High-yield bond covenant protection declines in 2014; manufacturing sector weakest

By Cristal Cody

Tupelo, Miss., Jan. 27 – High-yield bonds in the construction and homebuilding space and in the retail and business space were the only two sectors out of 18 North American non-financial corporate sectors that strengthened in covenant quality in 2014, Moody’s Investors Service said in a report on Tuesday.

The construction and homebuilding sector provided the strongest covenants and were rated an average score of 3.41 for 2014, an improvement by 0.21, according to Moody’s report, “Covenant Quality Strengthens in Construction and Retail Sectors.”

Moody’s covenant quality bond scores range from 1 for the strongest covenant protections to 5 for the weakest.

Strengthening in the construction and homebuilding sector was driven by secured bonds issued by private-equity sponsored HC2 Holdings Inc. on Nov. 13 and K. Hovnanian Enterprises, Inc. on Oct. 31, Moody’s said.

HC2’s $250 million offering of 11% senior secured notes due 2019 (Caa1/B/) received a covenant quality score of 2.51.

K. Hovanian’s issuance of $250 million of 8% senior notes due 2019 (Caa1/CCC/CCC) was rated a 2.77 covenant quality score.

Moody’s notes, though, that the construction and homebuilding sector “is the sector still most likely to issue HY-lite bonds, which present significant covenant risk and receive poor covenant scores because they lack either or both a restricted payments or a debt covenant.”

During the 12 months ended Dec. 31, 26.7% of all construction and homebuilding bonds had high-yield-lite covenant packages rated B1 or below, Moody’s said.

The high-yield retail and business bond sector covenant quality score improved 0.09 to 3.62 in 2014, Moody’s said.

The space’s covenant quality was strengthened by an unsecured bond issued by private-equity sponsored Guitar Center Inc. on March 26, according to the report. The $325 million offering of 9 5/8% senior notes due 2020 (Caa2/CCC/) was rated a covenant quality score of 2.46.

Manufacturing weakest sector

North American bond covenants weakened the most in the manufacturing sector in 2014, Moody’s said.

The covenant quality score for the space widened 0.49 to 4.34.

“For the fourth consecutive quarterly period, covenants in full-package high-yield bonds for the manufacturing sector weakened the most, increasing 0.49, albeit at a slower pace than Q3 2014’s weakening of 0.60 and Q2 2014’s weakening of 0.74,” Moody’s said.

Weakening in the space was driven by private equity-sponsored senior unsecured bonds brought by Gates Global LLC on June 12 and CommScope, Inc. on May 15, according to the report.

Gates Global’s $1.04 billion offering of 6% notes due 2022 received a 4.76 covenant quality score, while CommScope’s $1.3 billion two-part sale of senior notes was rated a 4.64 covenant quality score.

Overall score declines

Overall, the full-package average covenant quality score for the 12 months ended Dec. 31 was 3.88, or 0.16 of a point weaker than the 3.72 score for the same period in 2013, Moody’s said.

Covenant protection in the North American market deteriorated most in the risk categories of leveraging, which weakened 0.25, and liens, which weakened 0.25, according to the report.

The structural subordination risk category covenant quality score improved 0.03 to 2.93 in 2014.

“Protection against structural subordination showed the only improvement,” Moody’s said. “Issuers are pushing for fewer restrictions on their ability to increase leverage and to secure such debt. The slightly improved average structural subordination score indicates bonds may be benefiting from additional guarantee support from subsidiaries of the issuer and greater limitations on the ability of non-guarantors to incur debt.”

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