Warning: shoddy prophylactics in high-yield market
Investors feel better when risky bonds come with flak jackets. Drive-by deals, so named for skipping over the conventional road-show route in favor of a one-day turnaround, don’t give investors much time to ensure they’re protected. Shoddier bondholder provisions in a slew of recent, often rushed, deals indicate many are not.
MetroPCS is a case in point. The cellphone service provider secured itself considerably more leeway than other similar borrowers in a hastily arranged $1 billion sale last week. To ensure they’re paid back, bond holders like to restrict a heavily indebted company’s spending, investment and borrowing. As a general rule, high-yield issuers have been able to tap only about 5 percent of their available assets, according to Moody’s Investors Service median estimate. MetroPCS was granted access to close to 30 percent.
It gets worse. MGM Resorts, the casino operator, and Tenet Healthcare, the hospital operator, represent the worst credit available. Each is rated Caa1 from Moody’s. Covenant-lite deals are nothing new, yet both still-recovering companies managed to arrange debt with the more lenient provisions reserved for those with far less risk of missing payments.
Of course, most of the money being raised in high-yield markets these days is to refinance existing debt. And such balance sheet management is healthy, especially when rock-bottom interest rates make capital cheaper. Yet issuers are taking advantage of the fast and furious race for yield to weaken covenant language wherever possible.
The Federal Reserve’s commitment to low interest rates means there will probably be more opportunities. With corporate defaults slowing and investors craving better returns than the shrunken yield on U.S. debt, few will have the stomach to miss out. Junk bonds have generated around 15 percent this year against barely 1 percent on a five-year Treasury note.
Still, investors should beware how creative the bond engineers are getting. They’ve already wheeled out the “springing lien,” which sounds like it just might bounce right back into buyers’ faces. Momentive Performance Materials included the provision in a $635 million offering. Instead of providing collateral upfront, the specialty chemicals maker will provide it at some later date — when it is finished being pledged to other debt holders. When promises replace secured holdings, it’s surely time for better armor.