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Well, Glastonbury is cancelled and the new C19 variant is more dangerous than thought. But on the plus side, the US installed its new President without a civil war and it might snow in London over the weekend. Do you wanna build a snowman?
TL / DR: when to fix your interest, a trio of £ High Yield and even more ESG
1. It’s a fix
- A few discussions about interest rate hedging this week with clients and colleagues: dealing with legacy expensive fixed rate debt; are MTM swap liabilities part of Enterprise Value? and whether to fix rates now: surely rates can’t go any lower – or can they?
- Forward interest rates consistently overpredict realised rates – some of which is understandable (the “term premium”) but most of which has been due to the steady grind lower due to central bank intervention and demographic pressures.
- So a decision to fix interest rates only really makes sense if trading cash flows are not positively correlated with interest rates and if those higher interest payments would be unaffordable.
- For example real estate rents are pretty well correlated with interest rates but this is not the case for most EBITDA.
- Unfortunately, it’s a truth universally acknowledged that any decision to fix interest rates (or other costs) will be criticised after the event.
- I was looking recently at a business where swap MTM was 25% of market cap, and couldn’t really be ignored, but generally valuation or leverage is rarely adjusted for MTM liabilities, even by the credit ratings agencies. EPRA’s rationale is a typical example: “any fair value loss … will not crystalise immediately and rather will be incurred over the life of the swap”.
- Note that paying down a swap MTM looks awfully like repaying amortising debt – which has been utilised by some corporates like Marston’s to borrow more under the radar.
2. Shiny Sterling High Yield
- Despite the “Brexit Premium”, three different types of Sterling HY bonds over the past 10 days demonstrate investors’ appetite for the UK. All were upsized and / or coupons tightened by 0.25-0.5% in syndication.
- Together (mortgages): £500m 6 years (NC2) at 5.25%; pretty high coupon for a BB-, reflecting concerns over UK mortgage holidays / repossession delays. Upsized.
- The AA: the “deleveraged buyout” comes to market for more debt: £280m 5 years (NC2) at 6.5%, with a B+ rating.
- Pinewood Studios: £200m at yield of 2.74% for 4 years, rated BB / BBB-, at a tiny discount to pre-announced pricing – upsized from £150m.
- Pinewood and Together have both been materially impacted by Covid so this strong investor appetite is good news for other UK corporates with HY aspirations in 2021.
3. Green shoots
- Some interesting deals this week furnish’d and burnish’d with ESG.
- Tesco sold the first ever UK corporate “Sustainability Linked” bond: €750m at coupon of 0.375% for 8.5 years. If Tesco doesn’t reduce its CO2 emissions by 60% then the coupon will increase by 0.25% p.a. for the final two years. Investors loved the deal: 7x oversubscribed enabling much tighter pricing and resulting in a negative “new issue premium” (the elusive ‘greenium’?).
- Credit funds Tikehau, CVC Credit and Barings have recently announced financings for private equity deals where loan margins reduce by up to 0.3% p.a. if ESG targets are hit.
- Neither of these measures will make that much difference to investors’ returns but will provide powerful ammunition for managers when talking to their LPs or marketing teams.
- In the ultracompetitive world of direct lending, I expect this to become another area where credit funds strive to differentiate themselves to “win” the opportunity to lend to strong businesses, on top of the usual compromised lending standards. But weaker credits will continue to struggle to attract lenders.
UK debt financings this week:
- As well as the Tesco, Together, AA and Pinewood bonds mentioned above, United Utilities issued a £300m 8-yr Green Bond for environmental projects, at a coupon of 0.875%.
- Ibstock extended its £215m revolver by 1 year to Mar-23 and relaxed its covenants to June.
- The big deal of the week was INEOS Quattro’s multi-part loan / bonds across EUR and USD. The interesting part was the switch to secured loans away from unsecured bonds which probably reduced financing costs by €5m p.a..
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