Covenants for midstream, energy bonds 'problematic,' analyst warns

By Cristal Cody

Tupelo, Miss., Dec. 7 - Bond covenants in the midstream sector remain continue to pose concerns for investors, though smaller issues often trend toward tighter covenants, according to market sources.

Inergy Midstream, LP and Inergy Midstream Finance Corp. sold eight-year senior notes (B1/BB/) at par to yield 6% on Nov. 29 in an upsized $500 million offering that closed on Friday.

In trading, the notes were seen higher at an indicated market of 101 5/8 bid, 102 offered, a trader said on Friday.

"But it's very limited trading," the trader said. "A half-billion issue isn't that bad of a size. I'm surprised to not see a lot of markets in it - that tells me a few big buyers took it down because there's not a lot of secondary trading."

One small offering in the oil and gas sector came on Friday from Rex Energy Corp., which sold $250 million of 8 7/8% senior notes due 2020 (B3/B-) at 99.30 to yield 9%.

Low interest rates have encouraged companies to refinance upcoming maturities and high-yield issuance has reached a record high, bond sources said.

"All the midstream companies are problematic for their covenants," Robert Matz, an analyst with Covenant Review, an independent credit research firm, said on Friday.

"Usually when the market is this hot there isn't time to negotiate," he said. "We've had huge inflows and a lot of smaller deals as well. A lot of times, smaller deals have tighter covenants. People are looking at it more as a lifetime investment."

Moody's Investors Service said in a covenant quality assessment report that Inergy's "lower-tier weak protection" covenant package reflects a level of covenant quality in line with the energy, oil and gas-midstream peer group.

Key concerns with the issue included the liens covenant contains a subtle drafting flaw that would allow all loans and bonds to be secured, Covenant Review said in a report.

In addition, the notes' restricted payments covenant contains "flaws that would allow more cash to escape the credit than investors expect," Covenant Review said, "and if the acquisition and the proposed $225 million equity issuance close after the issue date, restricted payments capacity would build from the $225 million equity issuance."

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