The writer is a bond portfolio manager at Weaver Barksdale
Every pandemic has a silver lining. For high-yield bond investors, one upside of stressed credit markets is attractive new issuance.
Many companies have tapped the market for investor-friendly rescue financing. Bankers have priced deals at concessional rates, which have resulted in equity-like returns for those brave enough to buy. A three-year, first lien bond from Carnival Cruise Lines in April, for example, was priced at $99 with an 11.5 per cent coupon. It’s now trading at $112. Even paying $112, an investor would lock in 6 per cent through April 2023 for a security with almost zero loss potential thanks to its collateral protection.
But there’s a problem. You cannot buy CCL’s bond, because it is a private placement. Individuals can’t purchase these bonds, also known as 144As after the Securities and Exchange Commission rule that relaxed disclosure for bonds marketed to “sophisticated” investors. Only “qualified institutional buyers” can. QIBs must have at least $100m of assets under management, so even some institutions are excluded.
According to JP Morgan, 72 per cent of new high-yield issuance in 2020 is 144A. You might think this share dates back to the Liar’s Poker era of frenzied bond sales in the 1980s. But, as recently as 2005, private placements were only 1 per cent of the high-yield market. To reach the largest pools of debt capital, issuers had to register their bonds with the SEC, or document their intention to do so within a specified period.
Today 144As “for life” are 48 per cent of the market and they are likely to continue their growth as companies replace registered debt with 144A issuance. Take Tenet, a hospital company that relies on the high-yield market for much of its financing. It has five registered bonds maturing in 2025 or earlier, but only one of its six bonds with a maturity longer than five years is registered. Tenet’s treasurer, like many others, no longer needs investors like you.
This might not seem like a big deal. Shouldn’t individuals leave high-yield debt investing to professionals in light of its higher risk? I am a professional investor, so of course my answer to that question is yes. But here’s the wrinkle: 144A securities are sometimes at pole position in the capital structure.
The secured bond is the best deck chair on the Carnival cruise ship — yet it’s the only one you can’t sit in. You’ll find several offerings of CCL unsecured debt available for purchase in your Schwab brokerage account, along with its common stock. You can load up the boat with the riskiest CCL securities, but its safest investment is off limits to you.
Should CCL file for bankruptcy, the QIBs who bought the secured bonds will be treated like first-class passengers, rowing for safety in their collateralised life rafts, while the steerage-class unsecured bondholders fight over the company’s shipwrecked remains.
This phenomenon in high yield bucks a larger trend aimed at making investments more accessible to individuals. The SEC recently relaxed the accredited investor definition to permit a wider group of individuals to invest in “private capital markets”, including private equity but not 144A bonds. The recent boom in Spacs — a backdoor vehicle for initial public offerings with lower disclosure requirements — has swept up individuals, despite risks to retail investors.
It is obvious who benefits from increasing 144A issuance: large high-yield managers. Fund structures are becoming the only way for individuals, and small institutional investors, to invest in high-yield bonds. The SEC should reform 144A regulation to prevent Wall Street from streaking further ahead in this important corner of the capital markets. Why not let individuals invest in private placement bonds? If they’re allowed to sit in the equity deck chair, they should have the chance to upgrade to the 144A cabin.
Weaver Barksdale may hold interests in companies mentioned