Beauty is in the eye of the bondholder. How else to explain the number of Asian companies getting investors to accept proposals that can ultimately weaken their position as creditors? PT Lippo Karawaci, an Indonesian property group, is the latest, scheduling meetings from today in Hong Kong, Singapore and London to explain why holders of its $250 million of 7 percent 2019 bonds should exchange them for new notes due 2023.
The purpose, according to Lippo Karawaci, is to remove most restrictive covenants and to amend what events may constitute a default. It's also asking holders of other debentures due 2020 and 2022 to conform to the terms of the new notes, and by doing so, to extend the company's debt maturity profile.
As it stands, Lippo Karawaci, which is rated Ba3 by Moody's, the rating company's third-highest non-investment grade, has to refinance or repay $803 million of bonds before the end of 2022, according to data compiled by Bloomberg. Pushing that deadline out buys it more time, and allows the company to add about $100 million to its existing senior unsecured notes in the process.
This doesn't worry Standard & Poor's, at least not yet. The rating company said in a note Monday that Lippo's debt-to-Ebitda ratio will be less than 5 times in 2016 and 2017, despite the additional debt. That's predicated on the company being able to continue to dispose of some of its assets. But should there be a significant delay in those sales, or a further slowdown in Lippo's property and hospital projects, that would put a strain on cash flows and erode liquidity. A debt-to-Ebitda ratio of more than 5 times with no prospect of recovery would indicate a weaker credit profile, and could trigger a downgrade deeper into junk territory. (Interestingly, S&P said in another note Tuesday that Indonesia's corporate sector could be in for another tough year in 2016, with the already negative rating trend accelerating over the past six months, leaving companies exposed to further rating cuts.)
There are several reasons why companies seek to relax the terms of their bonds. Two of the most common are to avoid what is known as a technical default -- when an acquisition or other event nudges an interest coverage ratio or the like higher than is strictly allowed -- or to bring covenants surrounding previously issued notes in line with more recently issued ones. The latter course brings everyone down to the lowest common denominator, which as Evergrande Real Estate demonstrated, isn't always a good thing.
In January 2014, the Chinese developer won approval from holders of its 2015 and 2016 bonds to bring them into conformity with the terms of its more recently issued notes due 2018. That gave the company greater freedom to make investments and take on more debt, which it did. By the end of that year, Evergrande had been downgraded by both S&P and Fitch and the yield on its 2018 securities had gone from 8.65 percent to 11.32 percent.
As it is, speculative-grade companies in Asia have been so successful in relaxing bond terms that covenant quality has now slipped to the lowest level since 2011, Moody's said in a report last week:
Perhaps debtholders are taking heart from the second part of the Moody's report, which went on to say that the covenant quality score in Asia is still higher than the global average:
Really, though, this should be of little comfort. Countries like Indonesia and China don't have the bankruptcy laws or other legal protections of the U.S. and parts of Europe. As bondholders of Kaisa, another Chinese developer, learned the hard way, when there is a default, onshore creditors waste no time going to local courts and freezing assets. Offshore creditors suddenly find themselves way down the pecking order, with little recourse.
Giving companies the go-ahead to weaken the terms of their bonds may seem an inconsequential step at the time, but this is ground debtholders shouldn't relinquish so easily. History shows that doing so can open the door to a corporate spiral, allowing companies to accumulate debt that they ultimately struggle to service. A wiser choice is to see beauty in the status quo.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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