Why companies issue high-yield bonds

One of the reasons companies issue high-yield bonds is to finance acquisitions.

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That way, “their balance sheets take on some incremental debt, but only for the short term,” says Nicholas Leach, vice-president of global fixed income and high yield at CIBC Asset Management. He’s the lead manager of the Renaissance High-Yield Bond Fund.

In Canada, one company that has issued high-yields bonds is Valeant Pharmaceuticals, he adds. “Valeant has issued a great amount of debt over the last few years that has paid for numerous acquisitions. That has been their growth strategy, and they’re now the third-largest company that is traded on the TSX.”

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Plus, Valeant’s stock price has risen more than 400% over the last three years.

As a result, Leach says the company shouldn’t have been handed a junk label by ratings agencies. “Valeant could have sold assets and used the proceeds to improve their balance sheet and pay down debt, and [then could’ve] easily obtained an investment-grade rating. But, [that] wasn’t Valeant’s strategy.”

Read: Should you judge a bond by its label?

Meanwhile, Restaurant Brands International (the company responsible for the Burger King-Tim Hortons deal) has also issued high-yield bonds to fund acquisitions.

“Today, [the company’s] bondholders benefit from a cushion of $22 billion in common equity,” says Leach. “And, they rank ahead of Warren Buffet’s $3 billion in preferred equity investment.”

And yet, he adds, “one of the rating agencies has assigned [the company] a triple-C rating, which is one of the lowest on the scale. I think this is a really good example of [when] the market disagrees with [a] credit rating.”

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Why default rates are low

Current default rates on high-yield bonds are low because of where we are in the credit cycle, says Leach. “Credit cycles are usually seven to 10 years apart from peak to peak. And we’re about five years from the previous spike in defaults.”

Read: Global credit markets at a crossroad: IIAC

That said, “when you look back at previous credit cycles, default rate spikes are [typically] followed by several years of improving credit conditions. This time around, we expect the stable phase of the credit cycle [will] be [longer] due to the severity of the financial crisis.”

Read:

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