Bond Buyers Skip Fine Print as Low Rates Sow ComplacencyCaroline Chen and Charles Mead
To understand the rising concern about complacency in the corporate-debt market, look no further than the Clear Channel Communications Inc. bonds that investors showed up in droves to buy last month.
While the radio broadcaster has debt that’s 12 times its earnings and a credit rating that implies a default is a virtual certainty, it was still able to more than double the offering to $850 million. Not only that, the indentures governing the notes designed to protect bondholders lacked restrictions typically found in such risky offerings, such as limits on the company’s ability to issue more debt or shift cash to shareholders.
A sixth year of financial repression brought on by the Federal Reserve’s near-zero interest-rate policy are intensifying the risks in the $2 trillion global market for speculative-grade corporate bonds. Lenders are more willing to forgo standard protections to capture increasingly paltry returns. A measure of the strength of junk-bond covenants is about the weakest since Moody’s Investors Service started tracking the data in 2011.
“Investors are told, ‘Here’s the deal, take it or leave it,’” Martin Fridson, a New York-based money manager at Lehmann, Livian, Fridson Advisors LLC, who started his career as a corporate-debt trader in 1976, said in a telephone interview. “There’s very little power in the hands of the investors.”
Clamoring For Yield
Issuance of high-yield, high-risk securities lacking key restrictions on company actions that may be detrimental to creditors have risen during the last three years, according to Moody’s. Offerings of such debt over that period accounted for 19.3 percent of total junk-bond sales through April, said Mark Scioscia, an analyst at the New York-based ratings firm. Three years ago, the riskier debt made up 5.9 percent of the total.
In previous periods such terms were generally relegated to the highest-rated junk bonds, or those graded with ratings in the Ba tier, just below investment-grade, he said.
Investors have clamored for speculative-grade debt to boost returns as the Fed suppresses benchmark borrowing rates and injects cash into the financial system. Average yields on junk-bonds from the U.S. to Europe and Asia reached a record-low 5.86 percent this week, down from 10.5 percent in 2011 and below an average of 9.04 percent during the past 10 years.
The Clear Channel bonds, the proceeds of which were used by a unit to refinance securities maturing this year and next, have a rating of Ca, second-lowest on the Moody’s scale and described by the credit grader as “highly speculative” and “likely in, or very near, default.”
The securities refinanced previously investment-grade notes that were issued before the company’s $17.9 billion leveraged buyout in 2008 by Bain Capital Partners LLC and Thomas H. Lee Partners LP, Wendy Goldberg, a spokeswoman for Clear Channel, wrote in an e-mail.
“The new notes contained substantially similar covenants as the notes they refinanced, other than maturity and rate,” she said. The media company “grew the offering because of investor interest,” she wrote.
Three years ago, Darling Ingredients Inc. raised $250 million by selling 8.5 percent bonds that limited how it could spend its cash on buying back shares or repaying lower-ranked notes. The company went back to the market in December, issuing $500 million of 5.375 percent securities that relaxed the terms, making it easier for the food-recycling company to make those payments.
“It’s a problem for the bondholder because it changes the underlying bargain of how a restricted payment is supposed to work,” Anthony Canale, head of high-yield research at Covenant Review, said in a telephone interview. “This is an aggressive carve-out that’s giving the company the ability to take more money out of the credit that should be left in there to strengthen the bonds.”
Calls to Darling’s media line and Melissa Gaither, the company’s director of investor relations, weren’t returned.
Other companies are relaxing covenants intended to protect bondholder value when the borrower is acquired by another firm, Canale said.
Oasis Petroleum Inc. sold $1 billion of 6.875 percent, 8.5-year securities in September that allowed the company to call the bonds at 110 cents on the dollar if there was a change of control. Such terms are attractive for an issuer that expects to be acquired, because it allows them to buy back the notes at a cheaper price than the so-called make-whole premium they normally would have to pay, Canale said. In Oasis’ case, that would cost more than 110 cents on the dollar if they were bought back now, according to data compiled by Bloomberg.
Messages left with representatives of Oasis’s media and investor relations office seeking comment on the covenants weren’t returned.
Covenants are being loosened as the time investors have to review borrowing documents before commitments are due “has shrunk in some cases to a few days from about a week,” Kyle Jennings, co-manager of loan funds at Newfleet Asset Management LLC, which manages $2.5 billion in loans, said by e-mail.
While protections have deteriorated across the high-yield market, debt issued with looser covenants is especially pronounced in the loan market, according to Gershon Distenfeld, director of high-yield debt at AllianceBernstein Holding LP. That’s a consequence of investors “throwing money into the asset class rather blindly,” he said in a telephone interview.
“We own almost no loans, even though we have the ability to own a lot,” Distenfeld said. Covenants are falling by the wayside as the fear of rising interest rates push investors into loans that pay a floating coupon, he said. “It’s definitely not a good thing.”
More than $136 billion of so-called covenant-light loans have been sold this year, after a record $331.1 billion were issued in 2013, according to data compiled by Bloomberg. Borrowers have issued almost $108 billion of loans with covenants in 2014.
In 2010 -- the first full year of U.S. economic recovery following the worst recession since the Great Depression -- covenant-light loans represented less than 10 percent of new loans with tighter borrower restrictions.
“The advisers to the issuers are trying out new, flexible structures and if the market will accept it, they will use it,” Moody’s analyst Alexander Dill said by telephone. “All you need is one or two of these structures that are weaker than what we’ve seen before, brought into market, then it becomes entrenched and proliferates so, as a whole, covenant quality declines.”