- Credit agency analyzed 222 bond issue
- Top 12 sponsors winning much weaker covenants
- Their companies can layer on more senior debt
The rating agency analyzed 222 bonds issued by sponsor-backed businesses since January 2011, finding that the 123 bonds issued by companies backed by a top-12 sponsor had average scores of 3.75 on a covenant rating scale, significantly weaker than the average score of 3.12 for companies backed by other sponsors. As a point of reference, bonds from issuers without sponsors have an average score of 3.39.
Overall covenant quality declined in March to 3.97 on Moody’s five-point scale from 3.95 in February, the credit rating agency reported in April. Moody’s uses a three-month rolling average to develop its findings and bases its scores on a proprietary database of covenant provisions, keying for this study on bonds issued since January 2011. A lower number represents stronger covenant protection.
“On average, bonds backed by a top-12 sponsor received weaker scores on all six key risk categories we evaluate in our covenant analysis, with the biggest disparity in structural subordination,” Matt Musicaro, an associate analyst at Moody’s, said in an e-mail message. Structural subordination, one of six categories of covenants in Moody’s scoring system, means that companies backed by a top-12 sponsor can incur more senior debt.
Individual firms varied substantially in their ability to limit covenant protections for bond investors, the Moody’s report found. Bonds backed by the firms Clayton, Dubilier & Rice, Leonard Green & Partners andThe Carlyle Group have the weakest covenant scores of the top-12 sponsors, on average, Moody’s reported. Bonds backed by Madison Dearborn, Thomas H. Lee and GS Capital Partners, the private equity arm of Goldman Sachs, all had the stronger average covenant scores among the top-12 sponsors.
A number of factors can influence covenant scores, among them the timing of bond issuance during good market conditions, the share of deals that are secured or not, and the number of lower-rated bonds issued, Moody’s said.
Too, investors are less likely to demand convenant protections at times when credit markets are strong, and given a sluggish environment for M&A, bond investors appear willing to accept less protection in exchange for higher returns, said one investment banker, who asked not to be named.