Monday, October05, 2020 10:16 AM /by  Moody's Investors Service/ Header ImageCredit:  Investors Diurnal Finance Magazine

• The average covenant quality (CQ) score worsened 6% to 3.45 (weak) in the six months to 30 September 2020, with a higher score denoting weaker covenant quality
• Scores weakened in five of the six areas monitored by Moody's, with only liens subordination scores strengthening

Moody's Investors Service says in a new report thatthe quality of covenants in full-package emerging market (EM) bonds has droppedsignificantly over the past six months, with in particular cash leakage andrisky investments scores continuing to weaken.

Still, EM covenant quality remains considerablystronger than in North America and EMEA, with EM bonds having stronger scoresin five of the six key risk areas.

"The weaker scores in particular for cashleakage and risky investments can be attributed to repeat Chinese propertyissuers that predate their restricted payments income baskets to coincide withthose of their previous bonds," says Jake Avayou, a Moody's Vice Presidentand Senior Covenant Officer.

In addition, average permitted investmentscarve-outs for EM bonds issued during the period increased to 23% of totalassets, compared with 18% for the six months ended 31 March 2020.

Chinese property developers typically negotiate largepermitted investments carve-outs that enable them to invest in or enter intojoint ventures with entities outside of the restricted group.

"Still, EM bonds compare strongly to NorthAmerica and EMEA bonds, with weaker scores only on structural subordination,which remains a key concern for Chinese bonds," adds Avayou.

Asian companies continued to dominate EM bondissuance, accounting for 82% of issuance, followed by Latin America at 15%, andAfrica and the Middle East at 3%. There were no bonds from Emerging Europe inthe six months ended 30 September 2020.

Moody's CQ score combines six factors: (1) cashleakage, (2) risky investments, (3) leveraging, (4) liens subordination, (5)structural subordination and (6) change of control.

The average CQ score for EM bonds issued over thepast six months is now at the weakest level since Moody's published its firstEM covenants report in September 2018, and is also much weaker than the average2.95 (moderate) CQ score for the period from January 2011 through 30 September2020.

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