Bondholders’ understanding of the protection offered by the provisions within bond indentures (covenants) is of high importance for a thoroughly-informed investment decision. Covenants are often utilized to enhance the attractiveness of the risk characteristic to the high-yield space beyond the yields themselves, with tighter covenant packages that restrict issuers from engaging in potentially creditworthiness-deteriorating behavior.

This study conducts a literature review centered around the effects of covenant packages in the investment process, and contains sample analyses of covenant packages found in two universes defined by broad fixed income indexes (USBIG and HYM), based on data from the Mergent Fixed Income Securities Database.

Covenants are written in complex legal language and require significant efforts in terms of information processing and comparability. Therefore, a simple summary of covenant-related information, such as a score, is a very helpful approach to gaining a high-level understanding on where a bond sits in terms of bondholder protection when compared to similar issues. Given the covenant data characteristics, two covenant scoring methods are proposed – a simple density-based score, and a maximum representative bond model.