Network Rail’s AAA bond debut near, ABS to follow
Network Rail, the not-for-profit company that owns the UK?s railway tracks, will make its long-awaited debut in the public bond markets in the next few weeks, as part of its plans to launch billions of pounds of debt to finance improvements in the railway infrastructure.
The first issues from a new £10bn EuroMTN facility will be launched after roadshows starting next week, with the market anticipating up to £3bn equivalent of bonds, spread over several tranches denominated in euros and sterling.
The first benchmark deal will be led by HSBC and Merrill Lynch.
Fred Maroudas, director of funding at Network Rail in London, told EuroWeek yesterday (Thursday): "The size, maturity and timeframe of the first deal will be determined by the market, but we expect to issue benchmark deals in sterling and euros.
"We will be conducting roadshows in the UK and Europe, starting on March 4."
Bankers expect demand to be strong for the borrower's paper, especially in sterling, where supply is scarce. However, some investors are concerned about the likelihood that the rail industry could be restructured, while others will view the company's split ratings of Aa1/AAA/AAA as an obstacle.
The MTN programme has been set up as a bridge between Network Rail's short and long term funding. The company already has a £9bn bridge loan in place and a £4bn global CP programme, but its goal is to establish a debt issuance programme later this year.
The MTN programme became necessary after Network Rail's plans to securitise track access charges ? the fees it is paid by train operating companies that use the track ? became bogged down.
The securitisation, arranged by UBS and RBS Financial Markets, is eventually expected to provide most of Network Rail's long term funding. But the structuring process ran into protracted negotiations with the government and rail industry bodies over how much Network Rail should spend on the infrastructure, and the level of government support for its funding.
As negotiations continued, the structure of the securitisation evolved.
EuroWeek has learned that the latest form, likely to be final, is best described as a credit enhanced funding vehicle. Although technically secured on track access charges, the notes will be supported by an undertaking to cover any shortfall.
"Later in the year we expect to set up a debt issuance programme that will cater for short, medium and long term debt issuance," said Maroudas.
"Network Rail has long term assets, so it is sensible to have a diversity of debt instruments to cover a spread of maturities. Over the last 18 months we have looked to move from short to longer term debt, but over time we want to maintain a full maturity curve."
The structured vehicle will allow Network Rail to leverage its regulatory asset value and issue debt across a range of maturities. Assuming no more problems are encountered, Network Rail should be able to launch the securitisation during the first half of 2004.
One obstacle is likely to be removed this Sunday, when Network Rail, the Strategic Rail Authority (SRA) ? the agency which channels government money into the rail industry ? and the government make a submission to the rail regulator on a plan to defer £3bn of increased track access charges for two years. The regulator must then make a decision by March 10 on whether to approve the deferral, or "reprofiling" as it is called.
The MTN programme, to operate under the issuing name Network Rail MTN Finance plc, was arranged by HSBC and Merrill Lynch.
They are joined on the dealer panel by Barclays Capital, Citigroup, Dresdner Kleinwort Wasserstein, RBC Capital Markets, Royal Bank of Scotland, UBS and WestLB.
Around £3bn of funding will be used for working capital requirements, with a further £7bn available to refinance part of Network Rail's short term borrowing from banks.
The lion's share of this borrowing is the £9bn bridge put in by a syndicate of nine banks two years ago, when Network Rail was set up to buy the assets of Railtrack, the privatised rail network company, which had sunk into administration.
Lengthening the curve
Besides the bridge loan, which is not fully drawn, the company has £1.05bn of loans from the European Investment Bank and KfW, the German development bank, £400m of finance leases and £4bn outstanding from its global CP shelf, set up last June.
"Network Rail's strategy has been about lengthening the curve," said Maroudas. "We started with short term acquisition finance in the form of a £9bn bridge facility; we followed this with a highly successful £4bn USCP and ECP facility, which is fully utilised; and now we've set up the MTN programme to extend our maturity curve."
