A rash of refinancings is expected to heat up the already red-hot junk bond market this year as companies with maturing debt take advantage of low interest rates.
According to Securities Data Co., some $31.9 billion of high-yield bonds are callable this year, which means the companies that sold them can reissue them at more favorable rates. Most junk bonds become callable five years after they are issued.
In 1993-when most of this year's callable issues were sold-the average junk bond yield was 9.58%, according to Moody's Investors Service. Today the average yield is 8.88%.
"Issuers are going to look at current fixed-rate bond costs as being below trend," said John Lonsky, Moody's chief economist. "It's obviously going to be a very strong year."
The trend is good news for commercial banks that have jumped into the junk bond business in recent years.
"To the extent commercial banks have relationships, it gives them the ability to compete with underwriters who were involved in the initial offerings," said Carl Mayer, head of high-yield capital markets at Societe Generale Securities Corp. The U.S. investment banking unit of France's Societe Generale entered the high-yield market two years ago.
Mr. Mayer said he is seeing a "healthy competition between a bank that may have agented a credit facility and a traditional investment bank who has managed earlier offerings."
Last week, Revlon Inc. touched off the refinancing boom when it priced a $900 million issue led by Bear, Stearns & Co. The deal is the biggest junk bond issue so far this year.
Market participants said they could not predict if new issuance in 1998 will surpass 1997 levels, when volume soared to $107 billion. But refinancings provide "a nice head start on getting back toward that number this year," said Ned Zachar, senior managing director and head of high- yield research at NationsBanc Montgomery Securities Inc.
Next year is also expected to be strong, as $24.2 billion worth of junk bonds will be callable.
According to Mr. Lonsky, the junk bond boom will get an additional boost from the leveraged lending market, as borrowers of variable rate debt refinance into fixed-rate high-yield bonds.
"Corporate bond yield spreads remain relatively thin, implying that the high-yield issuer has a very strong reason to go ahead and refinance bank loans as bonds," Mr. Lonsky said.
Refinancers face a welcoming environment. U.S. Treasuries are at all- time lows, the economy is healthy, and corporate profits are in solid shape. The high-yield market now has a long track record, and has caught the eyes of traditional junk bond investors as well as crossover investors.
"A lot of investment funds, whether pension funds or insurance funds, have made a long-term commitment to the asset class," said Steve Huber, a fixed-income portfolio manager with Aeltus Investment Management, Greenwich, Conn.
"These days people are more willing to ride the tide than they were before."
When turmoil from the Asian financial crisis rocked the financial markets late last year, junk bonds, while volatile, held up well. Now, some investors view the securities as a "safe haven"-an idea that as recently as six or seven years ago was unthinkable.
If the Asian crisis causes recessionary concerns, junk bond issuance could slow. A move by the Federal Reserve to raise interest rates could also put some brakes on the market.
"We still like the high-yield sector, but are taking a more defensive posture," Mr. Huber said.
In the meantime, underwriters of all stripes are targeting bonds that are callable this year and next as sources of potential business.
"Those who've got the relationships and those who can execute" will get the business to refinance, Mr. Zachar said. "My sense is that issuers are willing to listen to new ideas from new players."
But the investment banks say they do not expect the competition in 1998 to be any more ruthless than it was in 1997.
"Clearly the banks are a competitive threat, but an existing competitive threat," said Dwight Sipprelle, head of high-yield at Morgan Stanley, Dean Witter, Discover & Co.
"It's unclear that for refinancings for companies that already have existing investment banking relationships, it would be harder for a new entrant to break in," Mr. Sipprelle added.
Just as commercial banks have built new bond businesses, investment banks have opened leveraged lending operations. Mr. Sipperelle said it is "not that obvious" that all leveraged borrowers will refinance their debt in the bond market, unless loan spreads widen.