JEM Southbank’s June 2020 nominal bonds are widely held. They have a Scheduled Maturity Date in June 2018 – if they miss the date, the bonds convert to floating rate with a final maturity in June 2020. We assess the options and make recommendations. We think these bonds offer good relative value even if you don’t already hold them
Southbank is in the process of appointing an advisor to help with refinancing plans for its June 2020 nominal bonds. The bonds have a Scheduled Maturity Date of 28 June 2018 (which we typically describe as the call date) and a Final Maturity Date of 28 June 2020, which is the legal maturity date of the bonds. It is important to note that it is not an event of default for the bonds if they are not refinanced by the Scheduled Maturity Date.
We believe Southbank’s sponsor, AMP Capital Community Infrastructure Trading Trust (the Fund), is proactive in managing refinancing risk, as it has demonstrated in recent years with the successful refinancing of other public private partnership projects (PPPs) the Fund owns.
Southbank has also indicated that it is in its best interest to refinance the nominal bonds by the Scheduled Maturity Date, in order to take advantage of prevailing and relatively benign credit market conditions, as it aims to achieve the lowest possible cost of refinancing, while minimising the need for an additional equity injection by the Fund.
What happens if the bonds are not refinanced by the Scheduled Maturity Date?
In the event that the nominal bonds are not refinanced by the Scheduled Maturity Date, the current fixed rate coupon on the bonds will convert to a floating rate plus step up margin as shown in Figure 1.
Figure 1
Note: Prices accurate as of 1 May 2017 but subject to change; indicative only
Source: Bloomberg, FIIG Securities
If this is the case, then we expect that investors’ economic loss will be the opportunity cost of the lower BBSW coupon stream plus 150bps, compared to 6.637%. However, we believe the real impact is the fixed coupon and what return you can achieve for a four or five year corporate bond rated in the BBB range. Please refer to the Relative Value section for further analysis.
If the bonds remain outstanding beyond its Scheduled Maturity Date, Southbank’s equity distributions will be locked up to preserve cash until a refinancing is achieved by the Final Maturity Date. It should be noted that once refinancing occurs, this cash is released and can be used to pay equity distributions. During the lock up period dividend payments are cumulative and are not lost. In addition, under the financing documents, a specified set of steps will need to be undertaken as part of the refinancing process. The document provides rights to the bond manager/trustee if certain steps are not undertaken, in accordance with the financing documents.
While considering its refinancing plan for the bonds, Southbank also has the opportunity to decide whether it wants to keep, or terminate and replace the long term interest rate swap it entered into when the bonds were issued. It is important to note that the decision to keep or terminate and replace the swap is independent of the bonds’ refinancing. For example, Southbank can refinance the bonds and still keep the swap in place.
Given that the BBSW rate as at 1 May 2017 was 1.94% as per Figure 1, this means that the swap is out-the-money for Southbank as it receives the lower base rate, while the swap counterparty is paid the higher fixed rate. The swap was entered into for the period from the Scheduled Maturity Date of the bonds to the end of the concession term. The swap locks in the base rate at which the refinancing debt can be raised, which – given the fixed nature of the future cashflows from the refinancing date – eliminates the risk associated with base rate movements.
Southbank has the opportunity to consider whether it is more economically viable and not detrimental to its financial profile, to take advantage of prevailing lower base rates and to pay out (up front at the time of refinancing of the nominal bonds) the mark to market on the more expensive swaps. However, the benefit from potentially lower funding costs from entering into new swaps with a lower base rate could be offset by the need for an upfront mark to market payment on terminated swaps. There will also be execution and transaction costs involved with terminating and re-establishing the swap transactions.
Should Southbank decide to terminate and replace the swaps at prevailing lower base rates, given its highly geared capital structure and limited ability to increase revenue, the Fund will most likely have to inject additional equity in order to maintain Southbank’s current financial profile.
Relative value
Figure 2 provides a comparison of the respective yield to worst (YTW) – ranging from mid 3% to mid 4% – for fixed rate corporate bonds with four or five year maturities rated in the BBB range, as well as other PPPs exposed to refinancing risk such as Praeco Pty Limited.
Figure 2
Source: Bloomberg, FIIG Securities
In the event that the nominal bonds are not refinanced by the Scheduled Maturity Date, and the coupon on the bonds convert to a floating rate plus step up margin, we would then compare Southbank against other investment grade floating rate bonds with maturities in the next five years.
Figure 3 provides a comparison of the trading margins, ranging from 1% to under mid 2%.
Figure 3
Source: FIIG Securities
Conclusion
As Figure 2 shows, the Southbank bonds have a YTW of 4.15% to the Scheduled Maturity Date, and are trading at an indicative margin of 2.5% as shown in Figure 3.
We believe the bonds offer good relative value at 4.15% YTW to the Scheduled Maturity Date. However, there is a possibility that the bonds may not be refinanced then, and in this case, the bonds would be trading at an indicative margin of 2.5% to the Final Maturity Date on 28 June 2020. In our opinion, this would still offer Southbank bondholders attractive relative value.
For investors who want exposure to a mature investment grade infrastructure asset with the state government backing the revenue, we recommend investors either hold the bonds or consider adding to positions.