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Independent voices stand up to bond issuers
October 12, 2017 / 6:07 PM / a month ago

Independent voices stand up to bond issuers

NEW YORK, Oct 12 (IFR) - Independent research firms are carving out a lucrative niche in the US bond market with hard-hitting analyses that bolster investor resolve when it comes to aggressive bond terms.

No-nonsense reports from the likes of Covenant Review, Gimme Credit and CreditSights have helped the buyside push back on deals that eventually get revamped - and sometimes even pulled.

Looking at details buried by underwriters and ignored or simply missed by busy investors, the firms have made themselves an indispensable part of today’s primary markets.

Unlike rating agencies, which are paid by issuers to rate the securities, or banks, which underwrite and sell them, the independents have only one role: to analyze bonds.

“Being independent with an investor-pay revenue model, we don’t have to write reports that are friendly to corporate issuers,” said Andrew Brady, global head of basic industries at CreditSights.

Noisy criticism of the litigation risks facing Syngenta, for example, helped lead the Swiss agribusiness giant to postpone a US$7bn bond in September.

And, among others, bonds from Vivint and Covey Park Energy were tweaked in the face of serious complaints about perceived weaknesses in their covenant structures.

A number of factors have been working in favor of independent research outfits.

For one, the long bull run in the bond market has encouraged borrowers to test the limits of how much they can push an investor base that is flush with cash it needs to put to work.

In addition, because spreads are so tight - and thus returns so limited - many buyside shops struggle to justify dedicating resources to the in-depth analysis of transactions.

And with coupons at a minimum, investors have embraced contrarian research that helps them haggle with issuers to demand more yield and better protections.

Adam Cohen, founder of Covenant Review, said he started his company after seeing an opportunity for an independent voice that would fight for bondholder interests.

“Very few large asset managers have bond contract lawyers who will look at deal indentures closely,” Cohen told IFR.

PLAIN TALK

Freed from the constraints - and sometimes the decorum - of analysts at banks and rating agencies, the independents offer a frank view of deals that often seems like a breath of fresh air.

Covenant Review garnered widespread attention earlier this year by launching a campaign against issuer-friendly structures with a report entitled “War On Covenants”.

And as market conditions continue to favor issuers - the Moody’s Covenant Quality Index was at its second-worst level ever in August - Cohen’s firm has kept up the battle.

In a report this week on a new bond offer for the LBO of medical tubing company Tekni-Plex, Covenant Review blasted a “ridiculous loophole” that encourages “abuse” by sponsors.

“We again urge investors to push back,” it said.

Not only does such criticism help buysiders negotiate better terms, it sometimes also spares them hefty losses.

Investors who heeded Gimme Credit’s warnings about Toys R Us during the summer were able to avoid the collapse of the retailer’s bonds.

“We rated the bonds Underperform when they were trading at 95,” said Kim Nolan, Gimme credit’s director of high-yield research.

“We had written reports about (the company‘s) overleveraged condition and the danger that its deteriorating sales and earnings likely would cause bond prices to drop.”

The Toys R Us 7.375% 2018 bonds ended up plummeting to around 20 on September 18 as the company filed for bankruptcy.

“We are especially good at warning bondholders about deteriorating situations,” Nolan said.

GETTING IT RIGHT

The success of the independents is clear from the size of their staffs alone.

Cohen was working by himself when he started Covenant Review 12 years ago, and now has 18 lawyers in the firm.

Eight analysts banded together to found CreditSights in 2000. The company now has a worldwide staff of more than 130 employees.

Yet for all that, the independents are still Davids in a market full of Goliaths, with nothing like the resources available to companies such as Moody’s or S&P.

Cohen noted that analysts at a small independent firm such has his have to do more than just analyze deals, for example.

“Not every employee we attract would have the ability to write good analytical reports and market (them) too,” he said.

And that also means regularly producing fresh analyses that will draw attention, when so many bonds are coming to market every single day.

“Being independent means we are forced to work harder and are under pressure to deliver investment ideas that are effective for our clients,” said Brady at CreditSights.

“Simply put, our survival depends on that.” (This story will appear in the October 14 issue of IFR Magazine.; Reporting by Shankar Ramakrishnan and Philip Scipio; Editing by Marc Carnegie)

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