Weekly Credit Risk Monitor /

Weekly Credit Risk Monitor

  • We round up the week's key developments in the world of sovereign and corporate credit

  • In focus: Interpipe initiation – strong financials protect from downside risks

  • Also in the news: Lebanon flexible exchange rate, Abu Dhabi Commercial Bank and Ukreximbank results and more

Stuart Culverhouse
Stuart Culverhouse

Chief Economist & Head of Fixed Income Research

Tellimer Research
7 May 2020
Published byTellimer Research

In focus: Interpipe initiation – Strong financials protect from downside risks 

We initiate Interpipe’s US$211mn 10.25% notes due 2024 with a Hold. Interpipe is a steel pipe and railway wheels producer with its own steel-making facilities. It recently completed a lengthy debt restructuring, which cleared its balance sheet of excessive debt. At the same time, an outstanding FY 19 performance helped the company accumulate significant liquidity before the recent oil price shock and Covid-19 pandemic hit. INTHOL 24s seem to have outperformed the market on the way down and never felt the full strength of the March-April sell-off. One may argue that the company’s strong financial position supported the bonds, but we tend to think that their illiquidity played a role too. INTHOL 24s are indicated at mid-price of 95 (YTM 11.7%), according to Bloomberg. Because the issue is callable at par at a short notice, the potential upside is limited to 5ppts, while the potential downside is likely to be higher as the worst is yet to come when the pipe producer’s revenues and cash flows take a hit in 2020. This is partially offset by the company’s low leverage (0.3-0.6x), high cash reserves (US$134mn), low maintenance capex (US$32mn) and no debt maturities until 2023. We view Interpipe’s strong financials as protection against the downside risks and assign a Hold to INTHOL 24s. 

Strong starting position ahead of a challenging 2020. 2019 was an exceptional year for Interpipe. The company came out of a lengthy restructuring with a sustainable debt level, while a temporary suspension of the 34% anti-dumping duty on railway wheels by the Eurasian Customs Union helped to generate its highest operating cash flow in 7 years. In FY 19, Interpipe’s revenues increased by 4% yoy to U$1,122mn, EBITDA was up an astonishing 64% yoy coming in at US$259mn, and the EBITDA margin increased 8ppts to 23% (Table 1 on page 3, full report). Such an impressive growth in profitability was driven by an almost six-fold increase in EBITDA of the wheels segment, which should not be viewed as a sustainable trend. Debt reduced to US$400mn from US$1.4bn through restructuring and the company accumulated US$256mn in cash. Net leverage came down to 0.6x from 8.1x. After the reporting date, Interpipe repaid US$121mn ahead of schedule, reducing total debt including contingent liabilities (US$84mn) to cUS$295mn. 

Bond structure supports prices, but call at par curbs potential upside. In 2019, as part of the debt restructuring, Interpipe issued US$309mn senior notes secured by stakes in the company’s key production facilities in Ukraine. In 2020, Interpipe redeemed a third of the issue, reducing the outstanding amount to US$211mn. The bonds have an amortising structure with the first instalment of US$150mn due on 31 Dec 2023, 12 months before the final maturity date. After the senior secured loan was repaid in January 2020, the bonds became callable at par at a short (10-60 days) notice. Interpipe has a strong incentive to call the bonds ahead of the first amortisation and final maturity. If the bonds are repaid by 25 October 2023, the company could save US$40mn in exit fees payable to the original bondholders (those who received bonds in the restructuring) and creditors under the senior secured facility. Effectively, this imposes a cap on INTHOL 24s price at par. Debt covenants loosened after the repayment of bank facilities, with total debt/EBITDA threshold set at 3 for debt incurrence test. 

