Debt covenants could add pressure to Russian banks’ liquidity, says Moody’s

Moody's Investors Service explains in a new Special Comment that the financial crisis and the resulting macroeconomic shock have exerted pressure on the compliance of banks with debt covenants. The breaching of covenants can trigger early debt repayments and thus weaken banks' liquidity positions. Under a worst-case scenario, this could lead to default. However, refinements to Moody's methodologies mean that its ratings incorporate these risks.
Moody's explains that the most important debt covenants are capital adequacy ratio (CAR) covenants, which, on average, exist in 20% of banks' market funding and 12% of their total funding. Thus, breaching CAR covenants could lead to pressure on banks' liquidity positions.
"However, banks currently have room for manoeuvre before coming critically close to breaching CAR ratios, given that many have recently received capital injections. This has helped such banks to comply with CAR requirements despite mounting losses on their loan books. Furthermore, CAR covenants are, in most cases, set in line with regulatory ratios — therefore, compliance with covenants is also related to the level of compliance with regulatory requirements," said Yaroslav Sovgyra, a Moody's Vice President-Senior Credit Officer.
Other important covenants include related-party exposure covenants, loan book concentration covenants and open FX position covenants, as well as non-financial covenants. However, these covenants cover a smaller proportion of market debt and Moody's does not expect non-compliance with them to exert significant pressure on banks' liquidity positions as the respective facilities could be more readily repaid by banks or — more likely — banks would try to renegotiate the covenants or obtain waivers from lenders. One further risk-mitigating factor is that banks have (on average) adequate liquid assets to cover liquidity risks linked to breaches of covenants.
"The balance of negotiating power has clearly shifted from banks to investors. In other words, the market has transformed from a sellers' (banks) to a buyers' (investors) market, leaving investors with more room to negotiate the terms and conditions of their investments," added Sovgyra.