Author: AtlanticIS

Infrastructure

Spain’s new tax on nuclear and hydro power plants is credit negative

AtlanticIS

Spain, September 15, 2021 – The Spanish government published Royal Decree Law 17/2021, implementing measures to limit the effect of rising wholesale gas prices on consumers’ electricity and gas tariffs. The law follows a government proposal, currently being debated in parliament, to claw back incremental profits that owners of Spanish nuclear, large hydro and large renewables plants would have gained from higher carbon prices under a no-subsidy regime commissioned before October 2003.1

The new law is credit negative for Spain’s unregulated electricity and gas utilities because it introduces a revenue deduction that will weaken utilities’ credit metrics, heightens political risk and diminishes the opportunities for arbitrage for hydropower generation.

Based on current spot gas prices, the new law will incrementally weaken the financial profiles of Enel SpA (Baa1 stable), Iberdrola SA (Baa1 stable), Naturgy Energy Group SA (Baa2 stable) and EDP – Energias de Portual SA (EDP, Baa3 positive). Their ratios of funds from operations (FFO) to net debt would fall by 20-130 basis points, all else equal, in 2021-22 (see exhibit). Endesa SA (Baa1 stable), whose credit quality benefits from being 70%-owned by Enel, would record a 550-600 basis point decline in its FFO/net debt ratio, given Endesa’s larger proportion of earnings coming from Spanish nuclear and hydro generation.

Sources: Moody’s Financial Metrics and Moody’s Investors Service

The new tax does not take into account the level of hedging already implemented by Spanish utilities for their 2021-22 output at power price levels reflecting gas prices below current levels. Assuming the Spanish government does not extend the tax beyond March 2022, the effect of the clawback on FFO/net debt ratios would be more muted in 2023 at 10-40 basis points (excluding Endesa, for which the effect would be closer to 300-350 basis points). In addition, the negative effect of the tax could be more than offset by higher realized power prices in the generation business.

The law is also credit negative for owners of Spanish nuclear, hydro and large merchant renewables plants because there is a risk that the government will extend the tax if gas prices do not come down materially by March 2022. Additionally, the limit on the increase in TUR will have a modestly negative effect on Naturgy’s debt position, and to a lesser extent Endesa’s, because of a resulting working capital deterioration. Sales and EBITDA should continue to reflect a full cost pass-through, however.

Spain’s new measures include a revenue deduction on nuclear, large hydro and renewables plants not benefiting from a specific remuneration scheme. Indexed on Iberian spot gas prices from 16 September 2021 until 31 March 2022, affected power plants will be taxed under a formula reflecting Iberian spot gas prices as long as spot gas prices exceed €20 per megawatt-hour (MWh). Under that formula, 90% of the estimated upside in wholesale power prices attributed to the wholesale gas price increase will be taxed. The government estimates that the total tax collection, which will be used to reduce consumers’ electricity bills, will equal €2.6 billion.

The measure includes a cap on the increase in the protected gas tariff (TUR), limiting the fourth-quarter 2021 TUR to 4.4% instead of 28% if the TUR were to reflect current wholesale gas prices. The law also limits to 15% the next planned TUR tariff revision for the first quarter of 2022. The Spanish government also plans to implement forced auctions, whereby major power generators must auction some baseload power generation in the forward markets to improve liquidity and open the market to new suppliers. However, it is unclear how utilities that have sold in advance their power plants’ output can offer capacity in an auction without breaking existing contracts.

The law also imposes changes to Spain’s water law, implementing monthly discharges for hydropower plants and minimum volumes of water stored in reservoirs each month. This is to avoid unwanted environmental effects on reservoirs’ plant and wildlife. These changes will reduce arbitrage opportunities for hydropower plant operators and likely trim their profitability.

The Spanish government’s new law illustrates the increasing risks of political intervention related to affordability faced by unregulated utilities, and comes at a time when wholesale power and gas prices are rising significantly. Other EU countries are likely watching the Spanish example closely and may consider similar measures given the electricity sector was prone to political intervention 10-15 years ago, when power prices last spiked. Other countries’ inclination to follow Spain’s example will also reflect each government’s desire to signal energy policy stability and predictability in the context of material investments required to decarbonize Europe’s electricity systems.