According to Jan Pethick, chairman of Merrill Lynch EMEA debt capital markets, the shelf makes sense for the borrower.
"If you look at the company's financing arrangements and the expected terming out that needs to be done, it makes sense to set up a programme like this as it gives real flexibility, both in terms of price and of taking the first step into the public debt arena and building the start of a yield curve," he said.
Pethick expects strong demand for the first deal, due in the next few weeks. "The key goal for Network Rail is to get a well traded benchmark with good investor support in Europe and the UK," he said.
"Because of the SRA support, the company can be seen as a quasi-sovereign and compared to other high grade public sector or transport credits. There is a shortage of UK country credit in the market and the SRA gives the paper that national flavour, so investor appetite should be strong."
Similar names among European public sector borrowers include France's rail companies Réseau Ferré de France or Société Nationale des Chemins de fer Français (SNCF). However, because Network Rail's deal is a debut public transaction, the borrower is likely to price outside those comparables.
Furthermore, Network Rail has been assigned a 20% risk weighting by the UK's Financial Services Authority (FSA) and BaFin, its German equivalent.
This contrasts with credits such as KfW, with its explicit German government guarantee, and Infrastrutture SpA (Ispa), which was awarded a zero risk weighting for its debt issuance programme to finance the Italian high speed railway system.
Among other factors that might scare some investors ? or prompt them to demand a premium ? could be the UK government's announcement in January of a potential restructuring in the rail industry.
According to a Standard & Poor's report, the government could change the roles and responsibilities of entities in the rail industry when the review is completed this summer.
While S&P said it understood that the SRA, and by association Network Rail, would continue to have the government's full support, investors may be concerned about the chance, albeit slim, that the SRA could be downgraded.
The review "could have implications for the credit quality of individual participants", said S&P analyst Craig Jamieson. A reduction in power and responsibility for the SRA could result in a downgrade.
Investors harbour grudges
There is also a risk that Network Rail could suffer from investors' resentment about the fate of its predecessor, Railtrack. Some investors harbour a grudge over the way Railtrack was put into administration in 2001, leading to precipitate downgrades ? even though bondholders were all made whole when Railtrack was wound up in 2002.
Established in that year, Network Rail is a company limited by guarantee (CLG), which is a private company without shareholders, run along commercial lines. Any profits are invested in improving the rail infrastructure, rather than paid to shareholders.
While the government does not specifically guarantee Network Rail, if it is ever unable to raise further finance, it can use standby loans from the SRA up to a maximum of £10bn.
That framework is similar to the one set up for Network Rail's CP shelf, which is supported by a £4bn standby loan facility from the SRA and a £1bn standby commercial bank liquidity facility.
S&P yesterday assigned a preliminary AAA rating to the new MTN programme.
The agency said the rating was "based on the credit enhancement provided by the SRA ... and its ability to meet its contractual obligations in a timely manner in all circumstances through the SRA facility in the form of a term loan facility, the MTN support facility (MTNSF), of up to £10bn and a direct agreement."
The MTNSF comprises a revolving facility available on five business days' notice and a standby facility available on 60 days' notice.
The total support offered to Network Rail by the government through the SRA amounts to £17bn, with £4bn of direct support. Maroudas said the new MTN programme does not alter those levels.
"The £3bn that will finance working capital does not increase the overall levels of support that the SRA has given us," he said. "We are merely restructuring our existing support facilities from the SRA."
The support for the MTN programme from the SRA expires on March 31, 2009, which means any bonds issued from it will have a maximum term of five years.
Any funds from the SRA will come from a combination of the authority's own liquidity and funds available at the Department of Transport. According to S&P, the "final rating is contingent on the execution of the MTN letter of comfort from the UK Secretary of State for Transport".
That letter is expected to be signed on March 3 and, according to minutes from parliament, would mean that the secretary of state "would intervene in a timely manner to ensure that adequate funds would be made available to meet any financial obligations incurred by the SRA".
