Severn Trent's successful bond issuance amid a quiet sterling market

Market update

Capital markets

• Severn Trent (Baa1/BBB+/A-) issued a £350M 14-year sustainability-linked unsecured bond on Thursday, following a quiet period in the sterling bond market.
  • We have only seen six non-financial deals since the start of June (excluding gilt issuance).
• The bonds priced at a spread of G+155 for an all-in coupon of 5.875%.
• We can draw a number of interesting observations from the deal:
  • The issue spread represented a 14-20 basis points revision from the initial price talk (IPT) of 170-175 and a 22-basis-points new issue concession (NIC) to their credit curve. This is broadly in line with experience in the wider corporate market.
  • Orderbooks were very strong, with the deal some 4.5x covered with £1.6B of bids for the £350M sold, indicating high levels of demand.
  • Why was the deal such a success in our view? To some extent, this may show investors distinguishing the good from the bad in the wider water sector. This reflects feedback from investors on the deal.
  • It would be easy for investors to discount the water sector more generally, but this deal shows that they are willing to put the additional credit work in to realise value on specific deals or names. At the present, issuers approaching the sterling market have a monopoly on investor attention.
• In recent years we have seen greater focus on large, liquid issuance, with housing associations (HA) targeting £250M+ long-dated pricing points, and meeting pushback on smaller, shorter or otherwise non-standard deal formats.
• However, lack of supply may make the traditional investor base for HAs more receptive to smaller, sub-benchmark deals, without sacrificing economic value for issuers on spread or other terms.
• This would provide a boost to the market, particularly for those HAs who find it difficult to commit at size or tenor given wider pressures on the business.

Sterling rates market

• The 30-year gilt yield is c. 10 basis points below its 4.78% level at the start of the month. Earlier in the month, this difference was more pronounced at ~20 basis points.
• Such periods of gilt rallies present windows of opportunity for HA issuers who wish to achieve a target all-in rate. For example, 5.50% may be achievable and is a common level we hear among borrowers.
• Chatham believes that HAs would benefit from internal discussions on acceptable pricing and levels to approach the capital markets in second half of the year.
  
• This would help treasury teams and board members work together to define (and revise) an issuance window that would work for the long-term objectives of the business, pre-qualify what defines a ‘market opportunity’, and streamline the internal decision-making and approval process.
• Please reach out to the Chatham team if this is of interest to you or your organisation.

Interest hedging strategies

• Interest rate hedging decision making has historically been simple for HAs; focused on whether to fix or not to remain TMP compliant. Majority of fixes were also transacted on an ‘embedded’ fixed rate loan basis.
• With an increased preference for ISDAs from banks, HAs are being presented with an increased choice of hedging instruments.
• The decision-making process behind hedging is therefore no longer as simple as it used to be.
• One way to approach this is developing a well thought out interest rate hedging strategy. This should cover topics such as:
  • What rate your business plan can take, under both the base case and stress scenarios.
  • What you can afford to pay for upfront paid products (where applicable).
  • How the interaction of roll risk, mark-to-market, collateral, and interest rate protection might influence your hedging decision.
• Treasury teams and boards also need to have a good understanding of these new approaches to hedging in order to make informed decisions ahead of time.
• Chatham can assist with helping you develop your interest rate strategy to enable you to establish a structured hedging programme.

Economic news

• Headline CPI remained unchanged at 2.00% in June. More importantly, Services CPI remains high at 5.70%, against consensus of 5.60% and the Bank of England’s (BoE) 5.1 forecast.
• Another gauge for services inflation is the purchasing managers index (PMI) measuring private sector activity. The preliminary report for July suggests that there was a moderation in services inflation over the month, following a period of stickiness. While this should offer some comfort to the BoE, there were two insights suggesting an upside risk to inflation over the coming months:
  • There is an acceleration in hiring on the back of an uptick in business optimism and increased demand, indicating future pressure to pay growth.
  • Manufacturing sector input costs are steepening due to Red Sea-related supply chain disruptions.
• While inflation is back to target at 2.00%, it is expected to linger above 2.00% in the short-medium term. This is reflected in our business plan assumptions.
• We anticipate that the BoE will welcome signs of softening services inflation while taking a cautionary approach to some of these upside risks in the last four meetings of the year. The BoE's bank rate remained at 5.25% after the Monetary Policy Committee (MPC) voted by a majority 7–2 to keep it unchanged.

Indicative pricing