small interruptions, it's still very healthy, and we will continue to aggressively build our business."
One investment banker said that the downturn "may discourage new entrants who are only making a very small approach to the market, but the more serious people will be unaffected by this."
Still, market observers say commercial banks face an uphill battle in the junk bond business when it comes to distributing issues to investors.
"The 3% underwriting fees will go up in smoke if the banks can't support their deals in the aftermarket," said Martin Fridson, chief high-yield strategist at Merrill Lynch & Co.
But no one disputes that commercial banks are making considerable progress. For the first quarter of 1997, Chase Manhattan Corp. was ranked sixth among lead managers of junk bond deals, with a 6.2% market share, according to Securities Data Corp. That placed the bank ahead of No. 7- ranked Goldman, Sachs & Co. and No. 8-ranked Lehman Brothers Inc.
Even banks that have yet to lead-manage a junk issue have made their presence felt, investment bankers said.
"The entrance of commercial banks has caused a proliferation of co- managers that has reduced the per deal profits for the traditional high- yield investment banks," said Fred Cohen, head of high-yield finance at Salomon Brothers Inc. "As all markets mature, increased competition puts pressure on the margins."
So is there any room in the high-yield market for any more commercial banks?
"Its very late in the cycle," NationsBanc's Mr. Sacher said. "Those that will survive will be those with significant professional and objective capital resources." u