3 min read 31 Jan 22
Since the beginning of the year, a few primary market deals have again raised concern about the gradual weakening of bondholder protection in emerging market corporate bonds.
When it comes to bond documentation, the devil is in the details. Offering memorandums are often in excess of 500 pages – the ones with over a thousand pages are viewed with a healthy degree of caution by the bond community – and sometimes only a few sentences/words make bondholders’ protection weaker and hence may change the economics of an investment. While there is some standardisation in terms and conditions in the high yield world, investors still have to do their homework. Here’s why, in 3 recent examples:
There are many more examples, e.g. early redemption structures or the inclusion/exclusion of FX losses in net income for the calculation of restricted payments (particularly important for emerging market bond issuers). Some areas of the market are much weaker than others. China high yield property developers have had appalling and deteriorating bond covenants for some time. Their very large, permitted investment carve-outs have enabled them to increase joint venture and associate’s investments – contributing to the lack of transparency about off-balance sheet items and cash leakage to unrestricted entities outside the restricted group (see chart). The debt incurrence ability of Chinese property developers has also been facilitated by the fact that (1) it is not based on a debt leverage metric and (2) the fixed charge coverage ratio (often EBITDA to interest) condition was getting increasingly aggressive (i.e., lower) over the years. Some property developers simply don’t have restricted payments, and others no debt incurrence conditions whatsoever (aka high-yield lite deals).
Source: M&G, Moody’s High-Yield Covenant Database, Oct 2021, Excludes high-yield lite bonds.
With China property now under immense stress and the rest of emerging market corporate bonds facing a lukewarm primary market at the start of 2022, perhaps this is a chance for the asset management industry to ensure - through engagement with issuers and advising banks - that covenants do not weaken further from here, and actually improve in some areas of the market. The more bond investors make their order conditional to bond document changes, the more likely terms and conditions will be amended to the benefit of bondholders.
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