Bond Covenant Quality Deteriorates to Record Low, Moody’s Says

A measure of investor protection on North American high-yield debt averaged over three months deteriorated to a record low even as covenant quality improved in March, according to Moody’s Investors Service.

The average covenant score, in which 1 is the strongest covenant quality and 5 the weakest, worsened for a third period to 3.97 last month, according to Moody’s Covenant Quality Index. While March’s single-month score of 3.76 improved from 4.17 in February, it’s still the fifth-worst monthly score during the past year.

Investors have been acquiescing to weaker terms from the least creditworthy borrowers as the Federal Reserve holds its benchmark borrowing rate close to zero into a fifth year, encouraging bond buyers to seek riskier assets. The extra yield investors demand to own junk bonds instead of government debt narrowed to an average 471 basis points March 14, the lowest level in almost two years, according to Bank of America Merrill Lynch index data.

“Investors are still facing less covenant protection while receiving relatively low yields,” Moody’s analysts led by Alexander Dill wrote yesterday in a report.

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