Bond investors have become increasingly concerned about event risk and the absence of meaningful covenants in bond indentures, leaving them exposed to potential credit losses.
In the current market environment, many companies face both internal and exogenous pressures to reward shareholders, often at the expense of bondholders.
Well-constructed covenants can provide bondholder protection in this environment, particularly in regard to event-driven credit risk. In Moody’s view, event-related restrictions are critical to bond-value preservation, assuming carve-outs are modest and are based on a firm’s need in the course of normal business. Strong covenants have already been shown to be effective in protecting bondholders in several instances, such as in the case of Ashland; conversely, weak or limited covenants do not adequately protect against credit deterioration in other instances, such as those of Sungard, First Data, VNU and Telstra Corp.
In light of this situation, Moody’s has identified several key indenture covenants that can help protect investors against event risk, and it has also developed a framework for assessing their strength. This framework includes general guidelines on the most effective provisions, as well as a mapping grid designed to evaluate the relative strength of each covenant package.