Australian investors press for bond protection

Published: 30 Jul 2009 22:55:10 PST

* Bond investors want same covenants as bank lenders

* Part of global trend as investors seek more protection

* Push starting to bear fruit as Aussie bond market revives

* Lack of standard global terms a major problem for investors

SYDNEY, July 31 - Australia's fund managers are pressing companies for more protection when investing in their corporate bonds, as the balance of power in the industry swings from borrowers to bond holders.

For years, bonds from non-financial firms - a rare commodity in Australia - were so sought after that borrowers would often dictate their own conditions to hungry investors.

Those were also the days of "covenant-lite packages" when debt agreements lacked restrictions on borrowers, encouraging them to use more debt to fund expansion.

But all that changed when the global financial crisis hit, triggering spectacular corporate collapses, forcing banks to ration credit and making investors far more risk averse.

"It is now easier for bond investors to get protection, simply because banks are more constrained in their lending and issuers want some diversity, so they are more prepared to give covenants," Stuart Gray, portfolio manager at Aberdeen Asset Management.

During the credit boom, fund managers would reluctantly accept disadvantagous terms on bonds for fear of missing out on rare opportunities to put their growing pile of cash to work.

Australian investors are now pressing cash-strapped issuers for more protection such as compensation if the borrower changes ownership or if the borrower's credit rating is downgraded.

The push has lagged a similar movement in the United States as Australian corporate bond issues dried up after the onset of the financial crisis.

But it is starting to bear fruit as the domestic corporate bond market comes back to life with a string of new issues [ID:nSP492336]. Local fund managers are working together to compile a basic covenant package for Australian bonds.

Construction firm Leighton Holdings Ltd <LEI.AX>, which raised A$230 million in bonds last week, amended its covenant documentation to make it more palatable after consulting investors.

"We made some minor amendments to what we had in mind and went to the market with a package that had the same covenants as what our existing debt providers received," said Leighton spokesman Justin Grogan.

Stock market operator ASX Ltd <ASX.AX>, another firm looking at selling bonds in Australia, was also asked by investors earlier in July to consider adding protection.

The firm, which has not yet completed its private debt raising, declined to comment, saying all discussions between ASX and potential bond investors were confidential.

"A well structured bond covenant package would typically incorporate a negative pledge, an inability to sell substantially or all assets and a provision of regular information," said Sarah Percy Dove, head of credit research at Colonial First State Global Asset Management.

A negative pledge clause prohibits a borrower from pledging its assets to a third party.

GLOBAL PUSH

Bond covenants worldwide have traditionally been weak compared with bank loans, but local investors felt the situation was even worst in Australia.

"Historically, bond issues in Australia have not had comprehensive bond covenants, but it's even more notable here than offshore," said Colonial's Percy Dove

"Or if there are covenants, let's say negative pledge, the clause excludes so much that it becomes useless," she added.

Covenants related to a company's change-of-control have usually been a common feature in U.S. bond documentation, but have been more rare in Australia.

"One of the key issues is credit ranking," said Tim Lindley, head of debt capital markets at Barclays Capital.

"Bond investors don't want to be in a less advantageous situation than other investors and want a similar level of protection," he added.

In particular, Australian bond holders want the same safeguards afforded to bank lenders.

Traditionally, banks have always had more protection than bond holders because of their long-term and ongoing business relationships with clients.

It has been far easier for corporate borrowers to amend covenants with banks than with bond holders.

"With the passage of time, it is not unusual for issuers to lose touch with their note holders," said Mark Nichols, managing director at Global Capital Advisors, a private placement consulting firm in New York.