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Heinz: Beans, Buffett and the return of animal spirits

After years of inactivity, the combination of strong corporate balance sheets and cheap funding has sparked demand for takeover deals. The largest and highest profile deal this year has been the acquisition of H.J.Heinz by 3G Capital and Berkshire Hathaway. It is exactly the type of business that Berkshire Hathaway’s Chairman and CEO Warren Buffett typically goes for: profitable growth; a very recognisable brand; and years of emerging market growth forecast in the future.

Berkshire Hathaway and 3G Capital are buying Heinz for $72.50 per share, a 19 percent premium to the company’s previous record high stock price at the time the deal was announced in mid-February. Including debt assumption, the transaction was valued at $28 billion. Berkshire and 3G will each put up $4.4bn in equity for the deal along with $12.2bn in debt financing. Berkshire is also buying $8bn of preferred equity that pays 9%.

Let’s not beat around the bush. It’s a great company. The business has seen thirty one consecutive quarters of organic growth, stable EBITDA margins, owns a number of globally recognised brands and should be well positioned for future emerging market led growth. Despite this, some are questioning whether Buffett is overpaying for Heinz. So is the price of the deal justified?

The answer, at least in part, lies with cost of debt. The pro-forma capital structure (per the offering memorandum) looks like this:

PF Capital Structure Sources ($m) Net Debt/PF EBITDA
Cash -1,250
1st Lien 10,500 3.87 x
2nd Lien 2,100 4.75 x
Rollover Notes 868 5.11 x
Total debt 12,218 5.11 x
Preferred Equity 8,000 8.46 x
Common Equity 8,240
Total 28,458

Current price talk on the first lien debt sits at $ Libor + 2.75% (floored at 1%) with the second lien at 4.5%. If this is finalised, the company will see an approximate blended interest cost of 3.9% on its new debt securities. Prior to the transaction, Heinz was rated as a solid investment grade business attracting a Baa2/BBB+ rating. Assuming the deal goes through, its new second lien notes are expected to be rated B1/BB-, some five notches lower than Heinz’s current rating, reflecting the much higher financial leverage and structural subordination.

It’s worth noting that through last year Heinz’s 6.25% 2030 bonds traded in a range of 4–5%, despite the much higher rating and lower financial leverage at the time; albeit some term premium is warranted given the longer dated nature of the debt. The bonds have since sold off in recognition of the greater risk – as things stand they will remain in place.


Now let’s compare the price action of the proposed debt financing to the preferred equity to be owned by Berkshire Hathaway. Whilst the paper is structurally subordinate to all other debt, it still sits ahead of some $8,240bn of common equity and attracts a cash coupon (which can be deferred) of 9% vs the 3.9% weighted average above. It’s also worth bearing in mind that the transaction has been structured to encourage the preferred equity to be retired, at least in part, ahead of both the first and second lien debt, potentially leaving bondholders with significantly less subordination than at day one. I’d argue that this is by far the most attractive (quasi) debt to invest in within the structure, though that is hardly surprising given that unlike Buffett, few of us can write a cheque of this magnitude.


As animal spirits return and the leveraged finance community falls over itself to lend to well known companies, the likely winners in the space will be the private equity community. Whilst we are nowhere near the levels of the great private equity binge of 2004-07, the value of takeovers in 2013 is already running well ahead of 2012. After years of corporate deleveraging, we may now be entering into a period of increased M&A activity. Company managers may find that if they aren’t willing to start leveraging up given the environment of extremely low borrowing costs, then investors like Buffett will do it for them.

The Heinz deal has been another recent shot across the bows of the bond market. Rising leverage has a longer term implication for credit markets, in that it is bad for credit quality. Bigger and bigger companies are clearly in play and this is something we will be keeping a very close eye on.

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Conference Call replay link: the UK’s AAA White Elephant – thank goodness it’s gone, now we can try to grow again.

In old Siam (now Thailand), kings would ruin unliked courtiers by presenting them with a white elephant – supposedly a badge of honour, but actually a dung producing money-pit. As Wikipedia describes it, nowadays a white elephant is an idiom for “a valuable but burdensome possession of which its owner cannot dispose and whose cost (particularly cost of upkeep) is out of proportion to its usefulness or worth”. The AAA credit rating that Moody’s gave to the UK was one such white elephant. A nice trophy to have, but one where the government believed that costs of upkeep included extreme austerity, now and into the future. The good news is that Moody’s has downgraded the UK, and best of all, has done so ahead of the Budget in March. The white elephant is dead, and now George Osborne can do a bit of fiscal stimulus – housing and infrastructure spending have huge positive growth multipliers, and can be justified easily, especially whilst gilt yields are so low. And if all else fails, we can always “QE” the yields lower still…

In this conference call from this morning, I look at the downgrade, the UK fiscal outlook, and the implications for the markets. The link below takes you to the slide deck and the audio.

