Quality of emerging market covenants deteriorates, Moody's
October 6, 2020
Monitor of covenants quality hits all-time low amid slowing issuance, according to rating agency
Moody's said on Monday the quality scores for covenants governing emerging market bonds, globally, fell to their lowest level on record in the six months period ended September 30th, with the main drag coming from Chinese property developers.
"This is the worst half-yearly score since our first EM covenants report in September 2018," Moody's said in a report, said adding that loosening of debt covenants in Chinese property bonds was particularly noteworthy.
However, the bond with the weakest score among emerging market bonds issues in the period was Chile's VTR Comincaciones SpA's secured bond, a $600 million 5.125% senior secured not due 2028.
"The (VTR) bond permits the company to make any RP (repurchase) if a pro forma senior secured net leverage ratio test of 4.0x is met. Also, the RP income basket can be accessed to make restricted investments regardless of whether the $1 debt test is satisfied, or if there has been a default or event of default. There is significant liens subordination risk, as the company may grant subordinating liens on the non-collateral assets to secure debt incurred under the $1 debt test, credit facility carveout, general debt carve-out and general liens carve-out," Moody's said.
In addition, Moody's points out that four bonds issued in Latin America compiled weak covenant classifications.
"All four high-yield lite bonds from Latin America were from Brazilian issuers, with all four bonds receiving the worst possible change of
control score of 5.0. Each of Petróleo Brasileiro S.A.'s – PETROBRAS (Ba2 stable) two bonds and Vale S.A.'s (Ba1 stable) bond do not
include a change of control put. Nexa Resources S.A.’s (Ba2 negative) bond includes a change of control put that is only triggered by
two of the five standard events and is further weakened by a ratings decline condition," the report said.
In the case of China, Moody's said the weaker scores can be attributed to "repeat Chinese property issuers that predate their restricted payments income baskets to coincide with those of their previous bonds. In addition, average permitted investments carve-outs for EM bonds issued during the period increased to 23% of total assets, compared with 18% for the six months ended 31 March 2020. Chinese property developers typically negotiate for large permitted investments carve-outs that enable them to invest in or enter into joint ventures with entities outside of the restricted group."
"More Chinese property bonds have made it easier to incur debt by using an aggressively low fixed charge coverage ratio (FCCR) threshold of 2.0 times under their $1 debt tests and by increasing the size of their debt carve-outs," the report said.
All that said, Moody's highlights that emerging market covenant quality remains stronger than in North America or EMEA (Europe, Middle East and Africa).