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WorldMay 1 2013

Hybrid debut powers National Grid investment plans

UK utilities operator National Grid made a highly successful debut in the hybrid market to finance large investment needs without jeopardising its credit ratings.
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Hybrid debut powers National Grid investment plans

National Grid is one of the largest investor-owned utility groups in the world, powering the gas and electricity networks in the UK and supplying electricity across New England and New York in the US. A heavily regulated business, the company needs to spend about £25bn ($38.3bn) over the next eight years upgrading, replacing and renovating its infrastructure in the UK and a further £10bn in the US.

“In 2013, we will spend about twice what we spent two or three years ago and that was about double our expenditure two or three years before that. So the pace of our investment is increasing substantially. We expect to fund it all from debt and retained earnings,” says National Grid global tax and treasury director Malcolm Cooper.

The group is no stranger to the debt markets but funding its investment programme with conventional bond issues would put inevitable pressure on their credit rating. “The credit rating agencies are very important to us because obviously, if our rating weakens, our cost of borrowing increases. Our credit metrics will weaken over the next few years but we wanted to minimise the impact,” says Mr Cooper.

With this in mind, the company started looking at hybrid bonds, which the rating agencies treat as quasi-equity. “The rating agencies give hybrids a 50% equity credit so we knew that if we raised hybrid debt, it would boost our balance sheet and give us more confidence about our funding programme over the next eight years,” says Mr Cooper.

Long planning process

UK power regulator Ofgem submitted final proposals to National Grid in December regarding future investment needs, but talks had been taking place for more than a year before that, so the company was well aware that its funding programme would be considerable.

“We first started looking at hybrids about 18 months ago. We had preliminary conversations with the rating agencies and we appointed Barclays and Bank of America-Merrill Lynch as our structuring agents. They are our equity brokers so they know our business well but they are also leading players in the hybrid sector,” says Mr Cooper.

Even though initial discussions began in 2011, the company did not come to the market until March 2013. Management felt it would be premature to actually issue hybrid bonds until there was certainty about the company investment programme.

“The board received Ofgem’s proposals in December, considered them extremely carefully and finally approved them on February 27. We announced this to the market on February 28 and at the same time we said we would undertake a roadshow for a proposed hybrid bond transaction,” says Mr Cooper.

National Grid undertook an extensive roadshow because it had never tapped the hybrid sector before. It was also unsure which currencies it would be issuing in, out of sterling, euros and dollars, and it was unclear about the call dates too.

Good call

Hybrid transactions gain their quasi-equity status because they are deeply subordinated and extremely long-dated. But there is always a call option. The equity credit is lost after the call option so issuers are strongly incentivised to use it. Generally, the call option comes after five years but National Grid was keen to extend this date in light of its long investment programme.

“We spent a week on the road seeing or speaking to about 150 investors. I sent one team to Hong Kong and Singapore and I took a team round Europe. We went to London, Edinburgh, Paris, Amsterdam, Frankfurt, Munich, Geneva and Zurich. I went on 10 flights in four days!” says Mr Cooper.

The Asian roadshow was designed to gauge local appetite for a dollar-denominated hybrid. Demand was there – but at a price – so National Grid decided to focus on sterling and euro transactions.

This choice proved wise. The group wanted to raise £1bn and €1.25bn and both tranches were massively oversubscribed, with order books of £3.75bn and €5bn respectively. The company also achieved a call option of just over seven years for the euro tranche and just over 12 years for the sterling piece – an impressive achievement in this sector.

“We are an extremely low-risk investment proposition and that makes us very attractive to investors so we were able to get relatively long call dates,” says Mr Cooper.

The group also succeeded in obtaining the lowest ever yields for a corporate issuer in the euro and sterling hybrid market. The sterling coupon was 5.625%, following initial guidance of 5.75% to 5.85%, while the euro coupon was 4.25%, following initial guidance of 4.375% to 4.5%. Mr Cooper says the company could revisit the market in two or three years’ time.

“We were very pleased with the coupon levels we achieved. National Grid is a good credit and that helped us, clearly. Market conditions also played a part but we benefited too from the effort that we put into debt investor relations. We meet investors regularly, they know us and they understand us as a credit,” says Mr Cooper.

Institutional focus

Most of the bonds were taken by large, long-term institutional investors but there was also interest from private wealth offices, attracted by the relatively high coupon levels compared to plain vanilla bonds.

In Asia however, interest was almost exclusively from private investors who were pushing for a higher coupon than National Grid was prepared to pay. “Pricing indications were about 50 basis points more expensive than in Europe, which is a lot of money, and they wanted a call option after five years. But I don’t regret the Asian roadshow as it raised our profile in that market,” says Mr Cooper. 

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Read more about:  Banking strategies , Issuer , Western Europe , UK