Mergers, Acquisitions, and Corporate Restructurings, 7th Edition

CHAPTER TENHigh-Yield Financing and the Leveraged Loan Market

JUNK BONDS, ALSO CALLED high-yield bonds, are debt securities that have ratings below investment grade. For rating agencies such as Standard & Poor's, this is a rating of BB or worse. The junk bond market is another financing source that can be used to finance takeovers—especially leveraged takeovers. It played a very important role in the fourth merger wave, but its importance has diminished in the years that followed.

HISTORY OF THE JUNK BOND MARKET

Contrary to what some believe, junk bonds were not a creation of the fourth merger wave. They went by the term low-grade bonds for decades. In the 1930s and 1940s, they were called “fallen angels.” In the 1960s, some of the lower-grade debt that was issued to help finance conglomerate acquisitions was referred to as “Chinese paper.” Financier Meshulam Riklis, chief executive officer (CEO) of Rapid American Corporation, stated that the term junk bonds first originated in a conversation he had with Michael Milken, the former head of Drexel Burnham Lambert's junk bond operation. Riklis claimed that when Milken surveyed some of the bonds that Riklis had issued, he exclaimed, “Rik, these are junk!”¹ In the 1920s and 1930s, approximately 17% of all new corporate bond offerings were low-grade/high-yield bonds. A broader range of firms used these securities to finance their growth. The ranks of the high-yield bonds swelled during the 1930s as the Great Depression took its ...