Investment-grade debt protection palaver

SA’S money managers resist bid to implement junk-bond style safeguards, writes Jaco Visser

APLAN to give investors the same level of protection when buying South African investment-grade corporate debt as they get with junk bonds is dividing the nation’s money managers.

The proposals being debated include limits on further borrowing, which will enhance the safety of the debt, says Jason Lightfoot, a portfolio manager at Futuregrowth Asset Management.

Stricter covenants may reduce the allure of the bond market as issuers will have to maintain debt safeguards on an ongoing basis, Investec Asset Management’s Simon Howie says.

South African companies last year sold the most bonds on record, spurred by the lowest interest rates in more than 30 years. Issuance by emerging-market companies also climbed to the highest ever, even as concern that Europe’s debt crisis would spread increased. Defaults by companies worldwide rose to 84 globally from 53 a year earlier, according to Standard & Poor’s.

“The debt-capital market is meant to be a less risky market, where the bulk of investors are

Covenant-light loans carry fewer safeguards for creditors….

pension or retirement funds,” says Mr Lightfoot, who helps manage the equivalent of $12.6bn of fixedincome investments at Cape Townbased Futuregrowth.

“Why are they not guaranteed the same protection as banks?”

The Association for Savings and Investment SA (Asisa) — whose members manage about R4-trillion — is debating standardised debt covenants.

Sales of bonds by South African companies rose 36% to $4.5bn in the first quarter from a year earlier, according to data compiled by Bloomberg. That compares with a 6.3% increase in emerging-market corporate issuance to $322bn, the data show.

Prudent underwriting practices have deteriorated with the inclusion of so-called covenant-light transactions and less-than-satisfactory risk management practices, according to March 22 guidance from the US Federal Reserve, the Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency.

Covenant-light loans carry fewer safeguards for creditors such as limits on how much debt a company can add to its balance sheet.

Covenants are generally appropriate for the risk and bond safeguards are different to banks’ conditions “for very good reasons,” says the Cape Town-based Mr Howie — head of South African and frontier credit at Investec, which oversees the equivalent of $86bn.

“A bank usually has a wider relationship with the borrower and is in a better position to negotiate and restructure,” he said. “This is very difficult with a wider group of institutional investors, which means a breach of a covenant can lead to liquidation more easily.”

South African companies’ average dollar-bond yields have declined eight basis points this year to 4.46% yesterday, JPMorgan Chase indices show. That compares with a 13 basis-point increase to 4.85% for average emergingmarket company rates.

The rand has depreciated 5%

A bank usually has a wider relationship with the borrower….

against the dollar this year, making it the worst-performer among 25 emerging-market currencies tracked by Bloomberg after South Korea’s won, which has slipped 5.7%. SA’s currency slipped 0.1% to 8.9164/$ in Johannesburg by midafternoon yesterday.

Secondary-market trading fragments ownership among a bond’s initial buyers and limits incentives to monitor the borrower’s compliance, says Bronwyn Blood, who helps manage the equivalent of $1.8bn in bonds at Cadiz Asset Management.

“For listed public companies in the investment-grade space, the question is whether covenants are really necessary and are just adding to the layers of governance required by the JSE,” Blood says. The JSE operates the country’s stock and bond exchanges. There’s never been a bond default in SA, the Cape-Town based Ms Blood says.

Asisa has started an “exercise to explore” the standardisation of bond covenants in response to requests from its members, says Adré Smit, a consultant at the organisation.

The South African bond market is “sound” and higher-risk investments such as high-yield bonds tend to have more explicit financial covenants to manage default risk and act as an early-warning mechanism, Jana Kershaw, a credit analyst at FirstRand’s Rand Merchant Bank, says.

The cost of insuring SA’s fiveyear debt rose to 156 basis points from 143 basis points at the beginning of the year. The spread between SA’s dollar debt due in May 2022 and similarly dated Treasuries has widened 31 basis points this year to 1.6% yesterday.

Having covenants in the highyield market gives investors comfort and makes monitoring credit risk an easier task for an asset that requires “rigorous analysis and in-depth understanding,” Cadiz’s Blood says.

“Covenants would aid the development of the high-yield bond space,” she says. Bloomberg