Market worries about the possibility of losses in the junk bond market have intensified to the point where at least one firm has found itself unable to avoid talking.
Morgan Stanley Dean Witter, whose shares have been buffeted in recent sessions amid investor fears of revenue losses and portfolio hits in its junk bond business, departed from its no-comment policy Wednesday and spelled out the degree to which the business line eroded its third-quarter profits and how much more damage it expects in the fourth.
In a brief statement, the company said markdowns in the third quarter on its high-yield portfolio cost it about four cents in per-share earnings, and that markdowns taken so far this quarter have roughly matched that.
The company also said its net trading revenues in its global high-yield business have been positive so far this year.
While not the calamity that had been bandied about in market rumors, the simple fact that Morgan Stanley felt compelled to comment pointed to just how tense the conditions in the junk bond market have become.
There is little appetite in the market for new issues, which has hurt firms on the underwriting side, and now there are signs of more bad news to come for the sector on the default side.
Moodys Investors Services third-quarter default survey, released Tuesday, said that the default rate among U.S. companies that issued non-investment grade debt rose from the beginning of the year, to 6.36%, even while default rates in general were down in the same period. The rise resulted from the fact that 80% of all borrowers that defaulted were U.S. companies, the survey said.
Overall default rates are expected to remain at Septembers rate of 5.13% for the next 12 months. There is still more downside risk than upside potential for default rates over the next 12 months, said the surveys author David T. Hamilton.
Talk of such writedowns did not surprise investors, who have been watching junk bond prices, along with the Nasdaq stock market, sink after a tepid rally late in the summer.
In this type of market, youre more than lightly to suffer larger losses on a particular issue or sector, said Thomas Haag, a high-yield portfolio manager at the Lutheran Brotherhood in Minneapolis. Were still seeing results of the dislocation in the markets from 1998, when the Russian debt default and the Asian currency crisis rocked financial markets worldwide.
Rumors of writedowns of high-yield, or junk, bonds held as inventory by the investment banks that underwrite these offerings have been swirling for days, partially fueled by news reports.
These reports and languishing share prices also prompted Deutsche Bank AG to publicly deny any significant problems.
On Wednesday, Deutsche Banks chief executive, Rolf Breuer, told the German newspaper Boersen-Zeitung that it is not expecting future losses from its junk bond business. Deutsche shares fell 6%, to $74.55 on the Frankfurt Stock Exchange.
Deutsche and Morgan Stanley have not been the only houses to see their shares get knocked on such fears. Bank of America Corp., J.P. Morgan, and Citigroup shares have all fallen over the last two days, partly on fears that their junk bond desks have taken big positions in junk bonds whose prices have dropped.
A depression of junk bond prices not only hurts high-yield desks when they hold positions in the bonds, but also slows down the new issue calendar, thus limiting the underwriting fees these desks earn, and trading revenues from selling these bonds on the secondary market.
Weve had a big price decline in whole telecom sector, and since its so big, it really hurts everyone in the market, said Margaret Patel, a manager for the Pioneer High-Yield Fund. Its had a more depressing effect [on the market] than one big credit, she said.
Still, at least one issue is on the calendar in an industry that has fared better than others over the last nine months. Banc of America Securities is scheduled this week to price $250 million of senior subordinated notes for Anchor Gaming, a Las Vegas manufacturer of video gaming and slot machines.