Moody's: Non-sponsored Caa-rated bond covenant quality has 'plunged'

By Cristal Cody

Tupelo, Miss., Oct. 3 - The covenant quality of Caa-rated bonds priced without private equity backing has "plunged" in 2013, according to Moody's Investors Service on Thursday.

"Companies without a private equity sponsor are starting to catch up to sponsored companies by offering bond deals with very weak covenant packages to help take advantage of the favorable bond market," Matthew Musicaro, a Moody's associate analyst, said in a release. "Many deals are oversubscribed, leaving investors with little ability to push back against weak covenant structures."

Non-sponsored companies traditionally have offered more protective high-yield bond covenants than companies with private equity sponsors, according to the report, "US Companies Mimic Private Equity With Weaker Caa Bond Covenants," released on Thursday.

Caa-rated bonds have seen the most deterioration this year in liens, debt incurrence and restricted payments covenants, Moody's said.

Of the 188 U.S. bonds included in Moody's high-yield covenant database since 2011 that were rated Caa at issuance, those with private equity sponsors have an average covenant quality score of 3.55, compared with the 3.03 score for those without sponsors, the agency said. Moody's scores covenant quality on a scale of 1 to 5, with one as the strongest.

"This gap has virtually disappeared for Caa-rated bonds issued in 2013, with PE-sponsored bonds averaging 3.71, virtually equal to non-sponsored bonds at 3.69," the report said.

Supervalu scores weakest

Of the eight non-sponsored Caa-rated bonds that scored in Moody's weakest covenant quality category since 2011, five were issued in the second quarter of 2013: TransDigm Inc., Legacy Reserves LP, Alere, Inc., Supervalu Inc. and US Airways Group Inc.

The issues include TransDigm's $500 million offering of 7½% senior subordinated notes due 2021; Legacy Reserves' $250 million sale of 6 5/8% senior notes due 2021; Alere's $425 million issuance of 6½% senior subordinated notes due 2020; Supervalu's $400 million sale of 6¾% senior notes due 2021 and US Airways' $500 million offering of 6 1/8% senior notes due 2018.

"Supervalu's Caa1 rated 2021 notes are particularly noteworthy as the only Caa-rated bond issued in 2013 to use a high-yield-lite covenant package, which lacks a restricted payments and/or debt incurrence covenant and automatically receives the weakest possible CQ score of 5.0," the report said.

The Caa-rated non-sponsored bond issued in 2013 that received the highest covenant quality score was from Ahern Rentals, Inc., "which issued the bond as part of bankruptcy exit financing and thus had little ability to demand weaker covenants," Moody's said.

Ahern's $420 million offering of 9½% second-priority senior secured notes due 2018 received a 2.09 covenant quality score.

Spreads still tight

Credit spreads of Caa-rated bonds remain tighter despite weaker covenants, Moody's notes.

"Some of the weakest Caa bonds have tighter-than-average spreads," the report said. "The spreads of all five non-sponsored Caa-rated bonds in the weakest category were tighter than the average spread of Caa-rated bonds in 2013."

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