There has been a great deal written about "junk bonds" in recent weeks. Junk bonds are best described as bonds that are not investment grade; that is, bonds whose quality ratings are such that trust companies and other financial institutions are prohibited from purchasing them for their clients. These types of bonds are usually rated B, BB or B, AB by Standard & Poor's and Moody's rating agencies. But over the last five years, the world of low-quality bonds has changed so much that it has become the fastest-growing sector of the corporate market.
The pioneer and dominant force in this market is the Wall Street firm of Drexel Burnham Lambert. As other companies realized the profits that Drexel was making, they swallowed their pride and entered the ranks. And when buyers realized the compounding effect of having 350 to 400 basis points more yield than was available on high-grade issues (a basis point being 1/100th of a percentage point), they, too, decided to take the plunge.
Like all markets, the low-grade market is subject to technical considerations. Two months ago, the yield spread between B rated industrials and comparable Treasury maturities was 300 to 350 basis points in favor of the low-grade issues. Four weeks ago, a $1.3 billion B rated Metromedia issue hit the market and the spreads began to widen. The spreads continued to expand as investors realized that more of these leverage-buyout type issues were being readied for the market. Today, the spread is 400 to 450 basis points. BB rated industrials are returning 55 basis points less yield than are the B rated issues.
It is also revealing to observe the commercial paper market in respect not just to that market, but to the junk bond market as well. The commercial paper spread between AAA and AA rated companies is only 10 basis points. Between AA companies and lower-rated issuers of A2/P2 paper, it is 25 to 35 basis points. These spreads have been on the narrow side because the quality companies have been issuing more commercial paper than the low-grade companies and because the low-grade companies have been cutting back on the amount of paper they have been issuing. In fact, with lower long-term interest rates, the lower-rated companies, A2/P2 and A3/P3, have been forgoing the commercial paper market to extend their debt with long-term low-quality issues of various types; that is, floating rate paper, straight debt and shelf issues that can be quickly sold when the market is right. The volume of low-grade long-term issues for 1984 is estimated to be a record $7 billion.
The Treasury will offer a seven-year note on Wednesday and a 20-year note on Thursday. Both will be in minimums of $1,000, and they should return 11.40 percent and 11.60 percent, respectively.