Covenant quality in October near 'historical lows,' Moody's reports

By Cristal Cody

Tupelo, Miss., Nov. 9 - U.S. high-yield issuance volume in October stayed high "on the back of continuing low interest rates, while covenant quality remained close to historical lows," Moody's Investors Service said in a report on Friday.

New deals brought to market totaled $39.8 billion in October after a record $46.6 billion in September, the agency said in the report, titled "Low covenant quality persists in October amid continued robust U.S. bond issuance."

"October's distinguishing feature is the poor covenant protection in the lowest-rated credits," Alexander Dill, head of Covenant Research at Moody's, said in a release. "For Caa-rated bonds, the historical relationship between ratings and covenant quality broke down in October after holding last month."

Four out of the 13, or 31%, of the Caa-rated bonds sold in October remained in the agency's weakest covenant quality category, compared with 3.5% historically and 7.7% in September.

The low average Covenant Quality scores were due largely to significant liens and structural subordination risk, Dill said.

Tenet Healthcare Corp.'s $300 million offering of 6¾% senior notes due 2020 (Caa1/CCC+) in October was cited in the report among several new issues with the weakest covenant protection.

Other bonds sold in October that provided weak covenant quality included Lennar Corp.'s $350 million of 4¾% senior notes due 2002, Hertz Corp.'s $1.2 billion two tranche-offering and Petco Holdings Inc.'s $550 million of 8½% senior PIK toggle notes due 2017, Moody's said.

The quality of the month's deals was impacted by a surge in PIK bonds, including those from TransUnion Holding Co., Jo-Ann Stores Holdings Inc., Jaguar Holding Co., BWAY Parent Co., Inc. and NBTY, Inc.'s Alphabet Holding Co., Inc., the agency said.

"These bonds receive low CQ scores mainly because they lack subsidiary guarantees and offer limited protection against liens subordination," Moody's said.

On a scale ranging from 1, the strongest, to 5, the weakest, the average covenant quality score in October was 3.80, improved from September's 3.88 score, but still low compared with the average of 3.65 for all bonds since January 2011, when the agency started to gather the data.

The weakest average covenant quality score in 2011 was 4.09 in September, followed by 4.01 in November, Moody's said.

"The degradation in quality is fully evident on an annual aggregate basis," the report said. "After a slow mid-year in 2012, covenant quality is returning to the low level it had at the beginning of this year.

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