Emerging Market Covenant Quality Scores Improve, But Risk of Cash Leakage Rises

Tuesday, April 28,2020 / 5:52 PM / by Moody's Investors Service / Header ImageCredit: MSCI

Risk of cash leakage rising amid coronavirus-led downturn and weakening protections
Score remains stronger than non-EM EMEA and North American issued bonds

Moody's Investors Service says in a new report thatthe covenant quality (CQ) score for emerging markets (EMs) improved slightly inthe six months ended 31 March 2020, but that the risk of cash leakage is risingamid the coronavirus-led downturn.

"The average cash leakage score for EM bondsweakened by 4% to 4.06 (weak) in the six months to March 2020, mainly becauseof repeat Chinese property issuers predating their restricted payments incomebaskets to coincide with those of their previous bond issuance," says JakeAvayou, a Moody's Vice President and Senior Covenant Officer.

Consequently, half of the 28 full-package Chineseproperty bonds received the weakest possible cash leakage score of 5.00.

"We did however see a slight overall improvementin the CQ score to 3.25 (moderate) for the six months ended 31 March 2020, from3.35 (moderate) for the previous six months, as the other five key risk scoreseither improved or remained the same," adds Avayou.

Liens subordination scores improved the most,strengthening by 10% to 2.57 (good), as a lower proportion of Chinese bondsincluded credit facility debt carve-outs that can be secured under thepermitted liens carve-outs.

The average CQ score remains considerably strongerthan for non-EM EMEA and North American bonds issued in the same period in fiveof the six risk areas that Moody's scores, except structural subordination.Structural subordination remains a key area of weakness because of the lack ofguarantees from onshore operating subsidiaries for Chinese bonds, whichaccounted for 70% of full-package EM bonds during the six months ended 31 March2020.

Moody's scored 60 EM high-yield bonds during the sixmonths ended 31 March 2020, of which 46 were full-package and 14 werehigh-yield lite.

Asian companies continued to dominate EM bondissuance, accounting for 80% of issuance, with Chinese companies in turn accountingfor 63% of the Asian bonds. Latin America accounted for 13% of EM bondissuance, and Emerging Europe for 7%. There were no bonds from Africa and theMiddle East in the six months ended 31 March 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 EMbonds from January 2011 through March 2020 is 2.93 (moderate).