Change of approach from Standard and Poor's could see Genesis and Contact bonds worth a combined NZ$475 mln redeemed early

By Gareth Vaughan

Two unsecured bonds issued by power companies with a combined face value of NZ$475 million could be redeemed early following a change in the way credit rating agency Standard & Poor's (S&P) classifies the bonds.

The bonds in question are both what are known as capital bonds. The first is a NZ$275 million issue from State Owned Enterprise (SOE) Genesis Energy and the second a NZ$200 million issue from Contact Energy. Both bonds were issued in 2011 with the Genesis one ultimately not due to mature until 2041 and the Contact one 2042.

Both bonds have been classified as 100% equity when S&P calculates its financial ratios for the issuer companies, with the interest they pay classed as dividends. However, S&P has announced changes to the criteria around how it regards these bonds. Both Genesis and Contact say this is a "rating agency event” under the terms of their capital bonds, meaning they now have the right to redeem the bonds at par value plus accrued interest.

Genesis, one of the SOEs earmarked by the Government for a sale of up to 49% of its shares, says it's "considering the matter and will advise bondholders and the market of its proposed course of action in due course." And Contact says it "will consider whether it will exercise its early redemption rights and will advise bondholders and the market in due course."

The Genesis bonds pay interest of 8.5% and the Contact bonds are paying 8%. Both were issued with BB-, speculative grade, or "junk", credit ratings from S&P. Both bonds are listed on the NZX debt market with the Genesis bond trading under the GPLFA code and the Contact one under CENFA.

Genesis investor relations manager Rodney Deacon told interest.co.nz S&P's changed outlook would now see it regard his company's capital bonds as 50% equity and 50% debt.

"So from now on when S&P look at our ability to service our debt and are assessing us for our credit rating, they're treating those capital notes on a 50% debt, 50% equity basis," said Deacon. "So to the extent that they have a number of ratios etc that they use to calculate our ability to meet certain criteria, or our ability to pay our interest costs and things like that, then they'll treat those capital notes as 50% equity, 50% debt.

"We can redeem them if we want because of the terms of the capital notes, but that decision hasn't been made yet," added Deacon.

Genesis paid interest of NZ$12.391 million on its capital bonds in the six months to December 31, 2012.

Genesis, Contact already treat their capital bonds as 100% debt

Deacon said that internally Genesis regarded the capital bonds as 100% debt, with them incorporated in its "optimal" 33.5% gearing ratio and total debt of NZ$945 million. See Genesis' interim results presentation here. Contact's annual results also included its capital bonds in the group's NZ$1.5 billion net debt. Contact's gearing ratio is 29.3%.

S&P's changed approach to how it views the bonds doesn't really put Genesis at any risk of a downgrade to its BBB+ credit rating from S&P, Deacon added. Contact has a BBB rating from S&P. See credit ratings explained here.

Thomas Jacquot, S&P's Sydney-based corporate and government director, said the credit rating agency's revised methodology indicates the types of features instruments need to have in order to qualify for 100% equity treatment.

"One of those is the requirement that the instrument should be perpetual, i.e. no fixed repayment date. Both the Genesis and Contact instruments have maturity dates, hence they can’t qualify for 100% equity treatment," Jacquot said. "These two securities are eligible for 50% debt, 50% equity treatment, but we need to assess the intention of each company before we are able to confirm that treatment or not."

The issue of bonds classified as 100% equity, firstly by Genesis and then by Contact, was a new structure for New Zealand. Previously both Vector and Kiwibank's parent New Zealand Post had issued bonds that received 50% equity credit.

With the Contact bonds, unless Contact calls them, investors have no right to redemption until the final maturity date in 2042.  Every five years, if they are not called, the original margin over the five-year swap rate, which was 4.55%, increases by 0.25%. The Genesis bonds also have a reset/call date after five years. If Genesis reset the interest rate, this would be done at the five-year swap rate plus 4.12%.

Meanwhile, Origin Energy the owner of 52.2% of Contact's shares, says it won't be redeeming two securities of its own whose equity content has dropped from 100% to 50% thanks to the S&P changes. Origin also says its BBB S&P credit rating won't change. The Origin securities in question are a A$900 million subordinated note listed on the Australian Securities Exchange and a €500 million capital security listed on the London Stock Exchange. Both aren't due to mature until 2071.

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