U.S. Junk-Bond Buyers Left in Dark as Private Deals Become NormCordell Eddings
The riskiest corporate borrowers are selling more debt than ever in the darkest corner of the bond market.
For the first time, a majority of U.S. speculative-grade debt issued this year was done through private offerings, accounting for a record 60 percent of all sales in 2015, up from 40 percent last year, according to Xtract Research LLC. The sales exempt borrowers from U.S. securities laws requiring minimum financial disclosure and investor protections. Such debt allowed Murray Energy Corp. to raise $1.3 billion to become the third-largest coal producer in America and gave Citgo Petroleum Corp. $1.5 billion to fund a dividend to its Venezuelan parent.
The deals are drawing concern from credit analysts who say investors are sacrificing safeguards in the pursuit of higher-yielding debt as the Federal Reserve suppresses interest rates for a seventh year. While purchases are limited to institutions that are expected to be able to fend for themselves, the transactions are raising the risk that they would be blindsided in a downturn.
“Investors are making decisions based on short-term goals,” said Evan Friedman an analyst at Moody’s Investors Service. “But down the road when the atmosphere changes they are taking a chance.” The risk, he said, is that “an investor may be underinformed and may learn of something material too late to react.”
For borrowers, selling debt under Securities Act Rule 144a saves money they would otherwise spent on regulatory compliance. Unlike in the past, when companies would issue 144a bonds on the condition they would become publicly registered at some point, borrowers are now selling the securities as “144a for life.”
That’s opening the door for issuers to push through changes to debt terms later because the notes aren’t subject to securities laws that require unanimous consent from bondholders, according to Valerie Potenza, an analyst at Xtract Research.
“An issuer can put whatever kind of voting regime in it they want and an investor just can’t be sure, perhaps until its too late,” Potenza said.
Techniplas LLC, a Nashotah, Wisconsin-based maker of plastic products, sold $175 million of bonds in April that give the company the right to change terms such as payment dates without seeking permission from all bondholders, according to Potenza. Univar Inc., a Downers Grove, Illinois-based distributor of chemical products, issued $400 million of similar securities this month.
Doreen Lettau, a spokeswoman for Techniplas declined to comment. Scott Johnson, a Univar spokesman, didn’t immediately return a call and e-mail seeking comment.
“144a-for-life bonds are not for the faint of heart,” said Karissa McDonough, the Burlington, Vermont-based director of fixed-income strategy at People’s United Wealth Management, which oversees $5.5 billion in assets. “The market is seeing more laxity come to investors. There is a number of things that can go wrong, and the risk is you are buying something you don’t know.”
Citgo Petroleum sold its bonds in February as part of a plan to pay a dividend to Petroleos de Venezuela SA. Murray Energy issued its debt in April to help buy a stake in rival Foresight Energy LP.
Fernando Garay, a spokesman for Citgo in Houston, and Gary M. Broadbent, a spokesman for St. Clairsville, Ohio-based Murray Energy, declined to comment.
“It’s become the predominant form of issuance, and the benefit is only to the issuer,” said Martin Fridson, a money manager at Lehmann Livian Fridson Advisors LLC. “Investors, if you asked them, they would unanimously prefer disclosure, but the market isn’t swinging in their favor.”
Investors can still negotiate disclosure requirements and other protections directly with the issuers.
“The marketplace is becoming more and more comfortable with the reporting they are getting,” said Justin Breen, a partner in the Leveraged Finance Group of Proskauer Rose LLP. “It hasn’t happened overnight. The market has come to accept it, and become accustomed to it.”
Investors have also been demanding less for private offerings.
Junk bonds sold by companies that publicly disclose financials yield only 0.08 percent less than the broader market, according to Bank of America Merrill Lynch Indexes. That’s down from 0.81 percentage point in 2009.
That leniency is triggering more alarm as defaults by companies pick up. The default rate among speculative-grade borrowers in the U.S. is expected to reach 3 percent by the end of the year, up from 2 in the second quarter, according to Moody’s.
The debt “almost always leads to less and worse disclosure,” said Scott Josefsberg, an analyst at Covenant Review. “Bondholders should care.”
(A previous version of this story corrected the size of the Techniplas bond offering in the eighth paragraph.)