After playing a hefty role in dragging down the equity market the last few years, telecommunications companies may also turn out to be the big party poopers of the corporate bond market in 2002.

That's because there seems to be no end to the bad news emanating from what was once seen as an extremely recession-resistant, non-cyclical industrial sector that was supposed to bridge the divide between the old and new economies. A proliferation of venture capital-backed start-ups in mid- and late 1990s unleashed gales of creative destruction in the new millennium and, so far, no end to the carnage is in sight.

The situation worsened with another big-name downgrade in April, when both Moody's Investor Service and Standard & Poor's lowered Nortel Networks Corp. to junk bond status. Lucent Technologies, Nortel's formerly high-flying competitor in the telecommunications-equipment industry, was hit with a similar downgrade last year.

The much publicized problems at bankrupt Global Crossing Ltd. also have taken their toll on the slumping sector, which as of late is more known for its defaults and deteriorating creditworthiness than its prospects for a recovery. "I have avoided telecom since the end of 1999, and I can't tell you how much grief that has saved me," says Margaret Patel, manager of the Pioneer High Yield Bond Fund, which had a return of 16.7% last year.

The timing worked out perfectly for Patel because, after the Nasdaq crashed in March 2000, telecommunications companies played a major role in pulling down the high-yield bond market. The soaring rate of defaults among junk-rated telecoms also had an impact in 2001, when there was a 60% decline in new issues in the corporate high-yield market.

High-yield bonds brought a return of 5.28% in 2001, which was the lowest-performing segment of a bond market that overall did well last year-beating out equities for the second year in a row. Bonds brought a return of 8.4% in 2001, compared with a drop of 11.9% in the S&P 500 Index, according to the Lehman Aggregate Index. "Telecom is pretty much the weak point of the high-yield market in 2002," says Morningstar analyst Alan Papier.

The industry flooded the market with small startup companies that came out of the gate in the mid-1990s with aggressive business plans at a time when it was relatively easy to get financing. The bottom fell out in 2000, when the anticipated growth didn't materialize. "The main thing has just been the fundamentals have been getting worse. Debt ratios are ever-growing as these companies still have trouble generating free cash flow," Papier says.

Even though telecoms make up 10% of the high-yield market, there is reason to believe that the worst performers have been weeded out and that a bottoming out has started, says Patel. "So many names have disappeared because of bankruptcy and liquidation," she says. "The companies remaining are all trading at distressed or semidistressed levels."

Now, however, a concern is that the telecommunications slump could have a similar impact on the corporate investment-grade market, says Gary Goodenough, manager of the Eclipse Bond Fund. One problem is that, as a result of the fallout from the Enron collapse, companies are being given very little wiggle room when it comes to credit, he says.

Telecommunications companies have been hit the hardest by the change in environment, he says. "Now, people are very much afraid of the unknown," Goodenough says. "Whereas all these companies got the benefit of the doubt, now, everyone is being shot first, and the questions are being asked later."

Prominent companies have fallen as the scrutiny increases on their books and their earnings decrease. WorldCom, for example, saw its share price tumble in March as the Securities and Exchange Commission investigated its accounting and loan practices. Moody's and Standard & Poor's both have warned the company's credit ratings may be downgraded. Moody's also warned it might drop the rating on Nextel Communications if it doesn't increase cash flow to meet capital expenses and interest payments.

Meanwhile, Verizon Communica-tions-one of the "Baby Bell" regional operating companies-reported a $2 billion loss in the fourth quarter, which was partly due to damage it suffered on September 11. The company then warned last month that it doesn't expect its earnings picture to improve soon.

Before its slide, the telecommunications sector was a relatively good performer in the investment-grade bond market, with the former "Baby Bells" and long-distance and wireless companies showing promise and stability, Goodenough says. "The investment-grade sector is very different in that they have gigantic revenue streams, big market positions, strong cash flows and seemingly reasonable amounts of debt," he says.