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Junk Bonds Living Up to Their Name

April 14, 1991

WASHINGTON (AP) _ A month after fallen junk bond financier Michael Milken was packed off to prison camp, the market he helped create in extremely risky, high-yield bonds is in even more trouble.

A subsidiary of one of Milken’s best customers, First Executive Corp., has been seized by California insurance regulators, junk bond defaults are rising and the Securities and Exchange Commission says it is looking into possible insider trading in the nearly $300 billion market.

All bonds are essentially loans to corporations or government entities. But junk bonds are among the riskiest because they can leave the issuing companies saddled with debt they may not be able to repay on schedule - leading to default.

During the 1980s, Milken and others used junk bonds to raise billions in dollars of capital for new or rapidly expanding companies but they also facilitated the hostile corporate takeovers that characterized the era of merger mania.

Nearly dead at the end of the decade, the market started to make a comeback and as recently as February investors were seeing record returns on their money.

But defaults by junk bond issuers are up, too.

Moody’s Investors Service, a major credit-rating concern, says 32 companies defaulted on $8.2 billion in junk bonds during the first three months of 1991, vs. $5.7 billion in defaults by 19 companies for the first quarter of 1990.

″The junk bond market is still very weak and will stay that way for at least the rest of the year. The default rate is running right now at around 16 percent annual rate. In other words, 16 percent of the bonds in the market are defaulting,″ said C. Richard Lehmann, editor of the Defaulted Bonds Newsletter.

Lehmann, who is affiliated with the Miami Lakes, Fla.-based Bond Investors Association, said his organization is forecasting another $35 billion in defaults this year.

The peak years for issuing junk bonds were 1985 and 1986 and if a company is going to default on them, it’s usually four to five years after they are issued, said Lehmann.

The quality of bonds issued in 1986 and 1989 to finance leveraged buyouts and taking companies private ″was vastly inferior″ to prior issues and ″those bonds are defaulting much quicker,″ he said.

But Kingman Penniman, senior vice president at the investment research firm Duff and Phelps Inc. in Montpelier, Vt., thinks the worst is over.

″The illiquidity of the market which caused prices to plummet last year has turned around and now we have more participants and more money going back into the market than there is supply,″ he said, adding that he expected to see a new supply of junk bonds coming into the market ″which is something that a couple of months ago was unheard of.″

Penniman attributed the turnaround to lessening fears about the depth pf the recession.

But Lehmann, the newsletter editor, thinks the junk bond market rally was only a brief reaction to the end of the Persian Gulf War and will be short- lived ″because there’s a tremendous number of sellers in the junk bond market rather than buyers - especially now with Executive Life’s″ problems.

Last week, California regulators seized Executive Life Insurance Co., the main subsidiary of insurance giant First Executive Corp., and once one of Milken’s biggest junk bond customers.

Next to the Resolution Trust Corp., the federal agency charged with cleaning up the savings and loan mess, Executive Life may be the largest holder of junk bonds in the world with $6.4 billion in junk.

Lehmann thinks a huge inventory of bonds is going to hit the junk market if California officials have to sell off part of Executive Life’s holdings or if New York regulators take similar action against First Executive’s other big subsidiary, Executive Life of New York.

Meanwhile, the SEC disclosed last week that it is looking into possible insider trading in the junk-bond market, although officials conceded it make take them through uncharted legal waters.

That’s because there is not a large existing body of law governing insider trading in bonds, compared with insider trading in securities.

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