Bonds issued throughout the world are assessed in an inconsistent fashion because of regional differences in covenant quality, according to a new report from Moody’s Investors Service.
North American investment-grade bonds, for example, generally boast stronger bond covenants than do their European counterparts, Moody’s noted in its first comprehensive analysis of regional differences in covenants across a number of rating categories.
However, European high-yield bond indentures often offer investors greater protection than the North American versions.
“Most intriguing is how covenant quality migrates to the European side of the Atlantic once one enters the high-yield space,” said Moody’s Vice-President Alexander Dill.
For example, U.S. and Canadian investment-grade bonds typically have stand-alone covenant restrictions on merger sales or asset sales; on the incurrence of secured debt, in the form of negative pledges or limitations on liens; and in sale/leaseback transactions, Moody’s pointed out.
In contrast, while the negative pledge/limitation on liens covenant is usually present in European investment-grade bonds, the mergers/asset sales and sale/leaseback covenants are only infrequently included in documentation associated with the issuance, Moody’s added.
“The only exception appears to be change-of-control provisions,” said Dill, who noted that both the North American and European regions have increasingly included change-of-control put options. In fact, by 2007 such options were present in over half of the North American and European bonds assessed by Moody’s.
The story is much different when it comes to junk bonds, however. Moody’s pointed out that the high-yield protections often absent from Ba-rated North American bonds are more likely to be found in high-yield European bonds. These protections include restrictions on certain actions by the borrowers, such as limitations on restricted payments, incurrence of indebtedness and subsidiary borrowings and non-ordinary course asset dispositions.
“Moreover, where these high-yield covenants are prevalent in both regionsÂ the European bond covenants were generally stronger than in North America,” said Dill.
Eight key covenants identified by Moody’s as protecting against event risk and de-capitalization, and which may be present in a covenant package related to restricted payments, change of control, merger restrictions, restrictions on asset sales, limitation on debt incurrence, negative pledge/ limitation on liens, limitation on sale/leaseback transactions, and limitation on subsidiary borrowing.
Moody’s evaluated more than 350 individual covenant packages on 760 bonds issued from 1998 through 2007 for the study.