Covenant quality on Hiland notes weak; investors shrug off concerns; notes jump in trading

By Cristal Cody

Prospect News, Sept. 12 - Covenant concerns may be taking a back seat as investors chase higher yield, according to bond sources and traders.

"Some people don't even look at covenants," a high-yield bond source said. "They just don't focus on them that much when they're buying new issues."

That's likely because "when we have a deal, we only have a handful of investors who help structure the covenants and everyone else figures it's OK," the source said.

Hiland Partners, LP and Hiland Partners Finance Corp. came to the market on Tuesday with an upsized $400 million issue of eight-year senior notes (B3/B-/) following a roadshow the previous week. The deal was upsized from $350 million.

The notes priced at par to yield 7¼%, 12.5 basis points beneath the low end of yield talk that was set in the 7½% area.

"Wow," a trader said on Wednesday while checking out the latest level.

The notes traded going out at 104.75 bid.

"As the markets get stronger and stronger, people care less and less about the covenants," the trader said.

Hiland, an Enid, Okla.-based provider of natural gas gathering and processing services, plans to use the proceeds, along with equity contributions, to pay down the company's revolving credit facility.

The Hiland issue holds several covenant flaws, according to reports from Moody's Investors Service and Covenant Review, an independent credit research firm.

The covenant package "offers weak protection," Moody's said in its report.

Covenant Review pointed out some of the deal's key concerns:

• Due to a huge flaw in the liens covenant, the company may secure all bank debt that it may incur under the debt covenant ahead of the notes.

• The company can make unlimited investments, including cash, in any unrestricted subsidiary or joint venture if the company could incur $1 of ratio debt.

• The restricted payments covenant has a version of the basket build-up that allows Hiland to 'dividend out' all available cash it generates each quarter to shareholders.

• The notes only will have registration rights if a future IPO of the company's equity is completed.

• The asset sales covenant would allow Hiland to repay other unsecured debt ahead of the notes.

"These flaws are not uncommon in these types of deals, but one of them is not a typical flaw for a high-yield covenant package," said Anthony Canale, a Covenant Review analyst.

"Usually, a liens covenant will provide only a limited amount of secured debt incurred ahead of the notes, but this would allow any bank debt to be secured ahead of the notes, which is not typical for a high-yield bond offering," he said. "We do see these in oil and gas offerings, so it's not unprecedented."

Another bond trader said the covenants are more likely to be studied in a junk bond deal versus an investment-grade offering.

"My gut is that investors aren't paying that much attention to the investment-grade area; there is more concern about high-yield," the trader said. "High yield has more parts and calls. But there is this whole grab for yield. Everybody's making a grab for anything."

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