Loose debt covenants have allowed indebted Chinese real estate developers to add even more leverage, according to a Moody’s analysis.
The rating agency’s latest covenant report, Looser debt covenants for Chinese property developers will preserve debt capacity in a coronavirus-led downturn, published on 2 April, showed an increasing number of rated Chinese borrowers could raise their leverage levels in a liquidity crunch because of looser debt covenants.
Indebted Chinese property companies have been leveraging up since 2015. According to the ratings agency, the rated borrowers’ average leverage ratio rose to 7.3x in 2019 from 5.6x in 2015.
The average leverage ratio was calculated by Moody’s analysts as ‘total debt-to-EBITDA’ size, based on disclosures made by Chinese property developers on their financials in the bond offering documents at the time of issuance.
They assessed 155 full-package high-yield bonds issued by rated Chinese property companies from 2015 to 2019, of which 65 were issued during 2019, according to Jake Avayou, Singapore-based vice-president and senior covenant officer at Moody’s.
The analysis showed 49 percent of full-package Chinese property bonds issued in 2019 satisfied a ratio-based test, based on a calculation of a fixed charge coverage ratio. These bonds allow the issuers to incur additional debt under the ratio-based tests, or so-called ‘$1 debt test’.
Moody’s High-Yield Covenant Database showed, during 2019, more Chinese real estate developers used a lower threshold for the ratio-based test, which makes it easier for them to pass the test and therefore incur additional debt.
Specifically, 48 percent of rated Chinese property full-package high-yield bonds issued in 2019 used a FCCR threshold of 2.25x or lower for their $1 debt tests.
In addition, Chinese property developers may incur more debt under debt carve-outs. According to Avayou, companies are not required to disclose to investors whether they are incurring debt under the $1 tests or the carve-outs.
It is understood that debt-outs are used by companies when they either cannot satisfy the ratio-based tests in the covenants, or can satisfy the tests but are not able to secure the debt under the permitted liens carve-outs without equally securing the bonds.