Liquidity weakens further for Asian high-yield corporates

Laura Acres of Moody’s discusses covenant quality in the face of eroding corporate liquidity.

The liquidity position of corporates rated by Moody’s in the Asian high-yield sector has deteriorated sharply this year, driven by looming debt maturities during the next 12 to 18 months, coupled with a reliance on uncommitted credit lines, and made worse by the end of the commodity wave.

As an indication of this trend, Moody’s Asian Liquidity Stress Index (Asian LSI) rose for the fourth consecutive month in October and stands at 29.1%, up 5.3% from September, which is its highest monthly increase.

The Asian LSI is also at its highest level since the second quarter of 2009.

Currently, 30 companies have the lowest speculative-grade liquidity score of SGL-4, indicating a reliance on external sources of financing.

The index, which increases when speculative-grade liquidity appears to decrease, is creeping close to the high of 37% recorded in the fourth quarter of 2008, the height of the global financial crisis (see Exhibit 1).

While this upward spike in the index in 2008 preceded a large rise in default rates in 2009, we have so far not seen a corresponding rise in Asian defaults, because many issuers have successfully rolled over bank lines or raised committed term funding for refinancing requirements and expansionary capital expenditure.

For example, Lonking Holdings (B1 negative) successfully refinanced its $168 million convertible bonds, on which the put option had been exercised, with a three-year offshore loan facility.

Similarly, Agri International (Caa2 stable) raised an up to 18-month facility from a non-bank financial institution to refinance its $150 million bonds, just before they fell due in July. Both examples highlight that as long as markets remain active and banks continue to lend, weaker liquidity, as measured in our index, may not necessarily result in a wave of defaults.

However, the weakening liquidity, taken in context with the high number of negative outlooks, and the general trend of downgrades exceeding upgrades, underscores the need to further monitor the Asian high-yield sector.

The liquidity position of many corporates appears weak due to their reliance on the domestic bank markets to refinance short-term debt. This exposes them to rapid deterioration in balance sheet liquidity and to the risk of default if funding markets are unavailable.

However, the climate today is quite different from the last quarter of 2008, when the Asian LSI reached its high point of 37%. Companies continue to raise funds from the banks, frequently at the last minute, for refinancing purposes. Funding choices have also broadened, with the high-yield bond markets providing finance in ever greater volumes; Chinese corporates, in particular, have access to trust loans and a growing domestic bond market.

Consequently, although defaults are expected to increase, they remain relatively low.

Strong appetite for US dollar bonds
In the year-to-date, rated Asian high-yield issuers have raised some $8.5 billion, with several deals in the market that are still to close. However, investor response to new issues has been mixed.

Repeat issuers such as Kaisa Group, Road King Infrastructure, Lippo Karawaci and Longfor Properties, all launched and priced within a day, with material oversubscription. This has been countered by weaker outcomes in other deals, including China South City Holdings, which finally closed at $125 million, having relied on a heavy private banking take-up.

Several deals, such as China ZhengTong Auto Services and Baoxin Auto Group, were postponed indefinitely due to difficult market conditions that dampened investor appetite. More recently, China Tianrui Group Cement postponed its third attempt in 2012 to access the markets both through US dollar and renminbi bond launches.

Overall liquidity for Asian speculative-grade companies may further deteriorate if the sovereign debt problems have a greater negative impact on economic growth in Asia, or if it causes lenders to further tighten lending, such that speculative-grade companies are charged higher borrowing rates.

Issuances from Chinese corporates dominate the high-yield space; the second half of 2012 in particular has seen a number of property developers come back to the markets, some of which have cleared at extremely attractive pricing. The deal for Longfor Properties, for instance, achieved the tightest pricing of any non-government linked corporate in Asia this year, clearing at 6.875% for seven years. This year has also been the first time that corporate bond issuances have come from Mongolia, namely in the resource space.

Asian deals provide the strongest covenant protections
Covenant packages for Asian high-yield bonds are much stronger than those offered by similarly rated US, European or Latin American issuers.

