In our third edition of this blog series on 144A bonds, we explore the difference in rating agency classifications between 144A high yield bonds relative to non-144A high yield bonds.
If you have not yet read the first two installations of this blog series, here are links to get you started:
- Part 1 - 144A Bonds and Why We Buy Them - discussing what these securities are, their increased importance in the high yield market, and why DDJ believes institutional investors seeking exposure to high yield should embrace investing in Rule 144A issuances.
- Part 2 - The Prevalence of 144A-For-Life Bonds – elaborating on an important trend in the high yield bond market: the prevalence of so-called “144A-for-life” bond issuance (i.e., those issued without registration rights) relative to 144A high yield bonds issued with registration rights.
The exhibit below displays the ratings classifications of the Bloomberg Barclays U.S. High Yield Index – broken out into 144A bonds (which includes both 144A-for-life and 144A with registration rights) and non-144A bonds.
As one can see in the figures above, the 144A bonds in the Bloomberg Barclays U.S. Corporate High Yield Index have a meaningfully lower ratings (i.e., a lower percentage of BB-rated bonds and a higher percentage of CCC-rated bonds) than the Bloomberg Barclays High Yield Ex-144A Index. This result comports with DDJ’s view of the reason that 144A-for-life bonds dominate total 144A high yield bond issuance (as discussed in Part 2 of this blog series). More specifically, issuers of 144A bonds tend to be private issuers with no public SEC registered securities outstanding, and in DDJ’s experience, such private issuers typically tend to have a lower credit rating than the large cap issuers in the index (which frequently have publicly traded stock as well as SEC registered bonds outstanding). DDJ believes that the ratings composition difference contributes to the majority of the aggregate yield differences between 144A high yield bonds and non-144A high yield bonds, as represented in the exhibit below.
Some market participants may look at the aggregate yield advantage of 144A high yield bonds relative to SEC registered (ex-144A) high yield bonds and conclude that the yield difference is compensation – or a “liquidity premium” – to investors due to the less liquid nature of 144A bonds. While DDJ does believe that a liquidity premium exists in the 144A high yield bond market to some extent, the size of the liquidity premium has decreased significantly as the 144A market has grown and matured. The exhibit below highlights the yield-to-worst for both the 144A component and non-144A component of the Bloomberg Barclays U.S. Corporate High Yield Index. It is important to note again that the yields in the exhibit are on an aggregate basis (144A component of the Bloomberg Barclays U.S. Corporate High Yield Index vs. the non-144A component of such index). DDJ believes that if the ratings composition differences highlighted above are taken into account – and the Bloomberg Barclays High Yield 144A Index and Bloomberg Barclays High Yield Ex-144A Index otherwise had the same quality composition – the yield differential between the two indices would meaningfully decline.
Interested in taking deeper dive on 144A bonds? Download the full whitepaper below (originally published in November 2018).
DDJ Capital Management is a privately held investment manager for institutional clients that specializes in investments within the leveraged credit markets. Since our inception in 1996, DDJ has sought to generate attractive risk-adjusted returns for our clients by adhering to a value-oriented, bottom-up, fundamental investment philosophy. DDJ has extensive experience investing in securities issued by non-investment grade companies within the lower tier of the credit markets, including high yield bonds, bank loans and other special situation investments.
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