Three Junk Sectors See Protections Improve

Within three industries for the third quarter, investor protections on North American corporate junk bonds strengthened this being the first time in 2014 that no sectors deteriorated according to Moody’s Investors Services.

Protections, also referred to as covenants, saw mild improvement specific to paper and packaging products, technology, and aerospace defense sectors. Kyle Goodwin and Alexander Dill, analysts with Moody’s reported yesterday that the average for all 13 sectors with a minimum of five new issues worsened, adding that their score rose from 3.62 from last year to 3.87 points. Meanwhile, three improving industries dropped 0.06 points. Using a scale of 1 to 5, the scores with higher numbers indicate less protection.

In average covenant quality, three sectors improved by 0.06 points, which is not a significant shit but it does break the trend of universal sector weakening seen in 12-month periods ending in the first and second quarter of this year. In a telephone interview, Goodwin stated that regardless this augurs and overall market trend remains to be determined.

Leading deterioration with an 0.6 point rise was manufacturing, making it the third consecutive quarter in which bond buyer protections for manufacturing worsened, the most of all non-financial sectors. It has been since the fourth quarter 2013 since the overall measure experienced a gain.

In addition, an increased demand for high-yield debt allowed issuers to get away with lighter protections, according to Goodwin. For the third quarter, investment grade yields ended at 3.18%, compared to 4.77% for a 10-year average, as shown by the Bank of America Merrill Lynch US Corporate index that encourages buyers to choose junk securities because of higher returns.

Goodwin also said that within the market, flexible covenant structures are successfully sold and replicated in later deals. As a result, there is proliferation of weak protection for the entire market.

Covenants on private equity sponsored bonds looked to be strengthening for the first time in the last four quarters. For those deals, protection got stronger by 0.01 point. Rated below Baa3 by Moody’s and less than BBB- by S&P is high yield, high risk debt.

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