Penn Virginia deal has 'flawed' covenants; covenant quality declines

By Cristal Cody

Tupelo, Miss., April 10 - Penn Virginia Corp. sold an upsized $775 million of 8½% senior notes due 2020 on Wednesday with weaker covenants, on par with weaker covenant protection seen over the year in the high-yield space, according to market sources.

Covenant quality in the high-yield space has declined for three consecutive months but did show some improvement in March, according to Moody's Investors Service.

Alex Dill, lead covenant analyst at Moody's, said in a report on Wednesday that its covenant quality index has fallen for seven of the last eight months.

"Our three-month rolling average covenant quality index reached a record low of 3.97 [on a five-point scale] in March, down from 3.95 last month," Dill said in the report. On the scale, 5 represents the weakest covenant protection.

"Covenant quality of North American high-yield bonds has deteriorated steadily since hitting a peak at 3.41 in July 2012," he said. "The [Covenant Quality index]'s record high quality of 3.37 was set in April 2011."

The average covenant quality score did improve to 3.76 in March from 4.17 in February, according to the report.

"Although it is an improvement, the March score is still the fifth-worst monthly score during the past year," Dill said.

Radnor, Pa.-based Penn Virginia, an independent oil and gas company, upsized its offering of notes (Caa1/B-) from $400 million. The company plans to use the proceeds to finance the acquisition of some Eagle Ford properties from Magnum Hunter Resources.

'Seriously flawed'

The deal has several "flawed" covenants, including the future guarantors and liens covenants, according to Covenant Review, an independent credit research firm.

The liens covenant is "seriously flawed and could allow substantially more debt to be secured than investors may expect," Covenant Review said in a report.

The restricted payments covenant also contains technical flaws that may allow more cash to escape the credit than investors expect, according to the report.

The issue has a restricted payments basket that is backdated to build from April 1, 2011, and the amount of backdated basket build has not been disclosed and could be significant, according to Covenant Review.

"The basket will build from approximately $153.8 million of net cash proceeds received in 2012 from equity issuances and from the $40 million of equity consideration to be issued in connection with the acquisition," the report said.

Another area of weak debt covenant protection is the notes' credit facilities basket, which will provide "for at least $200 million of headroom above issue date commitments under the company's secured credit facilities, which can be incurred as loans or bonds and secured, and the maximum amount of this secured debt capacity is unknowable by investors without company guidance," Covenant Review said.

"Additionally, the size of the credit facilities basket is at least $500 million, and investors won't know the actual size of this basket at any time without being told what it is by the company."

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