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The covenant quality of North American high-yield bonds deteriorated in July, pushing the proportion of low-rated bonds with weak covenants close to a record level, says Moody's Investors Service.
The Covenant Quality Index (CQI) deteriorated to 4.35 in July from 4.30 in June. Moody's measures bond covenant quality on a five-point scale, with 1.0 denoting the strongest investor protections and 5.0 the weakest. The index, a three-month rolling average covenant quality score, is weighted by each month's bond issuance.
The average CQ score for July's bonds actually improved to 4.08 in July from 4.25 in June. However, the picture was distorted as only one bond was completed during the first 10 days of July, as worries over late June's Brexit vote lingered, said Evan Friedman , a Moody's Senior Vice President.
"While the monthly CQ score improved in July, volume was half of what it was two months ago," according to Friedman. "Covenant packages clearing the market this summer are still not as protective as those that cleared in the first four months of 2016 ."
On a three-month rolling average basis, the percentage of new full-package bonds rated B1 and below that also rank in our lower-tier weak, or weakest, categories of covenant quality increased to 68% in July from 61% in June. That's the second-highest percentage on record, trailing only August 2015, where it measured 77%. The historical average is 34%.
Furthermore, the share of high-yield lite issuance increased in July. Lite covenant packages were present in 28% of the month's bonds, up from 22% in June and higher than the 23% historical average. High-yield-lite issuance came from four sectors; utilities, manufacturing, construction and homebuilding.
High-yield lite bonds feature an investment-grade style covenant package despite their speculative-grade rating and offer issuers increased operational flexibility. They receive the weakest possible CQ score of 5.0 because they lack debt incurrence and/or restricted payments covenants.