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6 degrees of Kevin Bacon, 5 ways to catch a subscriber – consolidation in cable

I’d been feeling pretty pleased with myself since last Saturday – I managed to get Sky TV, broadband and a landline installed in my flat. That was until earlier today, when after discussing some of the recent activity in this sector with our telecoms and media analyst, I was left feeling something of a technology dinosaur.

These three services sold as a single package is called a “triple play” offer. However, I have since discovered that this is so 2010. These days it’s increasingly about “quad play”, whereby consumers access video, broadband and voice services both inside and outside the home. Inside the home is provided by your cable, copper telephone line and/or satellite dish whilst outside connectivity is provided by a mobile network. The most visible example of this business model in the UK comes from Everything Everywhere (EE), mostly due to their……um……interesting adverts featuring Kevin Bacon. EE allows a subscriber to make voice calls, surf the internet and watch video content either at home or on the move via a combined mobile and fixed line broadband connection. Advances in mobile technology (4G) now mean that seamlessly streaming a film in your house on your iPad as you eat breakfast and then on your journey to work should be possible. This is the direction the industry is moving in the UK, with Vodafone, 3 and O2 expected to launch later in the year once they secure the necessary 4G spectrum that is currently being auctioned. In the US and portions of Western Europe it is already there.

So quad-play has a clear consumer proposition, i.e. ubiquitous and fast media consumption and connectivity from a single service provider. But what benefit do the telecom operators derive from this service? Firstly, they hope to stem the revenue declines and customer churn they have experienced over the past few years as a combination of competition and regulation have ground down prices. Secondly, quad play offers them a cost saving opportunity by shifting data traffic off their mobile networks and on to their fixed line infrastructure as fast as possible, either via an in-home WiFi point or a fibre optic link to the network towers outdoors.

Generally speaking, in each country there is an incumbent telecom operator offering both mobile and fixed line services (the UK is an almost unique exception after BT spun off O2). However, there is also a swathe of mobile-only and fixed line-only operators in each market and hence consolidation in the face of this strong industrial logic seems inevitable.

Last Wednesday, press reports suggested that Vodafone is considering acquiring cable operator assets. Two firms seem to be in their crosshairs for now; Kabel Deutschland and ONO (which operate in Germany and Spain, respectively). Both companies’ bonds rallied on the news that they could be taken over by a company with a much stronger balance sheet – they are both high yield whilst Vodafone is solidly investment grade. We think that Kabel Deutschland would be a better fit but either way Vodafone is clearly interested in fixed line assets across Europe. Last year it bought Cable & Wireless Worldwide in the UK and its interest could also stretch to alternative fixed line network operators like Jazztel (Spain), Versatel (Germany) and Fastweb (Italy).

Similarly, Liberty Global, an international cable operator, recently made a bid for UK cable operator Virgin Media. Virgin’s bonds were weaker on the news as LGI is a lower rated entity than Virgin and plans to leverage the business to a level commensurate with its other European cable investments (UnityMedia, UPC, Telenet). LGI already offers triple play services across its extensive European cable footprint but, along with the usual scale and tax synergies, Virgin brings with it significant experience in mobile as well as providing fibre optic connections to other UK operators’ mobile towers.

What can possibly come after quad-play? Internally we refer to what we believe is the next step as “penta-play”. This involves business models where service providers offer quad play delivery and services complemented by ownership of the content being consumed over those networks. The importance of control over content to a network provider was underlined by the US’s largest cable operator Comcast, with its $17bn purchase of the remaining 49% of NBC Universal it did not already own. If you think this is a US aberration, just think what would happen to Sky if it lost the Premiership contract and why BT has recently decided to park its tanks on Sky’s lawn with its recent expansion into Premiership football and rugby.

And after that? Well the regulators will probably demand these vertically integrated behemoths are broken up but that’s another story…. From a consumer’s point of view we think that consolidation and competition, to provide us with all our communication, entertainment and informational needs under one subscription, will eventually lead to lower prices for services previously purchased separately now being provided as a single service bundle. From a bond holder’s point of view the recent activity suggest M&A risk is on the rise with negative and positive impacts depending own whether you sit in the acquirer or the target, the better rated credit or the company with the weaker balance sheet, and your specific bond covenant protections.


