Asia covenant quality weakens due to China factors

Chinese property developers now have more flexibility in cash spending, debt and investment carve-outs

Moody’s research published on 2 May shows covenant quality in Asia to be worsening this year amid a surge in debt issuance from Chinese real estate developers.

The credit rating agency found that Chinese borrowers in the property sector had made the greatest contribution to the weakening of covenant quality across the region. These borrowers have refinanced their debt, with greater flexibility in terms of making restricted payments and risky investments.

Credit facility carve-outs are becoming more prevalent in the covenants of Chinese property bonds. Moody’s found that 40 percent of these bonds, in the 12 months to the end of March, included the carve-outs.

Property developers such as China Aoyuan Group also gained some flexibility to make investments beyond the parameters to which they had previously been restricted.

The restricted parameters are typically included in a covenant in the China property bonds or loans. This means if the issuers want to make investments in other businesses with the borrowed money, they need to do so in a permitted business, such as their core property development capacity.

The permitted investment carve-outs for the Chinese issuers – including China Aoyuan, which issued four bonds earlier this year – averaged 32 percent of total assets in the 12 months to the end of Q1. Moody’s said that Aoyuan’s permitted investment carve-outs were capped at 50 percent of its total assets.

The carve-outs here matter because dividends can be paid out when the carve-outs have been declared.

It is understood that Clearwater Capital Partners invested $28.5 million in China Aoyuan’s distress debt on a short-term basis and realised $3 million when it exited.

Annalisa DiChiara, a vice-president and chief credit officer at Moody’s, said in a separate report released this week that, as of the end of March, Asian high-yield corporates had $196 billion in debt for maturity through 2021. She added that $246 billion of corporate debt is set to mature across the region by 2023.

As per PDI reporting, some credit investors – such as Nine Masts Capital – are taking shorter duration papers with a view to investing in refinancing opportunities as borrowers face up to a wall of maturity.

Offshore creditors are facing a structural subordination risk from Chinese borrowers. “This is because the debt of onshore subsidiaries of Chinese borrowers is effectively senior to the offshore bonds,” Moody’s analysts said in the agency’s latest research. “The structural subordination is an area of weakness in bonds issued by Chinese companies because of the lack of guarantees from onshore operating subsidiaries for offshore bonds.”