Covenant quality 'worst' in nearly two years; Getty covenants flawed

By Cristal Cody

Tupelo, Miss., Oct. 4 - Covenant quality dropped to near record lows as high-yield issuance soared in September, a trend that began in July, Moody's Investors Service said in a report on Thursday.

The average covenant quality score is the "fourth worst since January 2011" and the second worst month in 2012 behind January, Moody's said.

The drop in stronger covenants that protect investors came as junk bond deals in September climbed to a record $46.6 billion on historically low yields.

Getty Images flawed, firm says

Thursday's offering from Getty Images, Inc. contained major covenant flaws, according to Covenant Review, an independent credit research firm, although the company did alter its covenants before the deal priced.

Getty sold $550 million of eight-year senior notes (Caa1/CCC+/) at par to yield 7% on Thursday.

The deal was downsized to $550 million from $750 million upon the finalization of a $200 million upsizing of the company's concurrent term loan, taking it to $1.9 billion from $1.7 billion.

Proceeds will be used to help fund the $3.3 billion purchase of the Seattle-based multimedia company by the Carlyle Group and management from Hellman & Friedman and to repay existing bank debt.

Under the changes made to the covenants, certain covenants, including the restricted payments, transactions with affiliates and asset sales covenant, will include carve-outs to facilitate reorganization transactions.

Covenant Review said one of the covenant flaws is the debt incurrence covenant that is generally based on the company's consolidated total debt ratio versus the usual fixed charge coverage ratio.

"This consolidated total debt ratio is seriously flawed in ways that may allow more incremental debt to be incurred than investors expect," the agency said in a report.

Other flaws found in the covenants included the change-of-control covenant, which would allow a public company that merges with a parent holding company to acquire Getty Images without triggering a change-of-control put, Covenant Review said.

Rockwood deemed weakest

Covenant quality scores of secured bonds and bonds issued by private equity-backed companies also dropped in September, according to Moody's.

"In another sign of weak covenant quality, secured bonds made up 11.8% of total issuance, below the historical average of 21.6%," Moody's said.

"September issuance continued to exhibit the inverse correlation between covenant structures and speculative-grade rating levels: higher-rated bonds have weaker covenant packages than lower-rated bonds because investors expect weaker credits to offer more protection," Moody's said.

Rockwood Specialties Group, Inc.'s covenant quality was considered the weakest of the September crop of bonds with full covenant packages.

Rockwood sold $1.25 billion, upsized from $750 million, of eight-year senior notes (Ba2/BB) on Sept. 20 - one of nearly 10 high-yield deals to price that day.

"With all these drive-bys going on, there's less opportunity for people to dig deep and review terms," said Robert Matz, an analyst at Covenant Review.

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