South Africa should be rated junk, and that really matters if you’re an EM debt investor

The worrying developments in South Africa in the past few months have caught the attention of the ratings agencies and the markets (see first chart).  South Africa is one of very few emerging market countries whose credit rating is deteriorating; it’s still officially rated investment grade, but we think it should already carry a junk credit rating and the market is not pricing this in.  And considering that the country has a 10% weighting in a commonly used EM local currency benchmark, this really matters for EM debt.

South Africa faces a number of financial, political and economic issues, none of which appear likely to be resolved quickly or easily.   Some of the problems, and especially those that the rating agencies reacted upon, are well known and widely discussed (namely gold and commodity export dependence, crime and social unrest, stubbornly high unemployment and income inequality, corruption and poor governance, unionisation and labour market rigidities, and a poor climate for investment culminating in renewed threats to nationalise mining companies).   The Economist has done some good pieces covering many of these topics, eg see here.

We think the market and rating agencies continue to underestimate the following issues regarding South Africa;

1. Debt sustainability
Although the central government debt/GDP ratio appears manageable at around 43%, or 60% of GDP including guarantees provided to state owned companies, this does not reflect the increasing debt burdens of local governments and municipalities. Getting accurate figures for local government borrowing is difficult, but the finances of several municipalities appear unsustainable, compounded by massive IT failures which have left thousands of bills unaccounted for. In addition, state owned utilities have also struggled to manage billing and revenue collection, reporting large uncollected debt balances owed by citizens. There are also cases of large arrears being run by local governments themselves, failing to pay for goods and services provided by, for instance, water boards as well as other state and private companies. As in Greece and Italy, payment arrears can comprise a significant portion of government ‘borrowing’ which is typically under-reported in official statistics.

2. Limited fiscal headroom
According to an analysis by Fitch, 90% of South African government spending is on current items such as wages, subsidies and interest, leaving very little available for longer term investment to fuel sustainable growth. At the same time, this also implies limited ability to absorb any significant rise in interest finance costs or any other external shock. In this context, the fact that around 90% of government debt issued is denominated in domestic currency suggests lesser vulnerability to a significant exchange rate shock. However, a large proportion of debt is now held by foreigners which means that exchange rate volatility could have a considerable impact on South Africa’s ability to refinance.

[More generally, a spike in foreign ownership in most EM local currency markets remains an acute concern to us, which is something we've repeatedly highlighted on this blog over the last year or so such as here.  Investors and EM policy makers I've spoken to remain far too complacent about flows into local bond markets (historically, EM debt crises have tended to follow big jumps in external debt levels and everyone is very sensitive to this, but foreign buying of local EM markets is a relatively recent phenomenon).  Interestingly, however, the IMF are starting to focus on foreign ownership of local currency bond markets as a key risk, eg see page 67 onwards in the IMF's recent GFSR.  Note that foreign ownership of domestic bond markets isn't solely an EM country problem - Australia stands out on this measure too as previously discussed here]

3. Implicit support of the banking sector increases sovereign liabilities
Another critical issue is the separation of the South African banking sector from government implicit support. To date, the population (and most investors) have taken it for granted that the government would stand behind the five largest banks, which account for 90% of deposits. As a result, there has been a lack of progress on implementing deposit insurance, let alone on implementing global banking reforms such as resolution regimes. The banking sector, therefore, remains essentially a contingent liability of the sovereign. The local banks, in turn, have leveraged this assumption by raising significant amounts of wholesale debt. They also remain very short term funded, with heavy reliance on local money market deposits from local insurers and pension funds. Consequently, these have built up massive exposures to the banking sector – again in the expectation of government support for the banks if needed.

Let’s think this through. Adding further government liabilities of about.90-100% of GDP to the existing ones in order to support the banks (and even more, if the insurers and pension funds themselves also have to be supported because of their investment concentrations in the banks) clearly creates an unsustainable burden on the sovereign. South Africa is gradually waking up to the fact that it cannot maintain an implicit bank support policy while also retaining strong investment grade sovereign ratings – these two are incompatible, as much of Europe has discovered. However, introducing some sort of resolution planning that avoids taxpayer support for banks will require major structural reform, including deposit insurance, bail-in of wholesale liabilities and balance sheet shrinkage, none of which will be popular in the short term.

