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Skip Navigation LinksHome :: Back Issues :: High-yield bonds - High noon for US high yield

December 1999

High-yield bonds - High noon for US high yield


Author: Rebecca Bream




Among the changes to US market regulations proposed by the SEC in November 1998 - a project so large it was dubbed "the aircraft carrier" by sceptical bankers - the plan to repeal a document called the Exxon Capital no-action letter slipped by without attracting much attention. Until now.

Law firm Latham & Watkins fears the move will damage the US high-yield debt market and reduce volume by making it harder for smaller companies to issue. Earlier in the year, it commissioned former SEC chief economist Charles Cox to assess the effects of the proposed changes, and the resultant critical report has just been published. It is supported by 15 leading US investment banks, including Merrill Lynch, Morgan Stanley and CSFB, as well as many high-yield issuers and investors.

Up to 90% of US high-yield bonds (worth $135 billion) are sold to investors as private placements, and known as Series A bonds. They cannot be traded but avoid the lengthy process of SEC registration, allowing corporates to issue opportunistically and fund at short notice.

But most investors do want to be able to trade. Around 180 days after the original private placement, the borrower registers a public issue with the SEC that has identical characteristics to the Series A deal, and is known as a Series B issue. The investors who bought the Series A paper then swap their bonds for the new, tradable Series B paper. These A to B exchanges have been made possible by the issue in 1988 of the Exxon Capital no-action letter, which aimed to facilitate more efficient and liquid resale of unregistered securities.

This system has allowed issuers to get their money first and complete registration later. "Borrowers can sell bonds on a private timetable without worrying about SEC registration," says Kirk Davenport, chairman of the international corporate finance practice group at Latham & Watkins. It has been beneficial in situations where speed is of the essence - for example, leveraged buy-outs and making acquisitions - and can bypass the need for costly bridge loans.

The SEC now proposes to replace the Exxon Capital document with Form B, a fuller registration process. It believes A to B exchanges don't provide investors with sufficient disclosure, as private placements require less information about the issuer. This could lead to problems if bonds are traded and end up with retail investors who might not understand high-yield debt risks. The SEC also feels that the system of exchange provides an incentive to avoid proper registration procedures.

But Latham & Watkins points out that over 99% of bonds go to institutions, even in the secondary market. "We disagree with the proposal to repeal Exxon Capital and replace it with a registration system available only to a select group of issuers. We believe that this proposal, if adopted, would substantially increase the cost of capital without any significant increase in investor protection," says Latham & Watkin's response.

The SEC alternative to A to B exchanges would make life easier for more seasoned bond issuers but harder for smaller companies (about half of borrowers) to do a deal. Latham & Watkins claims that by taking away the Exxon Capital letter, which for a decade has worked together with Rule 144A to create a "vibrant high-yield market", the SEC would be killing entrepreneurship and hurting start-up businesses. They think this would drive borrowers away from high-yield bonds and back to more expensive funding such as bridge loans and mezzanine debt. "We believe the SEC wants to do the right thing, but they didn't have the facts about the market," says Davenport.

The SEC's response has been muted. But the fact that SEC chief executive Brian Lane, the main author of the 650-page reform programme, has recently resigned signals that amendments may be made. "There is a high likelihood the SEC will reconsider its position," says Davenport at Latham & Watkins.

Some might assume that Latham & Watkins' report has been driven by self-interest - lawyers must benefit from a market built on complex exchange offers. But the firm claims no business will be lost if the changes go through; in fact they could involve even more legal work. "We felt an obligation to formulate a sensible regulatory regime. No-one was going to gain under this proposal," says Davenport.






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