Covenant Quality Improves After 5-Month Weakening, Moody’s Says

A measure of investor protection on U.S. and Canadian high-yield debt rose from the lowest level since 2011 as so-called lite-covenant issuance diminished, according to a new index from Moody’s Investors Service.

The average covenant score, in which 1 is the highest and 5 the weakest, improved to 3.84 in December from 3.9 in November, according to Moody’s Covenant Quality Index, which debuted today. That’s the first advance since June and up from the weakest level since November 2011, Moody’s said.

“The decline of covenant quality began in July as issuance rose,” analysts led by Alexander Dill wrote in a report today. Covenants are rules that borrowers agree to follow over the life of a debt issue.

Companies worldwide sold a record $3.95 trillion of debt last year as the Federal Reserve forces investors to take on riskier corporate debt for higher returns by holding short-term U.S. interest rates near record lows to spur economic growth. Investor protections were weaker last year than in 2011, Moody’s said.

Bond issuance was “dominated” last month by pay-in-kind notes, securities that allow issuers to repay holders with debt instead of cash, Moody’s said. Those sales were offset by bonds that had “moderate” quality, or securities with an index score between 2.6 and 3.4.

Debt with lite-covenant packages, which lacks protection against further debt incurrence or fails to restrict issuer spending, earn the weakest possible score from Moody’s.