Jitters Over Junk Bonds Increase : This Week, 3 Firms Said They’ll Miss Payments on Debt

Worries about how junk bonds will fare in a recession were heightened this week after three companies said they either have or soon will miss interest payments on their debt.

On Monday, Kohlberg Kravis Roberts & Co.’s Seaman Furniture Co. said it missed an August debt payment.

Bonds of Zapata Corp., the big offshore drilling and oil field services company, and Integrated Resources Inc., a financial services company, fell sharply Tuesday when each said they would miss interest payments.

“There are a lot of distressed issuers out there. It’s like a mine field,” a trader at one Wall Street firm said.

Publicly owned Texas-based Zapata, founded by President Bush among others, said it will not make a Sept. 15 interest payment on bonds due in 1997 and 2001 because of its recent financial performance and outlook. Trading ground to a halt Wednesday after prices fell sharply Tuesday.

Integrated Resources said it expects a $600-million second-quarter loss and said it would not make interest payments on senior notes. Its prices have also fallen.

“Obviously, these developments spurred concern about how junk bonds will do if the economy slows, but each of these companies had a specific problem,” said Bob Lupo, junk bond specialist at Smith Barney, Harris Upham & Co.

Other Factors Cited

There has been increasing concern over the high debt loads carried by some companies involved in buyouts and mergers. But bond market experts say other factors are also to blame.

“The viability of junk bond issuers hinges on many factors, only one of which is (debt) leverage,” Lupo said. He said other important factors are management quality, the firm’s market position and its earnings potential.

A key concern is the state of the economy.

“An economic slowdown would increase the potential for other junk bond issuers to miss payments, but we’re not at that point yet,” another Wall Street analyst said.

John Lonski, chief economist at Moody’s Investors Service Inc., a credit rating agency, said Zapata’s story concerns a recapitalization after a first default. Its case may prompt doubt about “whether other companies can successfully repair themselves.”

Zapata, like so many other drilling companies, saw its fortunes suffer when oil prices fell in 1986 and oil companies cut back on their exploration budgets.

While he said broad market implications cannot be drawn from the experience of a few companies, “the overall junk bond market is far bigger and riskier than in the 1982 recession.” Lonski said issuers may be more likely to default this time.

The Moody’s economist said the severe 1982 recession was not cataclysmic for junk bonds. While junk bond defaults did jump from 1981’s 1% to 3.4%, the rate was only marginally higher than the 3.3% average that covered the period between 1970 and 1988.

Firms Highly Leveraged

Lonski noted that in 1982, there were only about $23 billion of speculative grade issues and most were “fallen angels”--companies downgraded from investment grade.

Now, Lonski said, the junk bond market has grown nearly tenfold to around $210 billion, and most issuers are highly leveraged companies arising from buyouts or restructurings.

Moody’s Lonski noted that in December, 1981, the less risky Ba-rated junk bonds comprised about 42% of the overall market, but these safer bonds make up only 27% of the market now. A Ba-rated bond is just one notch below investment-grade securities.

“Junk bonds in a recession are going to have a hard time,” said David Blitzer, economist at Standard & Poor’s Corp.

He agreed with Lonski that the overall credit worthiness of today’s junk bond issuers is lower than during the last recession.

“Corporate earnings don’t do well in recessions or soft landings,” Blitzer said, adding that if the economy slips into recession, highly-leveraged junk bond issuers will be hit first.

A study, released late Tuesday by a Miami Lakes, Fla.-based bondholder group, Bond Investors Assn., has estimated the default rate for high-yield bonds at 11.2% since 1980.

“Taken together, the 11.2% default rate for junk bonds and the 49.6-cents-on-the-dollar recovery rate means that investors need to demand a 5.5% higher yield on junk bonds versus U.S. Treasuries to compensate them for the default risk,” said Richard Lehmann, president of the association.

The Bond Investors Assn. said its study shows that $21.1 billion, or 70.1% of the total $30.1 billion of bond issues that have defaulted since 1980, were non-investment grade issues, or junk bonds.

But the Alliance for Capital Access, a junk bond issuer group, termed the Florida study “seriously flawed.”