Despite Drexel's Fall, Junk Bond Market May Come Back
THE repercussions from the sudden fall of the United States junk bond market continue to swirl throughout Wall Street. The latest and most stunning casualty is the chief architect of that market - the Drexel Burnham Lambert Group Inc. It is seeking Chapter 11 bankruptcy proceedings.
Other ramifications include:
The $210 billion junk bond market wallows in stormy seas. The prices of a number of junk bonds have skidded downward, and no quick resurgence appears in sight.
Drexel's problems threaten to taint the investment industry as a whole. So far it is expected that only Drexel will be forced into bankruptcy at this juncture. The concern evident both on Wall Street and at the Federal Reserve Board is that the downfall of Drexel could threaten whatever public confidence remains for the investment community. The public is already deeply disenchanted with Wall Street after steep market downturns in late 1987 and in 1989.
The suddenly intensified aversion to financial risk here will make it harder for businesses saddled with heavy debt - whether through junk bonds or not - to raise additional capital within investment and banking circles.
Drexel's unraveling marks the end of a financial era. Drexel - feisty and creative - was the driving force behind the junk bond market of the 1980s. These bonds were used to finance most of the highly publicized hostile corporate takeovers of that decade.
Drexel's worsening difficulties finally came to a head Tuesday when its board decided to consider a Chapter 11 bankruptcy filing for the parent company and some of its subsidiaries. Drexel said that the bankruptcy filing would exclude its broker-dealer subsidiary, Drexel Burnham Lambert Inc., and Drexel Burnham Government Securities Inc.
Also Tuesday, Integrated Resources Inc., the nation's largest seller of tax-sheltered investments, sought Chapter 11 protection. The firm was unable to restructure more than $1 billion in debt, a large part of it held in high-yield junk bonds. Integrated, also involved in real estate, insurance, and mutual funds, was a major client of Drexel.
The Federal Reserve Board, troubled by the drama in the junk bond market, quickly announced that it would ``carefully monitor'' Drexel's decision to liquidate its holdings in government securities. The federal government now owns many junk bonds through its takeover of troubled savings and loan institutions. And junk bonds are now held by scores of insurance companies, pension funds and mutual funds.
``The junk bond market has taken a very bad jolt,'' says Merton Miller, professor of finance at the University of Chicago Graduate School of Business. ``That doesn't mean that the junk bond market won't come back. If junk bonds have been fulfilling a financial need, then it's quite possible that the market will come back, although not necessarily in the same form as in the past few years. Many markets have been hit hard and subsequently come back, such as the Hong Kong stock market a few years ago.''
If there is to be any winner in what has transpired on Wall Street this week, it may well be the traditional equities market, some analysts argue. Investments in equity-based mutual funds rose sharply at the end of last year, though falling off early in the year, according to the Washington-based Investment Company Institute.
``Equities are suddenly a very viable alternative,'' says Laszlo Birinyi, president of Laszlo Birinyi Associates. A former manager of equity analysis for Salomon Brothers Inc., he also believes that speculation about the ``demise'' of the junk bond market may prove premature. Of the more than $200 billion in outstanding junk, about $50 billion was involved in the major dealmaking of the late 1980s, including the $28 billion RJR-Nabisco takeover last year. But a significant part of the junk market was devoted to companies seeking long-term financing without having to undergo constraints from lenders, such as insurance companies.
One of the big question marks is what will happen to the corporations heavily indebted because of junk bond financing if the economy sinks into a recession? Will they be able to raise new capital in the conventional equities market? Can they continue to meet interest obligations?
``So far as IPOs [initial public offerings], I don't see all that much impact on new firms stemming from Drexel's problems,'' says Robert Natale, who follows the new issue market for Standard & Poor's. But firms that have gone private through leveraged buyouts and are seeking to get back into the capital market will find it difficult, Mr. Natale says.
In 1988 the federal government brought securities fraud charges against Drexel. The investment house ultimately pleaded guilty to six felony counts and paid $650 million in fines. The firm also dismissed junk bond wizard Michael Milken. He was subsequently indicted and is expected to face trial.