High-yield telecom bond covenants give stronger protection, Moody's finds; bonds trade flat

By Cristal Cody

Tupelo, Miss., Sept. 28 - Covenants for high-yield telecommunications bonds offer stronger protection for investors than other sectors, Moody's Investors Service found in an analysis of deals since 2011.

"We do see a lot of the covenant protections vary with market conditions and issuers take advantage of favorable conditions whenever possible," Mark Stodden, an analyst at Moody's, said in an interview. "But in general, because the telecom sector is so capital-intensive and there's a lot of [debt-financed] consolidation, we think that in order to get [their target] pricing, these issuers are putting in a little more protection."

tw telecom holdings inc. sold $480 million of 5 3/8% senior notes due 2022 (B1/BB-/) at par on Thursday.

"tw telecom [rated Ba3] is a fairly strong issuer within the telecom sector and they're really benefiting from some positive momentum as well," Stodden said.

Moody's review of 21 telecom bond deals priced since 2011 found stronger covenant protection on average than 398 North American non-financial company bonds.

"The relative strength of telecommunications covenant packages is primarily due to strong debt-incurrence provisions and better-than-average positioning of telecom bonds in terms of protection from liens subordination," Moody's said in the report.

Telecom bond issuers also use a leveraged ratio test to determine if they can incur debt, while other issuers use a fixed charge ratio test, Matthew Musicaro, an analyst at Moody's, said in an interview.

"In addition, telecom companies have less carve-outs than other industries," Musicaro said. "A carve-out is really an exemption for a company to incur debt if it can't pass the ratio test."

Companies in the telecom sector average 12% carve-outs, while the North American average is 23%, he said.

The sector's main weakness in covenant protection is below average protection against structural subordination, Moody's said.

SBA Communications Corp.'s new 5 5/8% senior notes due 2019 (B2/B-/) had weak protection against structural subordination and the weakest overall covenant quality score in the telecom sample, Moody's said.

SBA Communications sold $500 million of the notes at par on Sept. 20. In the secondary market on Friday, the notes traded at 105 bid, 105.5 offered, unchanged on the day, a trader said.

Bonds sold since 2011 by Consolidated Communications Inc., Zayo Group, LLC and EarthLink Inc. had the strongest overall covenant quality scores and the strongest debt incurrence protection in the telecom review, Moody's said.

"Consolidated and EarthLink are facing a decline of their traditional businesses and reinvesting for growth, leading investors to demand more protection against rising leverage," Moody's said. "In addition, market conditions at the time Consolidated's deal was launched in May 2012 were unfavorable and may have forced the company to offer more-restrictive terms to achieve its target coupon."

Matoon, Ill.-based Consolidated Communications Holdings Inc. subsidiary Consolidated Communications Finance Co. sold $300 million of the 10 7/8% senior notes due 2020 (B3/B-/) on May 22 at 99.345.

In the secondary market on Friday, the notes traded flat on the day in light trading at 105.75 bid, 106.75 offered, a trader said.

Telecommunications bonds had widened about 15 basis points on Wednesday, rallied some on Thursday and traded mostly unchanged on Friday, the trader said.

EarthLink's 8 7/8% senior notes due 2019 (B2/B-/) were seen at 99.5 bid, 100.5 offered on Friday, unchanged on the day. EarthLink sold $300 million of the notes on May 12, 2011 at 96.555.

September was a blockbuster month for new high-yield issuance, while covenant quality has declined, Alexander Dill, head of covenant research at Moody's, said in an interview.

"We saw that in August and continued to see that in September," he said.

Currently, market demand has surpassed concerns with covenants in other sectors, such as chemicals.

Rockwood Specialties Group, Inc.'s bond covenants for its deal a week ago were considered among the weakest in the industry by Moody's and Covenant Review, an independent credit research firm.

Rockwood sold an upsized $1.25 billion offering of 4 5/8% eight-year senior notes (Ba2/BB) at par on Sept. 20 to strong demand.

"A substantial portion of Ba2 credits have very little covenant protections; many use an investment-grade structure," Dill said.

Moody's said its analysis excluded 'high yield-lite' deals, such as those from Sprint Nextel Corp., Frontier Communications Corp. and Cincinnati Bell Inc.

"Many of these companies were rated investment-grade in the past, so their covenant packages did not contain meaningful restrictions," Moody's said in the report. "Despite declining credit metrics due to competitive pressures and secular trends, their covenant packages have not evolved to reflect their lower credit standing."

In fact, many fallen angels never change their covenant packages, the Moody's analysts said.

"Fallen angels used to be investment-grade and they see themselves as investment-grade despite what Moody's says," Dill said. "In many cases, when they're downgraded to non-investment-grade, they continue to use a light covenant package."

In the secondary market, Frontier Communications' 7 1/8% notes due 2023 (Ba2/BB/), which priced on Sept. 24 in a $250 million offering at 104.25, traded on Friday at 104 bid, 104.75 offered, a trader said.

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