4. Current account deficit
Despite the commodity boom of the last decade, and despite the fact that 42% of exports are currently in the form of commodities, South Africa has had a current account deficit since 2003. More strikingly, the lack of investment in critical sectors such as mining have not only led recently to labour unrest, but have also contributed to a declining productivity and competitiveness in those sectors which South Africa is highly reliant upon (a member of the South African Treasury I met at the beginning of this year cited a lack of investment as one of the country’s most critical problems, and recent unrest will hardly accelerate much needed FDI). Meanwhile, consumption of imported finished goods has continued to rise as domestic productivity has deteriorated in these sectors. The country’s increasing dependence on gold exports, which account for 25% of all exports, as well as on China, where around 15% of the exports go to, makes it increasingly vulnerable to external shocks. The high dependency on China worries us in particular, as we believe that China is in a structural slowdown rather than a cyclical slowdown as we’ve previously explained. If our China thesis is correct, it would have major implications for global demand for hard commodities and raw materials and would put pressure on countries reliant on exporting these commodities.  Again, many of these issues are things that South Africa has in common with Australia.

While it’s true that the four points above apply to varying degrees to a number of developed and developing countries, South Africa doesn’t look like an investment grade country to us when taken together with the issues previously highlighted. If the rating agencies follow this assessment – and their latest actions show a clear tendency – then this could have major implications for South African debt and currency markets.  South Africa has only just entered the widely used Citi World Government Bond Index (and enjoyed large inflows from foreign investors on the back of this) but would rather embarrassingly drop out again if it were to be junked.  Interest rate costs for not just the sovereign but banks and corporates would rise, potentially sharply, and the South African rand could slump (South Africa has few reserves with which it can intervene in FX markets).

If South Africa were to be junked, what would the impact be on EM debt more generally?  In terms of direct effects, given a 10% index weighting in EM local currency debt, a drop of, say, 10% in the rand and 5% in the bonds’ prices would detract 1.5%.  South Africa has a smaller weighting in external sovereign and corporate debt indices (typically 2-4% depending on the index) so the impact would be less.  Indirect effects are impossible to quantify; at the very least other African countries would likely be hit (many of whom run even larger current account deficits) although these countries form only a small part of the EM debt indices. It’s possible that investors will reawaken to idiosyncratic EM risks and contagion could spread to other regions.

It’s important not to over-blow the systemic risks, and bear in mind that events in the Eurozone, the US and China will obviously be far bigger drivers of returns for the wider EM debt market than events in South Africa. Nevertheless the message remains -EM debt, not so safe.

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Fallen Angel Delight – looking at returns from “junked” companies

Earlier this year, Stefan highlighted the potential for sovereign debt downgrades to push big European companies into high yield territory becoming “fallen angels”, issuers downgraded from investment grade to high yield. This is something the Financial Times has also recently picked up on. The chart below shows how near the average European sovereign ratings are to sub-investment grade.

Rating agencies have flexibility in “capping” corporate ratings to the sovereign ratings of their respective home countries – the so-called sovereign ceiling. S&P for example has no strict limit on the number of notches by which an entity’s rating can exceed the sovereign but Moody’s is less generous, allowing a maximum two-notch rating uplift versus the sovereign for non-financials (the maximum is one notch above for financials). The reality is that a strong credit worthiness correlation tends to exist due to the likely exposure of companies to their domestic economy, and the ability of the sovereign to tax them (or worse) if necessary.

Where the market is not focusing enough is on the current role of existing fallen angels – companies that migrated from an investment grade index into a high yield index since the beginning of 2012. So far this year the fallen angels weighting in the Bank of America Merrill Lynch European Currency High Yield Index has increased by approximately 15% to 43.66%, the highest it has been in over two years.

Fallen angels weighting

What is even more interesting is fallen angels’ contribution over time to total return.

Total return

Fallen angels have significantly outperformed the original issue high yield portion of the index over time, whether you look at annualised returns over the last 3, 5, 7 or even 10 years (+2.59%, +3.70%, +2.87% and +3.24%, respectively).

Now, many future fallen angels may be different from their predecessors from a credit quality point of view. In the past, downgrades pushing corporates and banks down to high yield were mainly due to company-related issues: worsening balance sheets and poor revenue outlook. They were therefore as risky a bet as the rest of the universe.