Read the full report here

Recap of the week’s key credit developments

Serbia (SERBIA): On Friday, S&P affirmed its long-term foreign currency rating on Serbia at BB+ and revised its outlook to stable from positive due to the economic consequences of the coronavirus pandemic. S&P’s statement said that the government’s fiscal and debt metrics would worsen this year, as would the external financing environment. General government gross debt was 52.7% of GDP at end-2019 on IMF figures. The agency also forecasts a 3.5% contraction in real GDP in 2020 due to coronavirus containment measures. This, balanced with the macroeconomic buffers such as foreign reserves and fiscal space, built up in recent years leads to the stable outlook. Haver figures show that foreign reserves have risen to EUR14.9bn (US$16.7bn) at end-2019 from EUR11.1bn at end-2017. This has since declined to EUR14.5bn in Q1 20. Greater balance of payments resilience, including from continued FDI inflows, could lead to upward ratings pressure. Fitch also rates the country BB+ with stable outlook, and Moody’s rates it Ba3 with positive outlook.

Ecuador (ECUA): On Friday, the IMF Executive Board approved US$643mn in emergency assistance for Ecuador, an amount equivalent to 67.3% of quota. The funds will be disbursed under the Rapid Financing Instrument (RFI), which had been requested by Ecuadorian authorities on 23 March. At that time, IMF Managing Director Kristalina Georgieva said that Fund staff were also having discussions with Ecuador for a successor arrangement to the existing EFF to support economic performance, strengthen the foundations of dollarisation and deliver broad based benefits for all Ecuadorians. The new RFI disbursements will support the balance of payments needs and sectors impacted by the coronavirus pandemic, including healthcare. The IMF notes the actions already taken by authorities to contain the spread of the virus and support households and firms. Crucially, for bondholders, the IMF statement also noted the authorities aim to complete a comprehensive debt restructuring agreement with private creditors, a statement that we think seems to go further and is more explicit than that implied during the authorities’ recent consent solicitation exercise which deferred coupon payments until August (see here). 

Lebanon (LEBAN): Finance Minister Ghazi Wazni has said that Lebanon will adopt a flexible exchange rate for the pound, once funding from the IMF and donor countries, and subsequently confidence, has been gained. The IMF noted the risks of an exchange rate shock on debt metrics in its Article IV report last year. The Finance Minister also said that Lebanon had entered talks with eurobond holders to restructure US$30bn in debt two weeks ago. The current fixed exchange rate of 1507.5 pounds per US$ will remain in place in the interim period, although black market rates for the pound have faced large depreciation. Last week the government also announced an economic reform programme, which includes reduced spending, better tax collection and restructuring of the electricity and banking sectors. The government’s recovery plan is based on an adjustment in the exchange rate to LBP3500 and included a formal request for an IMF programme. The continued commitment of the government to economic reform and a solution to Lebanon’s crisis has been positive for bond prices. However, riots which had stopped due to coronavirus containment measures reignited on 27 and 28 April in various cities. 

 Kenya (KENINT): On Wednesday, the Executive Board of the IMF approved US$739mn (100% of quota) in emergency funding for Kenya under the Rapid Credit Facility (RCF). The government had been seeking US$1.15bn in total from the World Bank and IMF, including US$800mn from the IMF under the new coronavirus emergency funding initiatives (RCF and RFI), after a request on 25 March. The funds approved under the RCF will be used in the authorities’ response to the coronavirus pandemic, which is significantly reducing growth and is creating fiscal and external financing needs, according to the IMF. The Fund also notes the importance of, and the authorities’ commitment to, resuming fiscal consolidation efforts to reduce macroeconomic vulnerabilities following the crisis. The pandemic’s impact on tourism, transport and trade, in particular, have led to urgent balance of payments and fiscal financing needs. The approved funds will deliver liquidity to cover the balance of payments gap this year. 

Turkey (TURKEY): On Wednesday, S&P affirmed its B+ long term foreign currency rating for Turkey and maintained its stable outlook. Fitch rates Turkey BB- (stable outlook) and Moody’s B1 (negative outlook). The agency said that the coronavirus pandemic would likely push the economy into a recession and cause the fiscal deficit to widen to 5% of GDP. However, it also expects that net general government debt by the end of the year will be contained at 34% of GDP, which would allow some fiscal flexibility. S&P expects that GDP with recover in H2 20 H2, to leave this year’s real GDP growth at -3.1%, and lead to 2021 real growth of 4.2%. The stable outlook balances the downside risks of the pandemic over the next 12 months with the resilience of the private sector, and the contained net general government debt. Medium-term forecasts remain largely unchanged, with growth of 3.5% in 2022 and 2023. 