Endnotes:

1 See Proposed profit clawback on nuclear and hydro is credit negative, impact modest, 4 June 2021.

Credit Outlook: 20 September 2021. Pg. 8
Moody’s Investors Service

Corporates

America Movil’s sale of Panama unit will benefit buyer C&W and its local peers

AtlanticIS

Panama, September 15, 2021 – Cable & Wireless Communications Limited (C&W, Ba3 negative) and America Movil, S.A.B. de C.V. (AMX, A3 negative) announced plans for AMX to sell its Claro Panama S.A. unit to C&W for $200 million. This transaction is positive for all participants, including the three remaining telecom competitors in Panama – C&W, Cable Onda, S.A. (Ba2 stable) and Digicel Group Holdings Limited (Caa2 stable) – because the deal would take AMX out of the Panama market, and allow a more rational competition.

The sale would also allow each competitor to hold more 5G cellular capacity, although a 5G auction date has yet to be set. AMX’s sale of Claro Panama would consolidate C&W as one of the largest operators in Panama.

The transaction has no material effect on the operators’ credit metrics, but it is credit positive for C&W, helping the company to consolidate its competitive position in Panama, C&W’s main market. C&W will generate 27% of its revenue in Panama, up from 22% today, and the new assets will represent around 6% of C&W’s consolidated revenue and around 4.4% of its EBITDA, as per our own estimates.

C&W plans to finance the acquisition using incremental borrowings and C&W own cash, which totaled $534 million as of June 2021. While the additional debt won’t be material, C&W’s debt/EBITDA ratio of 5.3x as of June 2021, including our standard adjustments, is high for the Ba3 rating category. We expect the company it to gradually return to pre-pandemic levels in 2022-23, although risks remain high.

The transaction will give C&W an improved market position in Panama with roughly half of the market share. We expect that the consolidated company will generate an EBITDA margin in the high-30 percent range, improving as it extracts synergies and improves its leverage.

Buying Claro Panama effectively gives C&W 760,000 more subscribers in Panama, on top of its roughly 1.6 million only in Panama, and 3.3 million subscribers, on a consolidated basis, as of June 2021.

Increasing competition since 2018 and later the coronavirus pandemic, have hampered C&W’s performance in recent years, costing the company some of its prepaid subscribers and reducing its average monthly revenue from subscriptions. A new marketing campaign in 2019 and continued upgrades to its network helped C&W’s curb its subscriber losses. But Panama’s restrictions on movement in 2020 because of the pandemic, which the government relaxed throughout the year but then reinstated in the first quarter of 2021, hurt C&W’s average revenue per user and its EBITDA. Those results came despite the company’s efforts to contain expenses and its addition of 61,100 mobile subscribers in the first quarters of 2021.

The transaction also benefits AMX, giving the Mexican telecom conglomerate $200 million that it plans to use to repay debt and further advance toward its net leverage ratio target of 1.50x from 1.64x as of June 2021. Claro Panama currently represents less than 1% of AMX’s consolidated revenue. AMX will retain the Claro Panama towers but plans to spin them off, along with most of its roughly 35,000 towers in Latin America, probably by early 2022.

C&W’s purchase of Claro Panama follows a pattern of telecom consolidation in Panama. In 2019 Cable Onda acquired Telefonica Moviles Panama, then the country’s mobile market leader. Panama fast-growing economy, with one of the largest growth rates per capita in the region, offers telecom operators there good opportunities for growth in a very competitive market.

Credit Outlook: 20 September 2021. Pg. 6
Moody’s Investors Service

Banking

Nubank expands product offering in Mexico with Akala acquisition, a credit positive

AtlanticIS

Brazil, September 21, 2021 – Brazilian leading online credit card fintech Nu Pagamentos S.A. (Nubank) announced the acquisition of Akala S.A. de C.V., Sociedad Financiera Popular, a savings and loans cooperative in Mexico, through its newly established Mexican subsidiary NU BN Servicios México, S.A. de C.V. (Nu Mexico). Nubank did not disclose the price of the transaction, but it has already received approval from Mexico’s banking regulator, Comisión Nacional Bancaria y de Valores (CNBV).

