Rule 144A Debt Offerings: The Impact Upon Bond Yields and Underwriter Fees

Securities issued, typically via private placement, under Rule 144A do not have to file a public registration statement with the Securities and Exchange Commission, but can be sold only to qualified financial institutions. Below is an examination of industrial and utility bonds issued under Rule 144A.

144A and Higher Yields

Rule 144A issues are found to have higher yields than publicly issued bonds after adjusting for risk. Yield premiums are higher if the issuer does not file periodic financial statements with the SEC. The yield premiums of Rule 144A issues may be due to lower liquidity information uncertainty and weaker legal protection for investors. Bonds issued under Rule 144A may have registration rights, which require the issuer to exchange the bonds for public bonds within a stated period, or pay higher yields. While high-yield bonds usually have registration rights, we find that the majority of investment-grade bonds do not. Registration rights have a greater impact on yields for high-yield than for investment-grade bonds. Underwriter fees for Rule 144A issues ar e not significantly different from underwriter fees for publicly issued bonds.

Rule 144A, the Securities and Exchange Commission and Bond Offerings

Since 1990, the Securities and Exchange Commission has allowed firms to sell security issues to qualified institutional buyers under so-called Rule 144A. Rule 144A issues are not required to be registered with the SEC and may not be resold to individual investors, but may be traded between qualified institutional buyers. Rule 144A issues may have “registration rights,” which require the issuer to exchange the original Rule 144A issue for a public bond issue within a stipulated period. If the exchange does not occur, the issuer must pay a higher interest rate.

The basic justification for the waiver of advance registration is the belief that large institutional buyers are sophisticated investors and do not need the SEC to examine each offering of securities in depth. Public issues of securities are required to be registered before they are offered for sale to individual investors, however, who are presumed to be less sophisticated and informed than large institutional buyers.

Rule 144A Market Growth

The Rule 144A market has been growing very fast. Annual issues of Rule 144A non-convertible debt have swelled from $3.39 billion in 1990 to $235.17 billion in 1998 and is much higher today. In the meantime, the traditional private placement bond market has shrunk from $109.94 billion annually to $51.10 billion. Rule 144A issues have accounted for up to 80% of the high-yield bond market in recent years.

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