Bonds are issued pursuant to an indenture, which governs the terms of the bonds and contains a number of restrictive covenants that apply to the issuer and certain of its subsidiaries. Corporate bonds can be investment grade or high-yield. As the name suggests, high-yield bonds offer a higher interest rate. Since they come with lower credit ratings than investment grade debt, high-yield bonds also come with a number of incurrence-based covenants. Maintenance-based covenants require the issuer to satisfy certain financial ratios on a quarterly or other periodic basis, while incurrence-based covenants regulate the issuer’s ability to take certain actions.

When bonds are callable or redeemable, it means that the issuer can pay off the bonds prior to the specified maturity date. Following the bond issuance, there is typically a “non-call” period of approximately 3-5 years during which the issuer cannot redeem its bonds. For example, a bond issuance could be labeled “7NC3”, meaning there are 7 years until the maturity date, with a non-call period of 3 years.

Indentures for high-yield bonds generally contain optional redemption provisions. As the name suggests, an optional redemption feature provides the issuer with the option to redeem its bonds. At the end of the non-call period, which usually lasts for 3-5 years after the issuance date, the issuer will be able to redeem a portion of its bonds. There is typically a premium payment associated with the optional redemption feature, with the amount of the premium declining as more time passes.

Prior to the time that the optional redemption feature is available, a make-whole redemption feature enables the issuer to redeem a portion of its bonds by paying a “make-whole” premium. Under the make-whole redemption provision, the issuer would have to pay the sum of the principal amount, accrued and unpaid interest, and a “make-whole” premium. The make-whole premium amount is typically the sum of all the interest payments due from the issuance date through the optional redemption date, plus the first call premium. Make-whole calls are rarely used because they are considered expensive for the issuer.

An equity claw redemption feature provides the issuer with the ability to apply some of the proceeds received in connection with one or more equity offerings toward redeeming a portion of its bonds. The equity claw provision typically allows the issuer to use the proceeds of equity offerings to redeem up to 40% of its bonds within the first 3 years or so after the bond issuance. There is usually a premium associated with an equity claw redemption.

An example of language in an equity claw redemption provision in an indenture is as follows: “At any time prior to [date], the Issuer may, at its option on one or more occasions, redeem up to 40% of the aggregate principal amount of Notes issued under this Indenture at a redemption price equal to the sum of 110% of the aggregate principal amount thereof, plus accrued and unpaid interest thereon.”

High-yield bonds typically do not contain mandatory redemption features. A provision may be included in the indenture to expressly indicate this, such as: “The Issuer will not be required to make any mandatory redemption or sinking fund payments with respect to the Notes.” A sinking fund redemption provision requires the issuer to redeem a specified portion of its bonds based on a periodic schedule.