Aircraft Carrier Takes Aim at 144A Market

The massive reform bill facing the Securities and Exchange Commission is now drawing fire from high yield sell-siders.

The 650-page proposal, dubbed the "aircraft carrier" due to its heft, could potentially change the face of the high yield market. And to hear attorney Kirk Davenport talk, it won't be pretty.

Law firm Latham & Watkins, where Davenport works as a partner, along with most of the major Wall Street investment banks, recently sent a letter to SEC officials deploring the possibility of the 144A market getting chopped in half.

The proposal has been out for almost a year now, and Davenport said last week that he was surprised there has not been more of an outpouring on the buy-side as well, but the word does not seem to be out on just how big the potential impact would be.

The overall proposal seeks to change the securities laws and make more information available to investors when issuers sell stocks or bonds, but one small aspect of it could clothesline the 144A market, Davenport said.

Essentially, the proposal, as it is written, would restrict the 144A market to a smaller subset of those companies currently using it. In fact, according to a study commissioned by Latham & Watkins, about 51% of the 144A high yield issuers would not qualify to do so under the proposed rules.

The "seasoned" companies that would qualify for the 144A process under the proposal are those that are large and have had public equity for a year, Davenport said. And that could spell trouble for the pre-IPO businesses so prevalent in cable and telecom.

"Companies won't fold the day this happened, but there are a number of companies who wouldn't have come to market without it."

So where will those companies turn to find capital?

There are a few options, Davenport said, but none are as good as the high yield 144A market because of the costs and the time required. But, they do exist and the obvious option is the public high yield market. The issuers also could turn to mezzanine financing, bridge loans, venture capital and traditional private placements.

In fact, it could even help those other markets if there suddenly is a rush to do those deals, but only insofar as the 144A restriction does not hamper it.

Gary Goodenough, a portfolio manager at Loomis Sayles said that anything that further regulates the market would be a negative and impede the market's ability to advance.

The high yield market is vibrant and it works, Davenport said last week, and making substantial changes would not be a good idea, he said.

"It doesn't make sense," Davenport said. "It doesn't make sense to change it. It's beginning to catch on in Europe... we got it right and it's the envy of the world."

The 144A market accounted for 78% of all high yield debt issuance in 1998, and so far this year, fully 80% of junk bonds have been 144A offerings, according to statistics from Thomson Financial Securities Data.

According to the study commissioned by Latham & Watkins, 144A deals extend even further than those numbers reflect. In 1997, 144A registrations accounted for about $260 billion, when taking debt and equity into consideration.

The study commissioned by Latham & Watkins was done by Charles Cox, senior vice president at consulting firm Lexecon Inc. Cox was himself a commissioner and chief economist of the SEC at various times in the 1980s, as well as acting chairman in 1987.

"It's a good deal for anybody available for [the new process]," Davenport said, "but a really bad deal for anybody who's not... if you shut the door, there will be some losers, but let's not find out."