Is this still true today? Well, reviewing the list of fallen angels in 2012, 41 out of the 110 European securities downgraded to high yield were due to sovereign downgrades (specifically from peripheral Europe – Spain, Italy and Portugal). This is equal to 37% of the total downgrades: more than one third of the total. This increase in the fallen angel population due to “externalities” (i.e. sovereign downgrades due to the eurozone debt crisis, rather than for the intrinsic worsening of their performance) has a potentially significant impact on the BB segment of the high yield market. Arguably, this increases the underlying quality of the market and, if historical risk/return characteristics hold, this could have a beneficial impact for high yield returns in general. On the other side, given the higher underlying quality of these downgraded issuers (lower leverage, better cash flows, global scale) their yields may be lower upon entering the high yield indices, and the potential for subsequent performance may be weaker than with “real” junk.



The UK’s current account deficit keeps getting worse. Terrible numbers today – time to reduce sterling exposure?

There were some reasons to be cheerful in today’s UK economic data – second quarter GDP growth wasn’t quite as bad as previously thought (the economy shrank by 0.4% rather than 0.5%), and stripping out the weak construction sector, the economy is growing at a reasonable (if below trend) rate.

But we also had news that the UK’s current account deficit showed a significant deterioration. The gap between imports and exports grew during the quarter, to a deficit of £20.8 billion – equivalent to 5.4% of GDP. Additionally the first quarter deficit data was revised higher by £4 billion to over £15 billion. The relative strength of the pound is hindering the effort of the UK to rebalance its economy away from consumption and towards manufacturing and exports. On a trade weighted basis, sterling is around a 4 year high – helping to feed our addiction to consumer goods (and as a positive side effect helping keep inflation below the BoE’s letter writing territory for the first time in ages).

The chart below perhaps acts as a warning for those of us who by domicile or asset allocation are exposed to the pound. It shows the UK’s current account position going back to 1955, and you can see that periods when the deficit exceeded around 3% of GDP, a severe weakening of the pound often followed. In the mid 1970s the pound fell by nearly 30% against the Deutsche Mark and US dollar, and big falls also followed in the early 1990s, and in the first wave of the credit crisis. Of course there are other things you can point to in all of these occasions (bad UK banks in 2008, leaving the ERM 20 years ago this month) but if the UK’s safe haven status comes under question (for example if we lose our AAA rating post the Chancellor’s Autumn Statement) that might give the currency markets an excuse to revalue the pound downwards.

UK current account balance

Incidentally, on a purchasing power parity measure (PPP, which looks at the level of exchange rates needed to equalise the price of buying things in different economies) sterling is fair value against the Euro, cheap against the Australian dollar (which looks 23% overvalued – if you’ve been there on holiday and paid a million pounds for a schooner of lager you’ll know that’s true), but 15% dear against the US dollar.


The quiet de-coupling of high yield from equity markets continues

High yield and equities have historically been seen as highly correlated in terms of their returns, and before 2008, this was true. However, what we have witnessed in the post-Lehman environment is a structural shift that requires a more nuanced appreciation of the relationship between fixed income and equities. This is something we looked at in a more in depth piece we published earlier this year.

This point has been reinforced by the surprisingly divergent performance of the European high yield market and the European equity markets so far this year.

The chart below shows that European high yield performance has been strong, returning a little over 12% year to date. This contrasts sharply with lacklustre equity returns. The MSCI Europe ex UK index is down 1.3% at the time of writing whereas the more concentrated DJ Euro Stoxx 50 is showing a negative 8.4% return.

Accordingly, whilst high yield returns will always be sensitive to the economic cycle and market sentiment, in a world of zero interest rates, financial repression, deleveraging and slow growth, we continue to believe that the relationship between equities and high yield bonds has shifted in a subtle but meaningful way.



Peripheral corporate bonds and mass downgrade risk

Staying with the Bon Jovi theme, ‘Ugly’ was a track released by Jon Bon Jovi on his second solo album in 1998. It isn’t well known, or any good for that matter, but it does aptly describe the price action of Spanish and Italian corporate paper of late.

Plenty of attention has been paid to the yield on Spanish and Italian govies – currently around 7% and 6% for 10-year bonds – but their bellwether non-financial corporate issuers have also seen their yields come under significant pressure. 5-year CDS levels for the likes of Iberdrola, Gas Natural, Repsol and Enel are trading near their all-time wides at 500, 525, 475 and 455 bps respectively. And it isn’t just the utilities that have come under pressure: Telefonica and Telecom Italia have also seen their risk premia balloon to over 500bps. (see chart 1)

Whilst the aforementioned companies are still rated investment grade – some by many notches – they are actually trading wide of the Merrill Lynch BB Euro High Yield Non Financial Index (current asset swap of +440). Put another way, the market does not believe that these businesses represent investment grade risks.

