Moody's finds most active private equity bond sponsors offer weak covenant protections

By Cristal Cody

Tupelo, Miss., April 23 - The 12 most-active private equity sponsors provide the weakest covenant protections on average, Moody's Investors Service said in a report on Tuesday.

Moody's studied more than 200 high-yield bonds issued by sponsored North American companies for the review.

"Of the 222 private equity-sponsored bonds we looked at, those issued by companies backed by the 12 most-active sponsors offered investors significantly less protection than those backed by less-active sponsors," Matthew Musicaro, associate analyst and author of the report, "12 Most-Active Private Equity Sponsors Provide Weak Covenant Packages," said in a statement.

The bonds priced between Jan. 1, 2011 and Feb. 28, 2013.

The 12 most-active private equity sponsors each have at least six bonds issued by five distinct issuers and are the largest equity holder in at least one of the deals.

According to the report, bonds backed by Clayton, Dubilier & Rice, Leonard Green Partners and the Carlyle Group have the weakest covenant scores of the top-12 sponsors.

Bonds backed by Madison Dearborn, Thomas H. Lee and GS Capital Partners had the best average covenant scores among the top sponsors, Moody's said.

"We find that, while not always the case, lower rated bonds, secured bonds or sponsors that are less active in post 2008 leverage buy-outs tend to have better covenant protections," the report said.

The weaker covenants leave creditors at greater risk of debt-funded dividend recapitalizations and subordination that could see them take losses in a default, according to the report.

Moody's rates covenant quality scores from 1.0 for bonds that offer the strongest covenant protection to 5.0 for those that offer the weakest protection.

The average covenant quality score of a bond backed by a top-12 sponsor was 3.75, compared with 3.12 for bonds backed by less-active sponsors, according to the report.

Bonds backed by a top-12 sponsor had weaker covenant scores across all six risk categories that Moody's evaluates in its covenant analysis, with the biggest disparity seen in structural subordination.

The average score for bonds backed by a top-12 sponsor was 3.32 in the risk category, about 43% lower than the 2.31 average for bonds without a top-12 sponsor.

"Heightened structural subordination and liens risk allow companies backed by a top-12 sponsor to incur more bank debt, which could reduce investor recoveries in a distressed scenario," Musicaro said in the statement. "Further, the combination of weak restricted payments and debt covenants make companies with a top-12 sponsor more susceptible to dividend recapitalizations, resulting in higher leverage and risk for investors."

Moody's covenant quality index showed deteriorating overall covenant quality in North American bond issuance in the second half of 2012, but the covenant quality of bonds backed by the 12 most-active private equity sponsors deteriorated more in the fourth quarter than that of bonds without a sponsor and fell to a two-year low of 3.95 from 3.61 in the previous quarter.

Of the bonds backed by the top 12 sponsors, 73% received a 'weakest' liens score, and the average liens score declined to 4.34 in the fourth quarter, compared to the historical averages of 55% and 3.80, respectively.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.