Moody's: North American high-yield bond covenant quality declines 'markedly' in August

By Cristal Cody

Tupelo, Miss., Sept. 12 - North American high-yield bonds continued to priced with weaker covenant protections, with the quality down "markedly last month," Moody's Investors Service said in a report on Thursday.

August was the fourth-worst month for the "bond covenant quality, and a continued decline in September would cement a trend toward worsening investor protections," Moody's said.

"The average covenant quality score weakened to 4.01 in August from 3.79 in July, approaching this year's low of 4.17, reached in February," Alexander Dill, head of Moody's covenant research, said in a statement.

Moody's uses a five-point scale, with 1.0 offering the strongest covenant protections and 5.0 rated as the weakest protections.

"A key driver of last month's weaker covenant quality score was a surge in the percentage of bonds rated Ba at issuance, which typically have weaker covenant packages," Moody's said. "Nearly half of the bonds issued in August were rated Ba, compared with the historical average of 27%, though the average covenant quality score of these bonds last month was in line with the historical average."

B-rated bonds represented 30% of August issuance, down from 60% in July, while Caa- or Ca-rated issues accounted for an overage 22% of deals in August.

Bonds sold in August with the most protective full high-yield bond covenants came from Mohegan Tribal Gaming Authority, which Moody's rated 2.21. Mohegan Tribal sold $500 million of 9¾% senior notes due 2021 in a private placement.

Other bonds with stronger covenant protection included Endeavor Energy Resources, LP's $250 million offering on Aug. 6 of 7% senior notes due 2021 (B3/B+/), which Moody's rated 2.74.

DreamWorks Animation SKG, Inc. also priced bonds with strong covenant protections, according to Moody's. DreamWorks sold $300 million of 6 7/8% senior notes due 2020 (Ba3/B/) at par on Aug. 7. Moody's rated the bonds with a 2.77 covenant quality score.

Among the bonds with the weakest covenant protections, Moody's cited Healthcare Technology Intermediate, Inc.'s PIK toggle notes, with a covenant quality score of 4.73, and ACI Worldwide, Inc.'s traditional structure, which scored 4.36.

Healthcare Technology priced $750 million of 7 3/8%/8 1/8% senior PIK toggle notes due 2018.

ACI sold $300 million of 6 3/8% senior notes due 2023 (B2/BB-/) on Aug. 15 at par.

Although the covenant quality score has weakened for two consecutive months, Moody's said its covenant quality index has improved modestly as weaker months have rolled off.

The index ended August at 3.85, a slight improvement from 3.87 in July and 3.93 in June. The index remains below the record high of 3.37 set in 2011.

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