High-yield bond covenant quality falls in 21 of 27 corporate sectors: Moody's

By Cristal Cody

Tupelo, Miss., Nov. 12 - The covenant quality of North American high-yield bonds deteriorated in 21 out of 27 non-financial corporate sectors and subsectors in the 12-month period ended in September, according to Moody's Investors Service on Tuesday.

"Covenant quality has been weakening all year and set a record low in September as bond issuance set a record high," according to the report "Most North American Corporate Sectors See Bond Covenants Weaken Further."

Based on a scale of 1.0 for the strongest investor protection to 5.0 for the weakest, Moody's Covenant Quality index hit 4.05 in September and broke the previous monthly record of 3.97 set in March.

The average covenant quality score for the 12-month period was 3.64, compared with 3.41 in the same period a year ago.

"Investors' continuing appetite for higher yields amid still-low rates on U.S. Treasury bonds has driven speculative-grade corporate bond issuance higher and covenant protections lower," Kyle Goodwin, a Moody's analyst and author of the report, said in an agency release.

Among non-financial corporate sectors with at least five new bond issues in the 12-month period, covenant quality in leisure, lodging and entertainment, homebuilding and metals and mining sectors deteriorated the most, Goodwin said.

The sectors with the weakest covenant quality during the past 12 months were midstream master limited partnerships, with a covenant quality score of 4.14, coal with a score of 4.05, and leisure, lodging and entertainment with a 3.91 covenant quality score.

Oil bond covenants strong

Sectors including chemicals, media and publishing, oil services, media services and cable improved over the period, Moody's said.

Bonds in the oil services sector came in with the strongest covenant quality during the reporting period with a 3.00 covenant quality score.

"The high covenant quality in the oil services subsector is partially explained by the prevalence of low-rated companies issuing debt during the past 12 months," the report said.

"Thirteen out of 15 issuances were rated B2 and below, with only two rated at Ba3. These companies must offer more-protective covenant packages to offset their lower ratings and remain attractive to investors."

The report noted that oil services companies issued the most protective private equity-sponsored and non-private equity-sponsored bonds.

The five private equity-sponsored bonds issued in the oil services subsector during the past 12 months scored an average of 2.82 compared to the average 3.64 score of all North American high-yield bonds issued in the period and the 3.09 average covenant quality score of 10 non-private equity oil services bonds, Moody's said.

The report found little difference over the reporting period in the bond covenants between private equity-backed deals and non-private equity-sponsored offerings.

"With an average CQ score of 3.60, non-sponsored bonds during the past 12 months have offered a nearly identical level of protection as PE-backed bonds, which had an average score of 3.70," Moody's said.

"The difference between the two has been immaterial during the past two years."

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