High-yield covenant quality worsens in October: Moody's

Fri Nov 9, 2012 11:40am EST

Nov 9 (IFR) - Covenant quality for high-yield bonds deteriorated in October, as especially lower-rated credits came to market with more aggressive structures, Moody's Investors Service said on Friday.

Of the Caa-rated bonds covered by the rating agency, 31% are in its weakest covenant quality category, compared with a historical average of just 3.5% and a September reading of 7.7%.

"October's distinguishing feature is the poor covenant protection in the lowest-rated credits," said Alexander Dill, Moody's vice president and head of covenant research.

"For Caa-rated bonds, the historical relationship between ratings and covenant quality broke down in October after holding last month."

The deterioration was mostly due to significant lien and structural subordination risk, said Dill. It cited as example Tenet Healthcare Corp's 6.75% senior notes due 2020, one of few Caa-rated bonds with a high-yield-lite pacakge to emerge since 2010.

Lower-rated bonds usually have stronger covenants than higher-rated bonds, because investors demand more protection for the increased risk.

Private equity-sponsored and secured bonds also saw covenant quality deteriorate in October, said Moody's.

And PIK, or payment-in-kind, issuance increased with five bonds from TransUnion Holding Company, Petco Holdings Inc, Jo-Ann Stores Holdings Inc, Jaguar Holding Company and BWAY Parent Company Inc coming with weak PIK structures.

NBTY Inc also issued a PIK bond through Alphabet Holding Company Inc, said the agency.

PIK structures accounted for 10.4% of October's overall issuance. Companies issue PIK notes at the holding-company level, usually to pay dividends to a private-equity sponsor.

Bonds rated B1 through B3 showed improvement in October, however. Just 16.7% of bonds in that category had the weakest covenant quality, down from 28.6% in September.

And one bond in that category achieved a strong score -- oil services company Offshore Group Investment Ltd, which issued 7.5% senior unsecured first lien notes due 2019 that were rated B3.

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