Covenant quality ends 2015 weak; stronger covenant protections forecast for 2016: Moody’s

By Cristal Cody

Tupelo, Miss., Jan. 13 – The covenant quality of North American high-yield bonds ended 2015 weak, Moody’s Investors Service said in a report on Wednesday.

Moody’s covenant quality index, which is a three-month rolling average covenant quality score, weakened to 4.32 in December on thin issuance from 4.17 in November, well below its record best of 3.39 in April 2011.

Moody's measures bond covenant quality on a five-point scale, with 1.0 for the strongest investor protections and 5.0 for the weakest.

High-yield bonds averaged a covenant quality score of 4.29 in 2015, weaker than the 4.21 average score in 2014, according to the report, “North American Covenant Quality Index: Bond Covenant Quality Worsens in December Amid Limited Issuance.”

Bonds priced in December deteriorated in their average covenant quality score to 4.53 from 4.32 in November, Moody’s said.

“We attribute the weakening to the limited number of deals that cleared the market and the relative absence of lower-rated transactions, which typically provide stronger covenant protection,” Moody’s said in the report.

In December, no Caa- or Ca-rated bonds were priced, “reflecting investors’ reluctance to accept riskier credits,” according to the report.

Historically, 20% of a month’s issuance volume consists of Caa- or Ca-rated bonds, and 8% of deals priced in November were Caa/Ca rated, Moody’s said.

The most protective high-yield bond priced in December came from Group 1 Automotive, Inc., Moody’s said.

The company’s $300 million offering of 5.14% senior notes due 2023 (Ba2/BB) sold on Dec. 3 received a 3.72 covenant quality score.

The full high-yield package for a $350 million offering of senior notes due 2023 (B3/B-) on Dec. 4 from ClubCorp Club Holdings, Inc. was the weakest in December, Moody’s said. The issue received a covenant quality score of 4.26, according to the report.

Bond covenant protections are expected to improve slightly in 2016, Moody’s said.

“Amid a climbing speculative-grade default rate and rising interest rates, investors’ appetite for risky debt remains muted,” Evan Friedman, Moody’s senior covenant officer, said in a news release. “We expect investors to exact a combination of higher coupons and stronger covenant protection, making it less appealing for companies to issue bonds for general corporate purposes and more difficult for troubled credits to clear the market.”

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