Overview

High yield bonds, also known as junk bonds, are primarily corporate bonds that carry a lower credit rating, typically below BBB- by S&P or Baa3 by Moody’s. These bonds offer higher coupon rates to compensate investors for the increased risk of default compared to investment grade bonds (rated at least BBB- or Baa3).

The high yield bond market originated and became widely recognized in the U.S., particularly in the 1980s during the era of corporate takeovers and leveraged buyouts as a means for companies—especially those with lower credit ratings— to leverage their balance sheets to raise capital. These companies, which might not qualify for investment-grade ratings, could still raise funds by offering higher interest rates to investors to compensate for the increased risk they might take for investing in the high yield bonds.

While high yield bonds are often associated with the U.S. market, they are also prevalent in other global markets, including Hong Kong.

High yield bonds are typically issued by:

• Corporations with weaker credit profiles: Companies with lower credit ratings, including those in sectors facing financial challenges, often issue high yield bonds.
• Emerging Market Issuers: Many high yield bonds are issued by companies in emerging markets that need to offer higher coupon rates to attract investors due to increased default risk.
• Private Companies or Smaller Corporations: Smaller or private companies that are less established or have higher leverage may issue high yield bonds to raise capital, as they cannot easily access investment grade markets.

Key Characteristics of High Yield Bonds

1. Issuer Base: Many high yield bonds are issued by companies in sectors such as real estate, infrastructure, and manufacturing. These issuers often seek funds for projects and to manage existing debt amid regulatory pressures.
2. Risks: High yield bonds generally carry a larger default risk since the issuers are typically of lower credit ratings. They provide such issuers with access to capital and flexibility in fund usage.
3. Coupon Rates: High yield bonds generally offer higher coupon rates compared to investment-grade bonds to compensate for the additional credit risk. This makes them attractive to investors seeking higher returns.
4. Investor Base: The investor base for high yield bonds typical includes institutional investors, such as hedge funds and private equity firms, as well as wealthy individuals or family offices with a higher risk tolerance. Retail investors tend to have less exposure to high yield bonds due to the higher risks and regulatory requirements involved and the larger denominations typically associated with these bonds.
5. Covenants: High yield bonds often come with more restrictive covenants compared to investment grade bonds. These covenants are designed to protect investors by limiting the issuer’s activities that could increase default risk. Common covenants include limitations on debt incurrence, limitations on making investments and payments, negative pledge, and requirements to maintain certain financial ratios. Such covenants would generally have a comprehensive list of exemptions negotiated to allow the issuer to undertake what otherwise would be restricted activities so that the issuer can operate in the usual course of its business as well as undertake other anticipated corporate actions.

Liquidity

High yield bonds are generally less liquid than investment grade bonds, particularly during financial stress or market volatility. They are typically traded in the over-the-counter (OTC) market rather than on formal exchanges. This structure can lead to a less transparent and more illiquid secondary market compared to investment grade bonds and bond prices can fluctuate significantly. Despite these challenges, the potential for higher returns makes high yield bonds an attractive option for many investors.

In the Asia-Pacific region, two prominent venues for listing high yield bonds are the Hong Kong stock exchange (HKEX) and the Singapore stock exchange (SGX). Both HKEX and SGX are popular choices for issuers due to their efficient listing framework and strong regulatory environment. As noted above, many high yield bonds listed on HKEX and SGX are for technical listing purposes only and are primarily traded OTC.

Conclusion

While high yield bonds are most closely associated with the U.S. market, they are also an important part of the bond landscape in Asia, particularly in financial hubs like Hong Kong. These bonds provide crucial access to capital for businesses with lower credit ratings, enabling them to fund growth initiatives, refinance existing debt, or pursue acquisitions. The flexibility in fund usage allows issuers to adapt to changing market conditions and seize new opportunities. High yield bonds will continue to serve as a vital financial tool for issuers in Asia, providing the necessary capital and flexibility to drive business growth and navigate the dynamic economic landscape.

Dominic Sze, Senior Of Counsel 

(E: dominicsze@hkytl.com T: +852 3468 7200)

This article is introductory in nature. Its content is current at the date of publication.  It does not constitute legal advice and should not be relied upon as such. You should always obtain legal advice based on your specific circumstances before taking any action relating to matters covered by this article. Some information may have been obtained from external sources, and we cannot guarantee the accuracy or currency of any such information.