CREDIT MARKETS

In Emerging Markets, Fewer Debt Covenants

By WAILIN WONG

May 19, 2007; Page B4

With emerging-market governments receding from international capital markets, companies in those countries are eagerly stepping up to fill the void.

Corporate issuance is outpacing that of sovereigns by a rate of 2 to 1, with the corporate market now at $600 billion, or about two-thirds of the U.S. high-yield market. Companies in emerging economies are also finding investors eager to take on risk in the search for higher yield, as emerging-market sovereign-bond risk premiums are at record-tight levels.

With so many investors looking for bigger returns, emerging-market companies -- like their high-yield counterparts in the U.S. -- are finding that they don't have to offer as much protection to bondholders in the form of covenants.

"More and more, as you still see a lot of liquidity held by investors, locally and globally, this high liquidity may be reflected in looser covenants," said Eduardo Uribe, managing director of corporate and governmental ratings at Standard & Poor's in Mexico City.

Covenants on corporate bonds can restrict a company's capital expenditures and ability to take on additional debt, or require management to maintain a certain level of free cash flow. These restrictions are traditionally present in bank loans, and a growing number of emerging-market companies are choosing to issue bonds, because they can now raise capital with more flexible terms.

Looser restrictions aren't necessarily negative, especially because there are a growing number of companies in emerging economies that are investment-grade international players and don't need to offer the same protection to bondholders as a company with shakier credit.

For many investors, the concern focuses on emerging-market companies that are further down the creditworthiness scale and drawing heavy investor interest for their deals, which often result in price tightening and oversubscription.

Alfredo Chang, portfolio manager at GE Asset Management, said at the EMTA event that bondholders are appearing to "take on faith" that they will escape relatively unscathed from negative credit events.

Investors also point out that weak regulatory and legal frameworks in developing countries can render covenants a moot point. Bondholders could still get squeezed if they don't get treated fairly in local courts.

"Covenants don't protect you that much -- property rights will," said Andrew Feltus, who oversees about $9 billion in global high-yield debt at Pioneer Global Asset Management, with about $1.5 billion of that amount in emerging markets.

Mr. Feltus said he prefers deals that are more similar to asset-backed securities. He cited the case of Russian bank Alfa, which has done several bond issuances under a diversified payment-rights program that securitizes financial flows. In March, the bank sold $400 million in bonds under this program.

For Mr. Uribe of S&P, bondholder protection could also decline in local-currency deals done in domestic markets, which, in countries such as Mexico, are flush with liquidity, as local pension funds become increasingly important players.

Treasurys Slid

U.S. Treasurys wilted on Friday, with pessimism over the market outlook fueling selling by those who believe yield movements are driven by patterns, and who then act accordingly.

John Canavan, a bond strategist with Stone & McCarthy Research Associates, noted that Treasurys began the day selling off, and yields, which move inversely to price, eventually found some equilibrium. But when that cracked, it sent yields moving upward again. "In the near term, this area should provide a little bit of bottom-fishing support" that should blunt any further swings, he said.

The benchmark 10-year note was down 12/32 point at 97 20/32. Its yield rose to 4.804% from 4.756%, as yields move inversely to prices. The 30-year bond was down 21/32 point at 96 25/32 to yield 4.958%, up from 4.915%.

--Michael S. Derby

Write to Wailin Wong at wailin.wong@wsj.com1

URL for this article: http://online.wsj.com/article/SB117950412020907646.html

QUESTIONS:

1.) Define the following terms: "emerging market", "covenant", "credit risk"

2.) What covenants are typically included on corporate bonds? What purpose do these covenants serve? Do covenants benefit only the borrower, or do they also benefit the issuing firm? Support your answer.

3.) What types of firms typically include covenants in their debt?

4.) What has been the recent trend in the use of covenants in emerging market debt? What factors might be contributing to these trends?

5.) What mechanisms (other than covenants) serve to protect creditors interests?