High Yield Bond

A high yield bond is a bond issued by borrowers with weaker credit quality that offers a higher interest rate in return. The higher interest is compensation for the greater risk that the borrower may not be able to pay. Investors can achieve a higher return, but also carry a higher default risk. The segment is defined by rating: anything below BBB- at S&P and Fitch or Baa3 at Moody's counts as speculative and therefore high yield.

Typical features are a fixed coupon, a tenor of roughly five to eight years, bullet repayment and a covenant package tested not continuously but only on specific actions, such as additional borrowing, distributions or asset sales. Call protection for investors in the early years is regularly added, after which the issuer may redeem early at defined prices, together with an obligation to offer to repurchase on a change of control. In leveraged buyouts this instrument is the classic permanent financing for larger transactions, while the period until placement is covered by a bridge loan.

For the issuer the advantages are the long tenor without ongoing amortisation and the comparatively limited intervention rights of creditors. The price is a considerably higher coupon and dependence on market capacity at the time of issue. For the acquirer of a company with bonds outstanding the change of control clause is the central review point, because it gives investors a repurchase offer and can in the extreme accelerate the entire financing. Repayment must then be built into transaction costs. The baskets for additional borrowing and distributions also require review, since they determine whether a planned structure is feasible at all. For listed bonds the question is added at what price a repurchase would actually be possible.