NEW YORK — High finance, perhaps more than politics, makes strange bedfellows.
That might explain why, among the multibillion-dollar insurance companies, corporate raiders, and other big-league financial backers assembled in ranks behind T. Boone Pickens in his debt-financed takeover run on Unocal, one finds the pension fund of the American Lutheran Church.
"From a financial viewpoint I don't think there was anything wrong with the investment," says John Kelly, the church's director of investment. "Unfortunately, some of the reaction I've had from some of our members shows they were not very happy with our backing this group."
The Lutherans' brief flier in takeover speculation--Kelly says it was the first such investment and, given the public reaction, probably the last--amounted to a commitment to buy $10 million of the $3 billion in bonds Pickens would float if his bid succeeds. For that the church will receive a $750,000 "commitment fee."
But the investment also shows how far so-called "junk-bond" financing has come from the days when such bonds were considered highly speculative instruments suitable for only a select group of strong-hearted investors. The bonds were often securities in failing or struggling companies with uncertain futures.
Junk bonds--or "high-yield" bonds in more formal nomenclature--now fall roughly into two categories. Not only are they older bonds in companies whose credit ratings have slipped, but they may be newly issued by companies whose credit ratings are so low that the bonds must be floated at relatively high interest rates to attract buyers.
In both guises, junk bonds are turning up in some unusual spots. Pickens's bid for Unocal, like his similar runs on Phillips Petroleum and Gulf Oil, is financed through a shell corporation that would borrow money to take over the company; if the bid is successful, the shell's bonds would be assumed by Unocal and covered by its considerable assets. But because the shell has no assets itself, the bonds technically fall into the junk category.
Used this way, junk bonds magnify the financial potency of market entrepreneurs such as Pickens. That has given the securities an exceptional and not entirely rewarding visibility, provoking talk of congressional investigations, moratoriums on their use, and so on.
"The fears of high-yield takeover financing are overblown because large companies are vulnerable for the first time," says Frederick H. Joseph, senior executive vice president of Drexel Burnham Lambert, the Wall Street firm that all but reinvented the junk bond a few years ago and now dominates the market it created with about 69% of total underwritings.
Yet, the debate over junk-bond takeovers, which involve less than 15% of the total volume of such bond issues, Joseph says, has obscured some far more significant--and to a small number of analysts, disturbing--changes in that market.
With the inexorability of every Wall Street vogue one can name, junk-bond sales have expanded from a boutique market for risk-oriented institutions to one broadly merchandised, even to the small investor.
In 1974, there were three mutual funds specializing in high-yield corporate bonds, with combined assets of $400 million. Last year, there were more than 30, with assets of $6 billion. Earlier this year, one of these laid claim to being the first to cross the $1-billion threshold.
The public owns junk bonds in expanding quantity in other ways. Some insurance companies have loaded up on the instruments, meaning that life insurance policies for hundreds of thousands of individuals and families are partially backed by bonds ranked by the major credit-rating services as investments with speculative properties and thus less than "investment grade."
Also in the market are savings and loan associations, whose depositors' dollars are themselves insured by the U.S. government. Officials of the Federal Home Loan Bank Board, which oversees the thrift industry, say $5 billion in junk bonds are held by S&L's--mostly by about a dozen institutions.
Attracted by Rates
These buyers are attracted not by the securities' credit, which is rated low by the rating firms of Moody's and Standard & Poor's, but by their high interest rates. While an investment-grade bond issued by a well-capitalized company with good credit might pay somewhere between 10% and 11% in today's market, a Drexel-underwritten high-yield bond issued by a young company with no earnings or credit record might pay 15% or 17%.
The market in these securities has been given the imprimatur of several academic studies showing that the yield on junk bonds more than offsets the relative increase in risk.