industries, such as manufacturing, financial services, and mining, issued high yield bonds (see table 1.5, p. 19). PURCHASERS The largest purchasers of these bonds are mutual funds and insurance companies, each of which purchases 30 percent or more of new high yield bonds, followed by pension funds, individuals, and thrift institutions which purchase between 7 and 10 percent each (see p. 20). We obtained detailed information on thrift purchasers of high yield bonds because of the concerns that these investments could pose a risk to federal insurance funds. In the past 2 years, federally insured thrifts have increased their holdings of high yield bonds. As of June 1985, thrifts owned about $5.7 billion in these bonds, representing about 0.6 percent of total net assets of federally insured thrifts. By September 1987, thrift holdings of high yield bonds had grown to $11.1 billion representing about 0.9 percent of total net assets (see table II.2, p. 25). II.2, p. 25). About 78 percent of this total was held by 10 thrifts, which had from about 3 to about 34 percent of their assets invested in high yield bonds. investment policies and procedures followed by 5 of these 10 thrifts which we visited in California vary, as does the amount they establish for loss reserves (see app. III, p. 26). We plan to evaluate the reasons for these differences in our final report. PURPOSES The The prospectuses and related data for a random sample of 124 high yield bond issues from a universe of 333 issues offered between January 1986 and June 1987 showed that bonds were used for many purposes. For 66 of the 124 issues, bonds were used for more than one purpose. The most common reasons for issuing bonds were general corporate purposes, cited on 62 percent of the prospectuses, and debt retirement which was noted on 53 percent. "Acquisitions" was a reason stated for issuing the bonds on 13 percent of the prospectuses. Other acquisition-related reasons included future acquisitions, named on 15 percent of the prospectuses, and retirement of debt of previous mergers and acquisitions, named on 23 percent (see table IV.1, p. 31, for sample error calculations). To determine the extent to which high yield bonds were used to finance corporate takeovers, we reviewed all acquisitions of non-financial corporations in 1985 and 1986 which began with a hostile (opposed by management) tender offer, a total 3 of 54 acquisitions. Of these, 33 were successful hostile takeovers and 21 were takeovers by "white knights" or other companies which made an offer after the hostile tender offer and were more acceptable to the management of the company being acquired. Bank borrowing was the most common financing method for the takeovers we studied--used in 39 of the 54 cases and representing about 42 percent of the total amount financed in both years. Publicly traded high yield bonds accounted for about 12 percent of the total amount financed in the 2 years. However, some of the financing for 11 of the 54 acquisitions was later refinanced using high yield bonds (see tables IV.2, p. 32 and IV.3, p. 34). In addition, three acquisitions were originally financed with privately placed high yield bonds that later traded in the public market. When these factors are considered, the percent of publicly traded high yield bonds used to finance corporate takeovers totals about 22 percent for the 2 years. As required by the act, we did this work in consultation with the Securities and Exchange Commission, the Federal Home Loan Bank Board, the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Savings and Loan Insurance Corporation, the Secretary of the Treasury, and the Secretary of Labor. Officials of these agencies provided technical comments on a draft of this report which we have incorporated where appropriate. Copies of the report are being provided to those agencies and are available to others on request. you have any questions or need additional information, I can be reached on 25-8678. If A. Simmons Senior Associate Director 4 II.2: High yield, non-investment grade bonds 25 III.1: Schedule of high yield bond default and recovery data as of December 1987 for six ISSUERS OF HIGH YIELD BONDS In the 6-year period between January 1, 1982, and December 31, 1987, 920 publicly traded, non-convertible, corporate high yield bond issues were offered which Moody's or Standard and Poor's rated non-investment grade or which had characteristics similar to rated non-investment grade bonds, but were not rated. The face value of these bonds was $108.2 billion. In addition, 586 convertible high yield, non-investment grade bond issues were offered in 1982 through 1987, with a face value of $28.1 billion. Table I.1 (pp.8 and 9) and figures I.1 (p.10) and I. 2 (p. 11) summarize data on the number and amount of high yield non-investment grade bonds issued by year and show that the number of companies issuing high yield bonds and the amount issued grew each year between 1982 and 1986, but declined in 1987. Our data show that the 1987 decline was caused primarily by a decrease in new issues between October and December. According to investment bankers and an observer of the high yield bond market, this decrease reflected investors' reactions to the stock market turmoil of October 19, 1987. They told us that during these months investors flocked to higher quality securities, which lowered the demand for high yield bonds and raised the cost of high yield financing to a prohibitive level. As the high yield bond market grew, the overall credit quality of new issues, as determined by the rating services, declined. Tables 1.3 (p. 13) and 1.4 (p. 16) and figures 1.3 (p. 15) and I.4 (p.18) generally show an increased percentage of new issues rated in the lower rating categories between 1982 and 1987. Table I.5 (p.19) shows the breakdown by industry classification of companies which issued high yield bonds between January 1, 1982, and December 31, 1987. The most frequent issuers were firms in the "manufacturing" "finance, insurance, and real estate" (19 percent) classifications. (31 percent) and |