Moody's: Covenant quality falls slightly in July for high-yield bonds

By Angela McDaniels

Tacoma, Wash., Aug. 13 - Covenant quality declined modestly in July, according to a report from Moody's Investors Service.

The agency said the average covenant quality score for U.S. high-yield bond issuance in July was 3.79, a small decline from 3.72 in June but well above the 2013 low of 4.17 reached in February. The agency measures covenant quality on a five-point scale from 1 for strong covenant protection to 5 for the weakest.

Issuance volume increased in July from June, when many companies postponed deals, Moody's noted.

In the agency's opinion, July's downtick in covenant quality does not yet indicate a trend to worsening terms. Moody's said issuers continue to offer better structures than earlier this year.

Caa/Ca bonds drive decline

Moody's said a key driver of weaker covenant quality in July was deterioration among bonds rated Caa/Ca at issuance. These bonds had an average covenant quality score of 3.85 in July, worse than 3.59 in June and the historical average of 3.37.

Bonds rated Caa made up 28% of issuance in July, compared with 22% historically.

Bonds rated B had an average score of 3.62 in July, better than the 3.72 average in June.

Bonds rated Ba made up only 12% of high-yield bonds issued in July, below 21% in June, the record high of 41% in April and the historical average of 27%.

Light covenant packages too

Issues with light covenant packages also contributed to worsening covenant quality, Moody's said.

Bonds that lack a debt incurrence and/or a restricted payments covenant automatically receive the weakest possible credit quality score of 5. These represented 16% of bond issues in July, up from 10.5% in June and near the historical average of 16.8%.

The agency said the record for covenant-light issuance was set in September 2011 at 41.7%.

The four covenant-light bonds issued in July came from four companies in three sectors: Gannett Co., Inc. (Ba1/negative) and Sirius XM Radio Inc. (Ba3/stable), media and publishing; D.R. Horton, Inc. (Ba2/positive), homebuilding; and Chemtura Corp. (Ba3/stable), specialty chemicals.

July sees three PIK bonds

PIK issuance also contributed to weaker covenant quality in July, according to the report.

Moody's said that due to their subordinated status, among other features, PIK bonds often have among the lowest scores of full high-yield packages.

PIK notes from Michaels Stores Inc. (B2/stable) and PC Nextco Holdings, LLC, a holding company of Party City Holdings Inc. (B2/on review for downgrade), were among the weakest bonds in July as measured by Moody's covenant quality scores. They scored 4.91 and 4.26, respectively.

The Michaels Stores bond broke the record for weakest covenant quality score in Moody's High-Yield Covenant Database.

Also issuing PIK notes were MPH Intermediate Holding Co. 2, a unit of Multiplan, Inc. (B2/stable), which scored 3.92.

Kodiak scores best

The most protective full high-yield packages in July came from Kodiak Oil & Gas Corp. (B2/stable) at 2.28, Quiksilver Inc.'s (B3/stable) two tranches at 2.59 and 2.89 and Post Holdings, Inc. (B1/stable) at 3.04.

Covenant Quality index

The agency's Covenant Quality index ended July at 3.87, recovering from its dip to 3.93 in June.

This index is a three-month rolling average weighted by each month's total number of bond issues.

Moody's said the index improved in July because a weaker month's scores (April) rolled out of the index.

The index remains well below last July's peak in covenant quality of 3.41 and the record high of 3.37 set in April 2011.

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