Honduras (HONDUR): Also on Wednesday, S&P affirmed its BB- long term foreign currency for Honduras and maintained its stable outlook. Moody’s rates the country B1 with stable outlook. S&P said that the continued stable outlook on the rating reflects the country’s ability to renew its short term debt, the government’s commitment to fiscal restraint, the broad access to financing sources and an economic recovery expected in 2021, that will help to contain the deterioration of public finances and external liquidity stemming from the coronavirus pandemic and the global recession. Minister of Finance Rocio Tabora said that the macroeconomic policy measures taken to respond to the crisis protect employment and economic activity. 

Argentina and provinces (ARGENT, BUENOS, NEUQUEN): As the deadline for the government’s exchange offer approaches on 8 May, the three main bondholder groups repeated their objections to the proposal and said they would reject the governments terms. Amid local reports that acceptance may be as low as 20%, this raises questions as to what the government will do next. We think it seems likely the government will extend the offer, possibly to 22 May (the end of the 30-day grace period on the 21s, 26s, 46s), and while there may be scope to modify the terms to improve the offer to increase participation (such as inclusion of accrued interest, shortening the grace period, or the inclusion of state contingent payments), there seems little willingness from the government’s side to compromise – despite suggestions by Minister Guzman writing in the FT this week that the government is willing to consider alternative proposals consistent with its own (flawed) DSA – and it is not clear how far the government would go to close the gap between the two sides. Separately, bondholders have also rejected the proposed terms for the Province of Buenos Aires’ exchange offer which is due to close on 11 May (see our Credit Weekly last week) while the Province of Neuquen extended its bondholder identification exercise to 11 May from 4 May.  

Global policy response: Central banks around the world have continued to loosen monetary conditions to support their economies amid the coronavirus pandemic. This week, these included:

  1. Malaysia: On Tuesday, the Central Bank of Malaysia cut the overnight policy rate for the third time this year. The rate has a corridor of +/-25bps. This latest cut was 50bps taking the rate to 2%, and follows a 25bps cut on 22 January and a 25bps cut on 3 March. The MPC cited the economic impacts of the pandemic but expects prospects to improve in 2021.
  2. Brazil: On Wednesday, Banco Central Do Brasil decided to cut its Selic interest rate by 75bps to 3%, after a 25bps cut on 5 February and a 50bps cut on 18 March. The latest cut comes amid the coronavirus pandemic induced slowdown in global growth and the fall in commodity prices. The Copom statement said that economic stimuli in major economies and the moderation in financial assets’ volatility caused the environment for emerging economies to remain challenging.
  3. Norway: On Thursday, Norges Bank cut its key policy rate by 25bps to 0%. This was the third cut this year: after starting 2020 at 1.5%, Norges Bank cut the rate by 50bps on 13 March and 75bps on 19 March. The latest decision follows the abrupt fall in economic activity due to the coronavirus pandemic, compounded by the effects of lower oil prices, which have contributed to the depreciation of the krone.

New issuance: This week, a number of sovereign issuers have priced bond deals as issuers take advantage of lower global yields and stabilisation in investor sentiment, including:

  1. Chile: On Tuesday, Chile (A+/A/A1) priced a dual tranche offering. This included a EUR500mn bond due 30 January 2025 with a 1.625% coupon, priced to yield 1.166%, and a US$1.458bn bond due 31 January 2031 with a coupon of 2.45%, priced to yield 2.454%.
  2. Slovak Republic: On Wednesday, Slovakia (A+/A+/A2) priced a dual tranche bond, comprising a EUR2bn bond due 14 May 2025 with a 0.25% coupon, priced to yield 0.35%, and a EUR2bn bond due 14 May 2032 with a 1% coupon, priced to yield 1.056%.

