As the coronavirus continues to spread, businesses are having to adjust to its many effects.
Some guidance can be taken from previous epidemics – most notably in Asia, with contagious diseases such as SARS and swine flu leaving an ongoing legacy of risk disclosure and analysis. But no epidemic in recent memory has had such an immediate and widespread impact as COVID-19.
While the situation continues to develop rapidly, we look at some immediate implications for both issuers in the market and bank borrowers.
Falling swap rates, volatility and negative rates
Recent drops in swap rates create a more difficult situation for unrated corporates and similar businesses to issue bonds.
To encourage strong retail participation, a minimum coupon is typically set at the start of a bookbuild – which can then run for five to seven days before the final interest rate is set. Issuers are more conscious than ever of being locked into significant margin increases if the swap rate drops over the course of that bookbuild.
Expected cuts to the Official Cash Rate (OCR) are also likely to lead to further drops in the New Zealand bank bill rate (BKBM) and floating interest rates, pushing closer to zero and negative rates.
What could this mean?
- More pressure on arrangers and issuers in the art of setting bookbuild periods, balancing timing and length to manage swap rate volatility and levels, and investor interest.
- More issuers looking to test the current general minimum coupon floor of 3% (noting that at the end of 2019, Argosy successfully priced at a 2.85% floor in its seven year follow-on green bond).
- Potential opportunities for issuers willing to pay a higher margin – whether due to credit, features or tenor – as investor funds look for a home.
- The spectre of negative rates is in prospect again (see our previous discussion of this here). While corporate bonds are typically fixed rate, it is a key focus for bank funding and potential mismatches in fixed/floating hedges will need to be considered. For issuers of floating rate notes, investors may look at whether any positive interest rate floor is present.
Business impacts, disclosure and due diligence
Corporates in exposed sectors will already be assessing the impact that the virus may have on their business and any applicable continuous disclosure requirements. More generally, many businesses across the economy will be reviewing and strengthening their business continuity plans, as the risks of staff or workplaces becoming unavailable increases (see also our discussion of personal quarantines below). From a finance perspective, some consideration should also be given to any stresses those impacts may put on financial covenants, representations and default events.
New Zealand’s Product Disclosure Statement (PDS) regime limits risk disclosure for new bond issuers to matters specific to the issuer or the financial products. While COVID-19 is expected to generally impact New Zealand businesses, the key questions from this perspective are whether the particular issuer is more at risk than others in the market and whether that risk would be material to bondholders (typically a considerably higher threshold than equity).
Issuers in exposed sectors would be prudent to spend time considering the risk in detail, and updating their analysis as situations develop.
What could this mean?
- Further engagement with bank lenders to discuss any expected impacts of COVID-19 on overall business, which may be led by borrowers where a potential waiver or amendment requirement is identified.
- A stronger focus on business continuity plan details in due diligence, investor meetings and bank lender engagement.
- For issuers in exposed sectors, developments in the impacts of COVID-19 may become a standing agenda item in due diligence or continuous disclosure committee meetings.
Force majeure, impossibility and increased cost clauses
Termination clauses are currently being scrutinised more closely in finance and other sectors. Bank facility agreements will typically include impossibility (or impracticality) termination clauses which banks could use to scale back funding in the event of extended market difficulties. As usual, this would be expected to be a last resort.
Prolonged market stress could also lead to margins rising under increased cost clauses.
In the New Zealand domestic bond market force majeure clauses are arguably less relevant (as offers are not underwritten by managers), however settlement underwrites remain a common feature for those issuing off Euro Medium Term Note (EMTN) or other international documentation.
What could this mean?
- More focus on the text of termination and clauses in bank facilities and potential amendment at the next refinance (particularly for older facilities).
- Pressure to amend force majeure provisions where domestic bond issuers are issuing into Australia or other international markets using offshore documentation (as well as for Kauri bond issues into New Zealand).
- For new bond offers, closer engagement with the arranger and managers on the state of the market and potential crystal ball gazing as to the likelihood of significant changes occurring during the offer period.
Personal quarantines and availability
A universal consideration will be the availability of management, directors and other parties throughout the process. While many elements of an offer can be managed through video conferences and email, others can be more difficult to resolve.
What could this mean?
- Procedures to ensure availability of key decision-makers include adequate home office provision (with print and scan facilities), and back-up signatories where applicable. Any international travel during a transaction will need to be monitored, including for the potential to be caught up in unexpected travel restrictions.
- More reliance on video conferencing and similar operations, including for investor discussions on bond offers. Roadshow presentations (both domestic and international) may bring particular difficulties.
- Early consideration of key potential bottlenecks will be needed. Although the New Zealand market has largely moved to electronic settlement rather than wet ink signatures, there remain difficulties with electronic signature use. Offshore issuances can also present unique problems – including requirements by some clearing systems for hard copy signed documents before settlement.
The impact of COVID-19 on more structured products will need to be considered on a case-by-case basis. The most prominent international example is the ‘pandemic bonds’ issued by World Bank, but lower profile issues such as valuation impacts on convertible bonds may need to be considered where equity prices have become volatile.
Chapman Tripp prepared a COVID-19 business protection checklist aimed at the construction sector but generally applicable – view it here.