Our covenant quality (CQ) score measures the level of protection a high-yield bond covenant package, as a whole, provides to investors. The score takes into account cash leakage, investments in risky assets, leveraging, liens subordination, structural subordination and event risk (change of control). A CQ score of 1 indicates a highly protective covenant package, whereas a CQ score of 5 is the weakest.

Exhibit 2 shows that Asian deals have an average CQ score of 2.21, which is considered good. However, when this score is compared with bonds issued in other regions such as the US (3.37 or at the lower end of the moderate level) and in the emerging markets of Latin America (2.86), covenant packages for Asian deals offer investors much stronger protections.

Our assessment of global covenant quality debunks the widely held perception among investors that covenant protection for Asian issuers is weaker than that in other regions.

We recently published a report on the record $47 billion of US high-yield bond issuances in September that were accompanied by the fourth-weakest monthly level of average covenant quality during the past two years. The average CQ score for the bonds was 3.88.

We will soon be launching a new covenant database that will rank bonds based on covenant quality. Investors can also use it to find market medians, carve-outs for a given region and compare covenant quality across industries, rating levels, sponsors and domiciles.

Downgrades exceed upgrades
Tightening macro-economic conditions around the region, faltering demand from Europe and continued investor uncertainty, have led to concerns over the ability of some issuers to access liquidity. The issue of funding, together with weaker demand for commodities and the softening in their prices, have been reflected in the number of downgrades exceeding the number of upgrades for the five consecutive quarters ending in September this year.

October has seen a slight moderation of the trend, with two downgrades and two upgrades. However, the upgrades of the two government-related issuers — Power Sector Assets and Liabilities Management (Ba1 stable) and National Power Corporation (Ba1 stable) — were driven by the upgrade of the Philippines to Ba1.

The increasing number of negative outlooks is also a telling statistic. At the end of October 2012, some 36.9% of the high-yield portfolio had a negative bias (that is, either negative outlook or on review for downgrade) — a marked increase from the 20.6% recorded in December 2011.

In particular, about 46% of the Chinese high-yield property portfolio is on negative outlook. The majority of the negative outlooks are for developers rated at single-B or below. This mainly reflects the weaker-than-expected contract sales and high refinancing needs of the lowly rated developers, as their weaker market position and credit profiles makes them more vulnerable to government controls over the past two years, to curb residential property prices. However, the larger number of deals in the high-yield bond markets during the second half of 2012 has provided a source of funds for both refinancing needs and future development.

Clear correlation between weak liquidity and lower ratings
Of the speculative-grade issuers rated by Moody’s, 80% with weak liquidity (SGL-4 scores) were in the B1 rating category or below, as of October 31, 2012, while 36.7% were rated B3 and below.

There continues to be a strong correlation between lower ratings and an increase in SGL-4 scores.

Companies scoring SGL-4 rely on external sources of financing and the availability of that financing is, in Moody’s opinion, highly uncertain.

Similarly, higher ratings correspond with issuers with much stronger liquidity positions, or SGL-1 scores.

Currently, all companies scoring SGL-1 are rated Ba3 and above. Such companies are most likely to have the capacity to meet their obligations during the coming 12 months, by relying on internal resources rather than on external sources of committed financing.

To date, investors in Asian paper have been seemingly reluctant to invest in bonds from companies rated lower than B2, effectively closing an avenue of funding for such firms to improve their liquidity positions. In year-to-date 2012, only one rated company, the Indonesian property firm, Alam Sutera Realty, has successfully closed a US dollar denominated bond, while holding a corporate family rating of B2.

The 12-month trailing default rate for Asian speculative-grade rated companies (ex-Japan and Australia) was at 2.63% at the end of the third quarter of 2012. There were no rated defaults in Asia in 2011.

We expect the default rate to remain low, albeit increasing slightly in 2013.


Laura Acres
Senior vice-president corporate finance group
Moody’s Investors Service

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