Bonds and notes have been a staple of leveraged finance in the United States since the early 1980s. They are high-yield (speculative‑grade), with an S&P’s or Fitch rating of BB+ or Moody’s Ba rating or below, and considered risky with regard to the issuer’s capacity to pay interest and repay the principal.
In cross-border acquisition finance, it has become a normal feature for high-yield bonds to be issued as senior subordinated notes secured by a second lien on the group’s assets and to rank pari passu with the senior secured term loans. They are rarely contractually subordinated, because the senior lenders accept their relatively comprehensive guarantee and security packages.
Over time, more and more US-issued high-yield bonds were issued without being contractually subordinated, even where they were intended to be junior to senior loans.
High-yield bonds are used in the acquisition finance structure instead of mezzanine debt, although very rarely together in the same financing. As a high-yield bond replacement, mezzanine finance may be provided as a private high-yield instrument with bond-like terms.
Unlike mezzanine debt, high-yield bonds contain only incurrence covenants to allow for the conduct of business without restriction. They normally pay a fixed rate of interest and are call protected for a limited period, during which they cannot be prepaid or involuntarily redeemed.
Where underwriting banks commit to provide a bridge loan (certain funds), the acquirer may issue bonds in escrow, pending closing of the acquisition. This is done to show the vendor – and perhaps a regulatory – that the funding is certain and will be forthcoming.