Moody's Investors Service says that covenant protection for offshore creditors against onshore bonds issued by Chinese property developers is weak, with a weakening in structural subordination and overall covenant quality (CQ) scores.
"The increased access of Chinese property developers to the onshore bond market and a lack of covenant restrictions on their ability to issue onshore debt increases structural subordination risk for offshore creditors," says Jake Avayou, a Moody's Vice President and Senior Covenant Officer.
Moody's says this risk is unlikely to materialize during the coming six to 12 months because Chinese property developers have so far used most of their onshore proceeds to refinance their other onshore debt.
"But if Chinese property developers increase their domestic issuance significantly to expand their operations, structural subordination risk will rise for offshore bondholders," adds Avayou.
Avayou was speaking on Moody's just-released special comment on high-yield bond covenants for Chinese property developers entitled, "High-Yield-Bond Covenants - Chinese Property Developers: Covenant Protection Against Onshore Bond Issuance Is Weak."
The report states that offshore bond covenants lack restrictions on onshore capital markets debt issuance.
The typical mitigant in an offshore bond against structural subordination risk is a cap (usually 15% of total group assets) on the amount of debt that subsidiaries that don't guarantee the bonds can incur under a company's debt covenant's fixed charge coverage ratio (FCCR) test.
But this cap excludes capital markets debt, potentially allowing onshore subsidiaries to issue unlimited amounts of onshore bonds as long as they have capacity under their FCCR tests.
As a result, structural subordination and overall CQ scores will weaken, indicating reduced protection for investors.
"To reflect the increased risk for offshore bondholders, we will add 0.25 points to the structural subordination risk scores of future offshore bonds if the structural subordination cap contains a capital markets debt exception," says Avayou.
Moody's says 71 of the 80 Chinese property bonds that it scored since 2011 contain the capital markets debt exception and will be re-scored to reflect this adjustment.
