Module IV· Debt TranchesIntermediate
Question
What are 'High Yield Bonds' and when are they used in an LBO?
Answer
Mechanics
High Yield Bonds (junk bonds) = bonds with a sub-investment-grade rating (BB+ and below). In an LBO they are used as a TLB alternative or for larger tranches.
Deep diveShow more details
Comparison (HY bond vs TLB)
| Aspect | High Yield Bond | Term Loan B |
|---|---|---|
| Investor base | Asset managers, insurance, mutual funds | CLOs, loan funds |
| Rating requirement | mandatory (Moody's + S&P) | optional |
| Minimum size | typically $200m+ | from $50m possible |
| Coupon | 6-8% Fixed | SOFR + 400-500 (Floating) |
| Amortization | Bullet | 1% Mandatory + Sweep |
| Call Protection | NC2/NC3 (Non-Call Period) | NC0 or Soft Call |
| Secondary market | active (Bond Trading) | active (Loan Trading) |
Consequence
HY bonds suit large-cap LBOs (>$500m deal size). In the middle market TLB dominates. In smaller middle markets the HY bond market is thin — US private placements / unrated private debt are the alternative.
Common pitfalls
- Fixed coupon = the sponsor does not benefit from falling rates (a floating TLB does)
- Call protection: on an early refi the sponsor must pay a make-whole premium (often 2-3 points)
Pitch tip
Question: "Bond or loan?"
Answer: "For large deals (>$500m) a bond, for better market breadth. For the middle market a loan, because it is more flexible. Concretely: bonds are rare below large-cap; a TLB or a private placement is more common"