Very Vague On SGD Perpetuals …. To Worry Or Not After Noble Perp?

An alarming development today which may have escaped some investors who are not concerned that Noble’s 8.5% USD perpetual has crashed in price terms.

This is apparently due to an option used by the company to potentially redeem the bonds at 100 using an equity-classification event trigger.

S&P ratings agency changed their methodology back in April 2013 and no one really paid much attention to it in this time zone because most of our SGD perps are unrated anyway.

In April 2013, S&P lowered the equity credit content for the Noble 8.5% perpetual from “high” to “intermediate”.

What is the implication of this ?

HONG KONG (Standard & Poor’s) June 16, 2014–Standard & Poor’s Ratings Services said today that it had assigned “intermediate” equity content to a proposed issue of subordinated perpetual capital securities by Noble Group Ltd. (BBB-/Stable/–; cnA-/–).
We will therefore classify 50% of the principal as debt and 50% of the distributions as interest expenses in our calculation of financial ratios. We understand Noble will treat the securities as equity in its financial statements. Our assessment of the equity content is subject to our review of the final issuance documentation.

“Minimal” equity content means the full principal of the securities are considered debt and all the distributions as interest expenses and according to S&P, “minimal” equity occurs when the expected maturity is shorter than the minimum of 20 years required to maintain an “intermediate” equity content unless the company specifically states an intention to replace the securities with an instrument of equal (ie. perp) or greater equity content (ie. shares and rights) if the security is called before 20 years.

What is the importance of being classified as equity vs debt for a corporation ?

It would broaden the equity capital on the balance sheet and make leverage ratios look better because the perp is not considered debt/borrowings.

Noble is now purportedly seeking to redeem the old perpetuals at 100 and replacing them with a new issue.

June 16 (Bloomberg) — According to person familiar with
the matter.
Co. hires BAML, Citigroup, HSBC, JPMorgan and Societe Generale to arrange offering of Reg S USD subordinated perpetual notes
Investor meetings to start today
Offering may follow, subject to market conditions
Proceeds will refinance 8.5% perpetuals issued Nov. 1, 2010 and be used for general purposes

The Equity Classification Event Trigger For Call

“The Securities may also be redeemed in whole, but not in part, at our option at any time, on giving not less than 30 nor more than 60 days notice to the Holders at their principal amount together with all outstanding Arrears of Distribution (if any), Additional Distribution Amounts (if any) and Distribution (if any) accrued to the date fixed for redemption upon the occurrence of: (i) any change or amendment to the Relevant Accounting Standard (as defined in “Terms and Conditions of the Securities”) such that the Securities must not or must no longer be recorded by us as “equity” pursuant to the Relevant Accounting Standard; (ii) a change in the equity classification ascribed to the Securities by Fitch, Moody’s or S&P which results in a lower equity credit for the Securities than the equity credit assigned on the Issue Date; or (iii) a change in, or amendment to, the laws or regulations of Bermuda or any political subdivision or any authority thereof or therein having power to tax, or any change in the application or official interpretation of such laws or regulations (including a holding by a court of competent jurisdiction), which change or amendment becomes effective on or after October 27, 2010 such that we would be or would become required to pay additional amounts in respect of the Securities (as provided or referred to in “Terms and Conditions of the Securities”) and such obligation cannot be avoided by us taking reasonable measures available to us.”

The new perpetual will be classified as “intermediate” so there is less chance of a call due to a lowering of equity classification whereas the old perp was classified as “high” equity content in the past as it was issued before the methodology change in April 2013.

As such, the 8.5% perpetual price plummeted from 103 to its current price of 100.75/101.25 (unverified) in a matter of hours.

The more important implication now for the rest of the perp holders in Singapore is if this will happen for the SGD perps that we are holding ?

Some points to note.

1. Only perps rated by the S&P and Moodys and Fitch etc. will potentially carry a call feature of this nature in their prospectuses.
2. Local corporates that are unrated are classifying perpetual debt as Equity in their balance sheets and coupon payments are taken as dividend payments.
3. This equity classification appears to be set in our accounting frameworks but I am not sure why only local corporates are not affected. (THIS IS UNVERIFIED as I have also been advised that perpetuals still count as 100% equity for corporates)

We notice that GLP perpetuals also have the same call feature – worthy of some investigation ….

The only positive to come out of this is that Noble would save 2% or thereabout in interest on their new perp. And more importantly, it does not seem to affect the credit worthiness more than accounting treatments.

There is also the possibility of investor backlash that could cause them to change their minds about the call price.

If anyone has anymore information to share, do make a comment.