Such a view isn’t without logic. The current ratings for the largest Spanish and Italian non-financial issuers (see chart 2) suggest that the market is right to be nervous. On average, the four largest Spanish issuers are only two notches above high yield status; for Italy’s five largest issuers it’s about three notches. That may seem like a fair bit of runway until you think about the pace of downgrades suffered by their sovereigns of late. Keep in mind that as late as July 2011 Moody’s rated Spain at Aa2, seven notches higher than its current Baa3 rating. Italy has also seen its rating cut a full four notches between June 2011 and Feb 2012 by the agency. And S&P hasn’t been much kinder, slashing Spain’s rating from AA- to BBB+ in under a year and reducing Italy from A+ to BBB+.

Both Spanish and Italian corporates saw negative rating actions as a consequence of those sovereign downgrades. Moody’s allows non-financial corporates a maximum two-notch rating uplift versus the sovereign, whereas S&P permits a maximum of six in extremis, with a couple of notches uplift far more common. The impact on Greek and Portuguese corporate bonds – such as EDP, OTE and Portugal Telecom – after their sovereigns lost their investment grade status serves to reinforce the potentially significant relationship between sovereign and corporate credit ratings.

So, in a hypothetical mass downgrade scenario what quantum of debt could be downgraded to high yield? If all Italian and Spanish non-financial paper were eventually to lose its investment grade status, we calculate that €47bn nominal of Spanish paper and €59bn nominal of Italian paper could fall into high yield territory. That would be a massive €106bn worth of paper – or 80% of the existing non-financial Euro High Yield index – heading into the high yield market. That’s a lot of paper for it to swallow.

Of course, the actual amount of debt that would end up for sale is difficult to quantify. This would depend, among other things, on index rules and investors’ willingness and ability to hold high yield bonds. However, it seems reasonable to assume that over the coming months and even years a significant amount of paper will need to find a new home. Yields may well have to climb further, potentially a lot further, before traditional high yield investors see value in these names.



US – a video from Chicago. Research trip on the US High Yield market

I recently returned from Chicago after a research trip. We put together a short video to share a few of our findings with the wider world. The mood of most economists, investors and indeed the man on the street was noticeably more upbeat than in Europe. With positive GDP growth, a housing market showing the first signs of stabilisation, if not growth, and – in our opinion – a banking system that is in better shape than its European equivalent, the US continues to provide a more benign context for High Yield investors. Indeed, whenever we encountered concerns and pessimism it was firmly focused on this part of the world. Consequently, we continue to find some interesting themes and opportunities in the US, both from a top down perspective and also for individual issuers and bonds.


Why does UK government guaranteed Network Rail keep issuing debt in its own name – and at a higher cost?

Network Rail, the organisation that owns and manages the UK’s rail infrastructure, has just issued more of three tranches of its index-linked corporate bonds.  These bonds are, like all of Network Rail’s debt, rated AAA and fully guaranteed by the UK government (the business was effectively nationalised in 2002 having bought Railtrack out of administration) .  These bonds were issued with spreads around 30 bps over similar maturity UK index-linked gilts.  That level of spread is typical of where Network Rail’s corporate bonds trade at the moment – and there is over £28 billion of this public debt outstanding.  This means that if that corporate debt were issued today it would bear a total interest cost that is £84 million per year higher than the cost of issuing gilts (plus the costs of issuing debt as a corporate, e.g. separate listings, investment bank fees).  Present value a perpetual income stream of £84 million at, say, 3% (the yield of ultra long dated gilts) and that is an additional cost of £2.8 billion.

So why isn’t the government borrowing in its own name at rates 0.3% per year lower than Network Rail and then directly on-lending the money to it?  After all it has already assumed all of the credit risk through the guarantee.  I know that £2.8 billion is relatively small in the scale of the UK’s debt problems nowadays (it was roughly the overshoot in May’s government borrowing requirement), and that assuming Network Rail’s debt obligations directly would increase the total UK national debt, but we’re talking about a simple accounting change to save billions of pounds.

Just don’t let’s get started talking about PFI…

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