C&B Notes

High Yield + Cov-Lite = Madness

Covenant-lite loans, with their often significantly reduced creditor protections, have been an increasingly large part of one corner of the debt issuance market over the past several years.  When these cov-lite loans are issued by high yield borrowers, yield-chasing buyers better beware.

The covenant quality of North American high-yield bonds drastically worsened in June, Moody’s Investors Service says in a new report.  The rating agency’s Covenant Quality Index, a three-month rolling average covenant quality, plummeted to 4.48 from 4.26 in May, just four basis points off its worst ever score of 4.52, set in August 2015.  Moody’s measures bond covenant quality on a five-point scale, with 1.0 denoting the strongest investor protections and 5.0, the weakest.

“June had the highest concentration of high-yield-lite bonds we have ever seen, driving the month’s very weak average covenant quality score of 4.68,” observed Senior Vice President Evan Friedman.  “High-yield-lite bonds, which automatically receive our worst-possible covenant quantity score of 5.0, represented a record 60% of last month’s issuance and a record 47% of bonds included in the June Covenant Quality Index.”

Also contributing to June’s weak average covenant quality score was a high volume of bonds sponsored by private equity, Friedman says in “June’s bonds provide worst protection of any single month on record.”  The Covenant Quality Index for private-equity bonds fell precipitously last month, to 4.31 from 4.04 in May, marking its second-weakest recorded score of 4.38.

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