The acquisition is credit positive for Nu Mexico and Nubank in Brazil because it will provide the financial technology firm (fintech) with an operating license to access cheap and stable core deposits and allow Nu Mexico to launch new products and services to support its Mexican expansion. This transaction is also aligned to the parent’s growth plans in the region and the rapid implementation of its successful online credit card franchise focused on low income and underserved individuals. This also signals Nubank’s strategy to start its operations by leverage regulatory and market knowledge from local and licensed operating companies.

Acquiring Akala, which is regulated and has a financial services designation, demonstrates Nubank’s intention to fast expand its operations in Latin America’s second-largest economy behind Brazil. The Mexican market has garnered interest because of its favorable operating environment, low credit penetration and strong potential for financial inclusion. According to Mexico’s Instituto Nacional de Estadística y Geografía, the national census bureau, the country has around 70 million internet users and 65 million smartphones, but only 24 million people, or 25% of the country’s working age population, has a credit card.

By being able to receive deposits from the public, Nu Mexico will be able to start with low cost of funding, which will allow it to manage its prices and have a competitive position with incumbent banks that dominate the credit card business in Mexico. With an innovative and low cost business model, the fintech will likely challenge large banks to accelerate their investments in innovation and to expand its business lines beyond their traditional products and segments.

Nubank’s acquisition follows the deal announced by Credijusto (Apjusto, S.A.P.I. de C.V., SOFOM, E.R.), a small Mexican digital lender to small and midsize enterprises (SMEs), in June that acquired Banco Finterra, S.A., a local bank focused on offering financial services to SMEs in the agricultural sector. Such transactions (see exhibit) indicate a path for fintechs to overcome the high barriers to entry into Mexico’s banking sector, and signal that licensed fintechs and digital banks specializing in niche markets will intensify competition in various credit markets, challenging the profitability of smaller incumbent banks.

Sources: Dealogic, Moody’s Analytics and Moody’s Investors Service

It is unlikely that fintechs will displace large Mexican banks because large banks will retain their dominance in the financial system by focusing on customers at the top of the economic pyramid. By comparison, fintechs and digital banks usually cater to Mexico’s sizable unbanked and under-banked segments. Additionally, several Mexican banks are forming alliances with fintechs, creating fintechs through joint ventures with large technology companies or are seeking smaller fintechs that can accelerate and improve banks’ digital strategies.

Nubank’s expansion into Mexico began when the company opened its Mexican subsidiary in May 2019, its first operation outside Brazil. In June 2021, Nubank raised $750 million in capital. which allowed it speed up its Latin American expansion. The expansion plans received an additional boost when Nubank in April 2021 received a $70 million capital injection and $65 million in revolving credit lines from US banks.

Credit Outlook: 27 September 2021. Pg. 9
Moody’s Investors Service

Corporates

Companhia Siderurgica Nacional acquires Elizabeth Cimentos, improving diversity, a credit positive

AtlanticIS

Brazil, June 30, 2021 – Companhia Siderúrgica Nacional (CSN, Ba3 stable) announced that its fully owned cement subsidiary CSN Cimentos S.A. had entered an agreement to purchase Elizabeth Cimentos S.A. and Elizabeth Mineração Ltda. (collectively, Elizabeth Cimentos) for BRL1.08 billion ($220 million). The deal is credit positive for CSN because the additional capacity in the cement segment will help diversify its cash flow and foster growth, while hardly affecting its balance sheet and liquidity. The acquisition requires customary approvals, including from Brazil’s antitrust authority CADE.

CSN had a robust cash position of BRL18.2 billion at the end of March 2021, including its shares of Usinas Siderurgicas de Minas Gerais (Usiminas, Ba3 stable), and will report historically low leverage and generate free cash flow north of BRL10 billion in 2021, offsetting leverage and liquidity risks coming from this transaction. Additionally, the acquisition could be self-financed at CSN Cimentos’ level, assuming the successful conclusion of the subsidiary’s initial public offering (IPO), which will generate an estimated BRL2.5 billion and give CSN additional flexibility to pursue growth while also reducing debt during the peak of the steel and iron ore industries’ cycle this year.

