Investors of Asian high-yield bonds have sacrificed covenant protection in the past decade in the chase for yield, according to a report by Moody’s Investors Service.
The credit rating agency said the region’s high-yield bonds have weaker covenants, with Chinese property developers’ bonds rising in proportion and having looser covenant structures over the years, but they remain stronger than bond covenants in Europe, the Middle East and Africa (EMEA) and North America.
“The average covenant quality score weakened to an all-time weakest yearly score of 3.33 (moderate) in 2020 from 2.36 (good) in 2011,” Moody’s said in a statement.
A lower score denotes stronger covenant quality on Moody’s 1.0 to 5.0 scale.
“We analysed 422 Asian full-package high-yield bonds from 2011 to 2020 and found that bondholders have been increasingly exposed to weaker covenants,” vice president and senior covenant officer Jake Avayou said in the statement.
“This is because issuance from Chinese property developers has increased in proportion and these bonds have included weakening covenant structures over the years,” he explained.
Avayou noted that despite the erosion of covenant quality in Asian bonds, they are still stronger than bond covenants in EMEA and North America and the worst yearly covenant quality score of 3.33 (moderate) for Asian bonds in 2020 was almost equivalent to the yearly covenant quality score of 3.32 (moderate) for North American bonds in 2011, which have also gradually worsened over the past decade.
However, Asian covenants have the potential to deteriorate further, Moody’s cautioned.
It said looser debt and permitted liens covenants allow companies to incur more secured debt.
“Fixed-charge coverage ratios decreased to an average of 2.2 times in 2020 from 3.0 times in 2011 and carve-outs increased to an average of 34 per cent of total assets in 2020 from 21 per cent in 2011, worsening average leveraging scores.
“The introduction in 2017 of credit facility carve-outs that can be secured can result in pushing senior bondholders down the capital structure. The average liens subordination score weakened to 2.71 (moderate) in 2020 from 1.95 (good) in 2011,” the agency said.
It also said a higher proportion of bonds predate the restricted payments income basket and do not disclose the accumulated credit.
Moody’s said lower fixed-charge coverage ratios have made it easier to satisfy the debt ratio, a prerequisite to accessing the income basket.
“The practice of predating income baskets without disclosing accumulated credit, and easier access to the baskets, can result in significant cash leakage,” it said.
Meanwhile, Moody’s said, larger carve-outs for investments in joint ventures enable companies to pursue growth opportunities, particularly among Chinese property developers.
Further, structural subordination is high for bonds from Chinese companies because of regulatory constraints, it said.
“Still, change of control provisions in Asia have remained quite standard and offer good protection,” it added.