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Interest rates may be at record lows, but some experts have noticed a growing number of corporations, private equity firms and other businesses are issuing high-yield, or junk, bonds to finance mergers and acquisitions or other deals.

Interest rates may be at record lows, but some experts have noticed a growing number of corporations, private equity firms and other businesses are issuing high-yield, or junk, bonds to finance mergers and acquisitions or other deals.

“Since the financial distress in 2008, a lot of companies haven’t been able to get financing, so some turned to high-yield, low-rated debt,” said Ermal Luzaj, a manager at Sax, Macy, Fromm & Co. P.C., and head of the CPA firm’s hedge fund service group. “At the same time, investors are looking for better rates in this low-interest rate environment, so Wall Street’s getting creative, and some risky structures — like ‘covenant light’ (or loosely restrictive) loans — are coming back.”

At the end of 2010, Sax Macy advised a client involved in a private equity firm’s buyout of a New Jersey-based pharmaceutical development company, Luzaj said.

“More than $100 million of bonds, with yields of about 7 percent, were issued,” he said. “Smaller companies don’t have the ability to issue these bonds, but some private equity or other investment firms may issue them to raise capital to buy out smaller firms.”

Technically, a junk bond is a debt instrument that’s rated as “below investment grade” by agencies like Standard & Poor’s, Moody’s or Fitch Ratings. The designation is considered a red flag by conservative investment vehicles, like many pension funds, banks and insurance companies, which have bylaws prohibiting them from buying junk bonds.

But nationally, evidence indicates the corporate and investor appetite for high-yield investments clearly is growing.

U.S.-based companies, for example, issued a record $180 billion of junk bonds during the first six months of 2011 — well more than half of the $264 billion issued during all of 2010, according to Dow Jones Newswires. It’s even more pronounced in New Jersey: Seven high-yield bond offerings were made for a total of $2.2 billion during the first six months of 2010, while in the same period in 2011, there were 16 offerings — none of which were investment grade — that totaled $8.5 billion, according to Thomson Reuters.

The state’s 2011 transactions included the January sale of $1.2 billion of Princeton-based NRG Energy Inc. bonds and, in the Somerset section of Franklin, Inventiv Health’s June 30 sale of $370.5 million of bonds.

The annual yields on these bonds range from about 7 to 8 percent — far less than the 20 percent seen in the 1980s, when junk bonds first made a big splash and, some observers say, helped drive corporate valuations to unrealistic highs. Despite the difference in yields, some experts say it’s all relative, considering that conservative investments like 10-year U.S. Treasury notes are now priced to yield about 2 percent a year.

“Many high-yield securities are risky, but they offer attractive returns,” said Barry Sziklay, a former investment banker who is now a partner with the East Hanover CPA firm Friedman LLP. “Investors are looking to alternatives to provide them with a higher rate of return than may otherwise be available for other investments.”

He said high-yield bonds may perform well if the economy recovers, but noted a recession or other significant downturn in the economy could pose a greater risk for high-yield instruments, as compared to traditional investments.

And while Sziklay said he has seen a rise in companies turning to high-yield financing, the activity he sees is very case specific, and some companies, depending on their circumstances, are seeking out other ways of raising capital.

“I just had a meeting with a material engineering company that’s looking to raise capital,” he said. “But they’re not going to try to float a high-yield bond, mainly because there’s a perception that the economy just isn’t at the right point for that, and because they’re still at the research and development stage. So they’re looking to raise funds from people they know, like friends and family.

“After that, they may seek out venture capital, and later on, they could look to go public or get bought out by a private equity firm or other investor. But right now they’re just not at the right stage for high-yield financing.”

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