Abu Dhabi Commercial Bank (ADCBUH): ADCB reported results for Q1 20 earlier today. Net income fell to AED209mn from AED1.15bn a year earlier. Revenues increased, but so did costs and provisions. Recall that ADCB merge with UNB and AHB, and the effective date of the merger was 1 May, 2019. This may limit the usefulness of yoy comparisons based on as-reported figures, but the issuer did provide some proforma numbers too. Lower funding costs drove a 3% qoq rise in net interest and Islamic financing income to AED2.8bn. Non-interest income was almost 20% higher than in Q4 19, at AED687mn, but was lower than the comparable Q1 19 figure, reflecting a decline in card-related fees, lower volumes and reduced trading gains. Costs increased qoq, but operating profit of AED2.2bn was still 7% better than in the previous quarter. The cost/income ratio was 34% (Q4 19: 35%). ADCB's NPL ratio rose to 4.7% from 3.2% at end-19, and coverage fell to 109% from 123%. The net impairment charge was almost AED1.9bn in Q1 20. This compares to the FY 19 charge of less than AED2.4bn. Management disclosed that AED1.072bn of the Q1 20 charge relates to NMC Health, Finablr and associated companies. ADCB believes charges related to these companies are 'adequate based on currently available information' and emphasised that the charges 'do not equate to a write-off.' As a reminder, ADCB disclosed US$981mn (cAED3.6bn) exposure to NMC Health and US$182mn (AED668mn) exposure to Finablr. Related provisions booked in Q1 2020 equate to about a quarter of the total exposure. A drop in retained earnings (due to a AED2.6bn dividend payment) and higher risk-weighted assets meant that the CET1, Tier 1 and total capital ratios fell to 10.8% (YE 2019: 12.9%), 12.7% (YE 2019: 14.8%) and 14.1% (YE 2019: 16.3%) respectively. A AED4bn fair value adjustment on investments also contributed to the decline in capital ratios. The March 2020 ratios would have been even lower in the absence of regulatory forbearance, which has reduced required buffers and limited the impact of higher provisions on capital (these provisions may be added back in capital ratio calculations). Without the provisions adjustment, the CET1, Tier 1 and total capital ratios would have been 10.7%, 12.5% and 13.9% respectively. 

Kuwait Finance House and Ahli United Bank: The Kuwait Central Bank has asked to re-assess the planned purchase of AUB by KFH. This may cast even more doubt on this transaction. The disclosure comes after AUB decided not to exercise a call on a US$400mn pending the outcome of KFH discussions and after KFH and AUB agreed to delay discussions until December 2020. We note also that there were reports saying that the Kuwait Finance Ministry had asked for more information on the transaction. KFH stated that no correspondence had been received. Added to this, the CEO at KFH had his contract rescinded without notice, and a new appointment was announced on the same day. Further, AUB stated that 'technical studies' carried out as part of the transaction may need to be refreshed. The transaction is seen as more positive for AUB, which is rated BBB (positive watch)/BBB-(stable) at S&P/Fitch. KFH is rated A1 (negative review) at Moody's and A+ (stable) at Fitch. 

Ukreximbank (EXIMUK): Ukreximbank has published results for FY 19. Here are three takeaways: (1) Full impact of Covid-19 is not yet known: As would be expected, declining corporate liquidity and profitability and the weaker UAH are expected to have a negative impact on asset quality. Management acknowledges that the pandemic ‘may continue to adversely affect the Bank’s financial position and operating results’ but the extent of the impact ‘cannot be determined at this time.’ (2) FY net income was down to just UAH65mn: FY 18 net income was UAH805mn, so the yoy decline was over 90%. Net interest income fell to just UAH42mn in Q4 19 from almost UAH210mn a year earlier. Further, FY provisions and costs both increased. A deferred tax adjustment of UAH569mn (FY 2018: UAH105mn) also contributed to the weak bottom line. It is worth highlighting that Ukreximbank reported a profit of UAH2.27bn for 9M 19, so there was a loss of more than UAH2.2bn in the final quarter of last year. (3) Cash and equivalents account for 24% of total assets: Although total assets and net loans both fell yoy and qoq, cash and equivalents rose to UAH33.5bn from UAH26.6bn at end Sept 2019 and UAH18.5bn at end-18. This may (partly) explain why on April 28, the Chairman of the bank stated that Ukreximbank is considering buybacks. We calculated that the bank could generate about US$50mn if all five outstanding Eurobonds were repurchased. This estimate of potential gains only took the difference between offer prices and par into consideration.