Covenant fright: Asia’s high yield boom comes at expense of investor protection

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The good, the bad and the insidious in Asian high yield bonds.

Here are two facts.

One: a bank tells us that its year-to-date volumes in Asian high yield bond issues are up fourfold in a year.

Two: Moody’s says the covenant quality on Asian high yield bonds has fallen to its weakest level on record.

The two are not unrelated.

These are remarkable times for high yield, in Asia and worldwide. Globally, Moody’s says that 2018 is already on track to be a record for high yield in dollars, eclipsing 2017’s $453 billion, itself a record.

But there is a more significant subset of that data: that $115 billion of the global 2017 dollar high yield total was rated B3 or lower, up 53% year-on-year, making up more than a quarter of all high yield; and that the Caa grade was up 83.9% year-on-year to $43 billion.

Patterns like this are being reflected in Asia too, as Indonesia and India have joined China as prolific sources of high yield corporate deals. That’s no surprise: investors want yield and they have to venture down the credit curve to get it. Asia is no different from anywhere else in that respect.

Getting worse

But it should not escape anybody’s attention that in the fourth quarter of 2017, Moody’s assessment of covenant quality on Asian high yield bonds fell to its lowest level since the measure was invented at the start of 2011. Moody’s assesses six risk areas – cash leakage, investments in risky assets, leveraging, liens, structural subordination and change of control – and found that the first four of them are getting worse in Asia.

The scale of the deterioration is best understood by comparing the data with when Moody’s started looking at it. In 2011 82% of high yield bonds fell into the strong and good categories for covenant quality. Now only 31% do so. Only 5% were classified as weak in 2011. Now it is 22%.

Analyst and senior covenant officer Jake Avayou finds the growth of credit facility carve-outs, secured against company assets without equally and ratably securing the bonds, to be particularly insidious. Moody’s found the practice in eight out of 10 bonds it looked at during the quarter. “Moody’s views credit facility carve-outs without being tied to a specific purpose – such as capital expenditures for example – as a weakness.”

In a market like this investors are going to accept tighter pricing – that’s just how markets work. They are going to go down the curve too. No problem. But must they accept a deterioration in investor protection as well? That’s not a sign of a healthy market.

Euromoney will be spending February talking to people in Asian high yield about the market, its outlook and its health, and report back in our March edition; drop us a line on chris.wright@euromoney.com if you have a view to share.