While the letter is not a guarantee, it does constitute a strong statement of intent towards the SRA. Letters of this kind are often used with private finance initiative bonds to avoid express guarantees from the government, and investors are generally comfortable with their use.
Moody's yesterday took a different line from S&P, rating Network Rail Aa1, one notch below S&P's rating of AAA. This verdict from Moody's means the company will face difficulties positioning itself as a quasi-government credit and will have to pay a higher spread than if it were triple-A rated by all three agencies.
Moody's said the rating was unlikely to move upwards "without an explicit increase in the level of support and commitment shown towards the SRA by the UK government".
Moody's said it would view as positive "any reforms that would result in closer, more specific, alignment between the SRA's obligations and those of the Crown. However, a decrease in the level of commitment and support towards the SRA from the UK government could put downwards pressure on the SRA's rating."
Network Rail securitisation changes track as deadline
Network Rail's securitisation of track access charges, held up since last year by wranglings with rating agencies, the UK Treasury and the Strategic Rail Authority (SRA), appears to be nearing completion.
Arranger UBS is believed to have agreed a structure for the not-for-profit railway track company that is less like a straightforward securitisation than originally planned.
More accurately described as a credit enhanced funding vehicle, the pseudo-securitisation will leverage Network Rail's regulatory asset value to issue debt across a variety of maturities and possibly currencies.
Technically, the bonds issued will be secured on Network Rail's revenues, which comprise direct government grants and track access charges paid by train operating companies to use Britain's railway lines. These charges, too, are heavily subsidised by the state.
Thanks to rating agency pressure, the deal will depend on some form of credit support from the government. A Department for Transport report on its contingent liabilities, published this month, describes "a financial indemnity to meet debt service costs in the event of a shortfall".
But with an explicit guarantee out of the question, the rating agencies are wary of granting the hoped-for double-A rating without a firm government undertaking to step in, should Network Rail suffer a similar fate to Railtrack.
Their caution increased when the government announced a wide-ranging review of the structure of the rail industry in January.
Moody's, in particular, takes a pessimistic view and granted a rating of only Aa1 to the SRA in February, noting that "a decrease in the level of commitment and support towards the SRA from the UK government could put downwards pressure on the SRA's rating".
Consequently, the agencies have been pushing for, and seem to have obtained, a commitment as close to a guarantee as possible without threatening the government balance sheet or breaking EU rules on state aid.
There is a precedent ? the government's explicit guarantee of the cashflows underpinning London & Continental Railways' recent £1.025bn bond was only considered a contingent liability .
The lack of explicit contractual support for the SRA has been one of the main stumbling blocks for the securitisation, which has been in the works for nearly two years.
The dispute has been caused partly by the desire of Gordon Brown, chancellor of the exchequer, to observe the "golden rule" of only borrowing to invest in capital projects, thus lowering the public sector borrowing requirement.
Track access charges, which make up a large part of the SRA's obligations, are considered current spending rather than capital investment.
While Network Rail and the Office of the Rail Regulator would like to increase track access charges (TACs) to meet the not-for-profit company's deficit, the SRA has emphasised grants and spending cuts.
Consequently, the parties have been negotiating to shift the balance of payments away from TACs and towards grants.
Under rail regulator Tom Winsor's plan, announced in December, only £2.5bn of Network Rail's £22.2bn funding requirement over the next five years would come from grants, with the remainder made up of TACs and debt.
But the Treasury would like to see two-thirds of the total paid as grants. Such a move would cut £2.9bn a year off the government's PSBR.
Furthermore, a £1.5bn per year increase in TACs is likely to be deferred for two years when the parties present their proposals to Winsor on Sunday, saving £3bn.
If the regulator agrees, he will increase the regulatory asset value of Network Rail, enabling it to borrow more to finance the shortfall.