Junk-Bond-Style Checks Resisted by Investec: South Africa Credit

A plan 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, said Jason Lightfoot, a portfolio manager at Futuregrowth Asset Management. Stricter covenants may reduce the bond market’s attraction as issuers will have to maintain the debt safeguards on an ongoing basis, Investec Asset Management’s Simon Howie said.

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 corporates also climbed to the highest ever, even as concern that Europe’s debt crisis will 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 pension or retirement funds,” Lightfoot, who helps manage the equivalent of $12.6 billion of fixed-income investments at Cape Town-based Futuregrowth, said a March 6 e-mail. “Why are they not guaranteed the same protection as banks?”

Bond Sales

The Association for Savings and Investment South Africa, whose members together manage about 4 trillion rand ($448 billion), is debating standardized debt covenants, the Cape Town-based body said by e-mail.

Sales of bonds by South African companies rose 36 percent to $4.5 billion in the first quarter from a year earlier, according to data compiled by Bloomberg. That compares with a 6.3 percent increase in emerging-market corporate issuance to $322 billion, 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 U.S. Federal Reserve, the Federal Deposit Insurance Corp., 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,” said Cape Town-based Howie, who is head of South African and frontier credit at Investec, which oversees the equivalent of $86 billion.

“A bank usually has a wider relationship with the borrower and is in a better position to negotiate and restructure,” he said by e-mail. “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, or 0.08 percentage point, this year to 4.46 percent yesterday, JPMorgan Chase & Co. indexes show. That compares with a 13 basis-point increase to 4.85 percent for average emerging-market company rates.

The rand has depreciated 5 percent 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 percent. South Africa’s currency slipped 0.1 percent to 8.9164 per dollar by 2:53 p.m. in Johannesburg.

Monitoring Compliance

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

“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,” which operates the country’s stock and bond exchanges, Cape Town-based Blood said by e-mail. There’s never been a bond default in South Africa, she said yesterday.

Asisa has started an “exercise to explore” the standardization of bond covenants in response to requests from its members, Adre Smit, a consultant at the organization, said by e-mail.

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 Ltd.’s Rand Merchant Bank in Johannesburg, said in an e-mail yesterday.

Default Swaps

The cost of insuring South African five-year debt rose to 156 basis points from 143 basis points at the beginning of the year. The spread between the country’s dollar debt due in May 2022 and similarly dated Treasuries has widened 31 basis points this year to 1.60 percent yesterday.

Having covenants in the high-yield 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 said.

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

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