Asia high yield covenants buck global trend

Author: Ashley Lee | Published: 31 Jul 2014
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Asia high yield bonds’ investor protections have diverged from a global trend of weakening covenant packages. They’re expected to remain investor-friendly compared to those seen in Europe and the US.

Moody’s Asia-Pacific Covenant Quality report noted that Asia’s covenant packages remain stronger than those in Europe and the US – although non-Chinese bonds tend to have stronger scores.

Investors have insisted that covenant packages remain tight in Asia because of weak bankruptcy regimes and structural subordination. Moody’s report even noted that they strengthened in the second quarter, bucking global trends.

But there is some loosening around the edges. "What I’ve seen from our deals is not any material change in the scope of the covenants but the loosening of some of the baskets including permitted debt and investments," said Kyungwon Lee, Shearman & Sterling’s Asia head of capital markets.

While structural subordination of Chinese bonds has been a long-standing issue, Moody’s expressed new concerns about larger baskets for cash leakage and risky assets – especially for real estate developers.


  •   Asian high yield bond covenants have remained strong due to investor fears over structural subordination and a lack of familiarity with Asia’s legal systems;
  •   But Chinese real estate bonds now include larger baskets for cash leakage and risky assets;
  •   Lawyers also expressed concerns over how the unrated Regulation S market is affecting high-yield development in Asia;
  •   Regardless they do not expect cov-lite to become prevalent in the region, although looser covenants might be possible in sponsor-backed deals.

Chinese real estate bonds

Nearly $18 billion in high yield bonds have been issued in Asia in 2014 year-to-date, according to Dealogic. Over 60% of those bonds have been from China, with Chinese real estate developers alone counting for 46% of total Asia high-yield volume.

Moody’s noted that some repeat issuers are now pre-dating income baskets to coincide with their previous bond issuances. This allows restricted payment capacity to increase for above what should leave the restricted group, given the additional debt servicing requirements of the new issuance of notes.

Larger Chinese real estate issuers started that trend when they successfully came to market with larger baskets. Smaller developers noticed, and took advantage of favourable market conditions to secure similar – but probably smaller in scale – terms of basket size.

"We’ll see one-off cases, where based on credit strength investors may be willing to live with lesser covenant packages"

According to the covenant quality report, six of 12 high-yield deals scored in the second quarter pre-dated their income baskets by over three years, and the offering memoranda did not disclose the amount of the accumulated credit in the income basket.

Lawyers weren’t concerned. Sources agreed that standard high-yield covenants are included in the vast majority of deals, and that larger baskets are needed to allow repeat issuers to expand their operations in a more difficult market.

Unrated Reg S deals

Larger concerns centre on how unrated Regulation S-only deals erode standards in the rated market. Lee observed looser covenants in these deals from China; he doesn’t see those from elsewhere in Asia.

Although investors and lawyers encourage issuers to participate in the ratings process and follow international best practice, successful unrated deals sold under Regulation S dissuade cost-conscious issuers from doing so.

An in-house counsel expressed concerns about the quality of those issuers – and of banks’ due diligence of them. Other lawyers cited concerns about loose covenant packages and poor drafting and documentation.

But so far investors have seemed amenable to their terms – even if they’re lower than what’s typically seen in the market – pushing other issuers to lower their own standards.

Outside China

Elsewhere in Asia covenant packages haven’t eroded to the same extent. "Comps in Asia tend to be fairly strict with investors looking for certain covenants and investor protection," said a capital markets lawyer active in the region.

For example, Lee said that although covenants remain fairly conservative in Indonesia, he doesn’t see cash management accounts often anymore. Instead, he sometimes sees interest reserve accounts, in which debut issuers put six months of interest in escrow.

It’s unlikely that investors would accept the removal of standard protections. They remain concerned about the enforceability of covenants in the region due to undeveloped judicial systems and untested restructuring and bankruptcy regimes in many jurisdictions.

Sponsors to lead cov-lite

Investors in Europe are complaining about a lack of investor protection in high yield bonds. But lawyers do not anticipate the same issues in Asia; in fact, they believe that cov-lite deals will remain relatively rare in the region.

Last year Wynn Macau sold a bond without covenants; it only included a change of control put option for investor protection. But that’s not reflective of the market standard. "Outside the casino sector, I would be hard-pressed to predict that Asian companies will be afforded cov-lite packages anytime soon," Lee said.

Cov-lite development in Asia will depend on sponsor-backed deals, said the capital markets lawyer. Private equity sponsors have pushed the high-yield market in Asia, introducing products such as Term Loan Bs and payment-in-kind (PIK) notes into the market.

"I can see more cov-lite if deals are sponsor-backed," he said. "But elsewhere, covenants are comparatively strict compared to the US and Europe as a result of being in more difficult jurisdictions."

But corporates are unlikely to follow. "We’ll see one-off cases, where based on credit strength investors may be willing to live with lesser covenant packages," said Lee, adding that he doesn’t expect a wave of cov-lite deals.

See also

European high-yield tussles over change of control

Asifma guidelines hope to soften private bank rebate criticism

US general solicitation rules create overseas deal confusion

Bangladesh bond first explained