High-yield bonds, back in style with a stellar rally in the first half, will rack up double-digit returns for the year despite nagging worries over defaults, market players say.

Annualized returns of 50% or more through June 31, which astounded even seasoned junk investors, probably will keep the broad market clicking into 1992.

"Right now, the market is riding a crest, is flush with good economic indications, and has a great supply-demand mix," said Robert Lupo, managing director of high-yield research at First Chicago Capital Markets. "Absent an aberration or dramatic event, the second half will be modestly up to sideways, but all in all this year will be up dramatically."

According to Salomon Brothers Inc., high-yield bonds returned 27% in the first six months, handing back 2.07% last month alone.

The run-up was a classic swing of the pendulum: The market had gone so far in one direction that it came back nearly as hard, analysts say.

Last December, the average junk bond yielded close to 19%, nearly 11 percentage points more than 10-year Treasuries. That spread was just four percentage points two years earlier.

But victory in the Persian Gulf, easier credit from the Federal Reserve, and a buoyant stock market sent junk investors on a buying spree that trimmed junk spreads to fewer than seven percentage points.

Now, "the supply-demand situation is so out of whack, you have nobody focusing on the fundamentals of the credits," said Richard A. Buch, portfolio manger in Kidder, Peabody & Co.'s high-yield asset management group. "As bad as it was a couple months ago, when everybody was scared to buy, now people are scared to sell. That's a scary sign."

"I don't doubt we'll get double-digit returns" for the year, Mr. Buch said, but added that second-quarter earnings reports, due out in coming weeks, may help bring prices more in line with fundamentals.

Rally aside, default risk still haunts the market.

The Bond Investors Association reported this week that corporate defaults plunged 80% in the second quarter of 1991 -- but the group still expects $25 billion of corporate debt to go belly up this year.

"I think we're on the way up," said Richard Lehmann, president of the Florida-based bondholders group. "I don't think you'll ever see the number of defaults we saw in the first quarter."

But others remain skeptical. High debt levels, softness in commercial real estate, and uncertainties in the financial system will keep the pressure on junk-grade companies for years, they say.

"In May and June, defaults were down, but it's too early to really say there's a permanent easing off," said Andrew Kimball, associate director at Moody's Investors Service. "Downgrades have continued to outpace upgrades, which suggests companies are still under pressure."

Mr. Kimball noted that a less-than-robust economic recovery would not only affect high-yield companies' operating results but also limit their ability to tap bank credit lines or the public capital markets.

"Many $(companies$) have refinancing events coming up," he said. "if they can't get cooperation from banks or the market, these companies will fail."

Said First Chicago's Mr. Lupo: "The economy is a very big risk. The market is very sensitive, and it would impact prices if the economy has a double-dip."

Yesterday's Market

Columbia Gas System Inc., which blindsided Wall Street last month with talk of a possible bankruptcy, gave bond buyers a glimmer of hope yesterday when it announced arrangements to pay interest on its short-term notes.

The news lifted the Delaware-based gas utility's bonds as much as three points in thin trading. In midafternoon, bids on Columbia Gas 9s stood at 90, about three points higher on the day.

Most other speculative-grade issues advanced 1/4 point. Investment-grade corporates, meanwhile, languished for the third straight day as issuers again shunned the market.

Fannie Lauches IO Zeros

The Federal National Mortgage Association added a new item to its menu for investors yesterday: zero coupon interest-only mortgage securities.

The derivative securities were part of a three-piece stripped deal managed by Merrill Lynch Capital Markets.

The $200 offering splits cash flows from a pool of Fannie Mae 9 1/2s into three classes: the usual interest-only and principal-only pieces, and a new "Z-IO" class.

The first class of IOs give investors the first 60 monthly interest payments on the underlying pool. The Z-IO holders then receive the remaining interest payments.

"It's time-tranched," said Debbie Cohen, vice president of capital markets at Fannie Mae. "The first class is going to be more stable than a regular IO, and might appeal to mutual funds, commercial banks, thrifts -- institutions that are interested in shorter maturities.

"The second piece, which gets the rest of the interest payments, will appeal to various total-return accounts, like insurance companies," she said.

The three classes, which have an average weighted maturity of 350 months, also can be recombined to create various synthetic securities.

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