The transaction involves the acquisition of a plant with an annual production capacity of 1.3 million tons that serves Brazil’s northeastern markets in the states of Paraíba and Pernambuco. This plant complements CSN Cimentos’ existing 4.7 million production capacity in Brazil’s southeast region in the states of Minas Gerais and Rio de Janeiro.

Pro forma for the transaction, CSN’s cement revenue has the potential to increase by about 30%, and the share of the cement segment in CSN’s consolidated results would increase to 3% of total revenue from 2% currently. Although still small relative to the group’s overall size, a larger footprint and scale in the cement business will provide a buffer to CSN’s consolidated cash flow during future downturns in the steel and iron ore markets, which contribute 51% and 42% to the company’s total revenue, respectively.

CSN’s adjusted EBITDA increased to BRL14.4 billion in the 12 months that ended March 2021 from BRL6.3 billion in 2019, and adjusted leverage declined to 2.4x from 4.8x on positive industry momentum. We expect CSN’s adjusted leverage ratios to decline to around 1x-2x over the next 12-18 months and to be within the 3.0x-4.5x range over time based on a range of price scenarios for iron ore 62% Fe of $70-$100 per ton and normalized steel operations. Net leverage, assuming a recurring BRL10 billion cash position, will fall to below 1x in 2021 and settle around 2-3x over time. Leverage ratios could strengthen depending on how much debt reduction the company pursues this year.

CSN’s credit quality and liquidity have improved materially since late 2020 amid a robust increase in cash and cash flow coming from strong steel and iron ore operations, and several liquidity-enhancing initiatives carried out by the company. These include the IPO of its mining subsidiary, the around BRL4 billion reduction in gross debt so far this year, the sale of about half of its preferred shares in Usiminas for BRL1.3 billion, the issuance of $850 million in new 10-year notes to tender the $925 million notes maturing in 2023, and the ongoing refinance of BRL3.4 billion in debt with Banco do Brasil S.A. and Caixa Economica Federal that come due in 2021-22.

Still, CSN’s track record of aggressive financial policies, including a highly leveraged capital structure, appetite for growth and dividend requirements to service debt payments at the parent level are key risks. However, we acknowledge that CSN is proving to be more conservative in its financial management and in preserving its credit quality even while pursing opportunistic acquisitions.

The acquisition will also help to consolidate Brazil’s fragmented cement market, improving the competitive landscape by rationalizing competition. Brazil has an annual installed cement production capacity of about 102 million tons, and had an annual consumption of 60 million tons in 2020. That is an improvement from the 2018 trough of 53 million tons, but still below the 2014 peak of 73 million tons peak. The sector has struggled with sequential contractions in cement demand since 2014, which led domestic cement prices to drop to a low of BRL25 per 50 kilogram bag in 2017-19, from nearly BRL35 in 2011.

Cement demand in Brazil was hard hit by lower residential construction derived from the country’s economic recession in 2015-16 and a retrenchment of public and private investments. In 2020, cement demand grew 10.9% from the previous year because of the strong performance of the self-construction segment and a pick-up of real estate construction activity, which together contribute to around 80% of the total cement consumption in Brazil. For 2021, cement demand growth will soften, reflecting less disposable income available for self-construction with the phase out of government support to individuals but still firm residential construction activity.

Credit Outlook: 5 July 2021. Pg. 8
Moodys

Banking

Peru allows state-guaranteed loans to be restructured, a credit positive for banks

AtlanticIS

Peru, March 9, 2021 – The Government of Peru (A3 stable) issued an emergency decree to allow banks to restructure loans under its state guarantee programs Reactiva Perú and FAE-MYPE until 15 July 2021 and also allow an additional 12-month grace period during which borrowers will repay only the interest portion of their loans.

By allowing banks to restructure existing Reactiva and FAE-MYPE loans through mid-July, allowing an additional grace period, and providing state guarantees for up to 98% of a loan (depending on its size), banks have strong asset-risk protection for longer. However, Peruvian banks also risk reduced interest income dragging down their margins.

The Reactiva Perú program was set up in April 2020 and is a PEN30 billion ($8.9 billion) state-guaranteed credit facility that provides working capital to small and midsize enterprises (SMEs) and large corporates. The program aims to relieve liquidity strain and limit the number of loan defaults among corporate and SME borrowers, which supports banks’ asset quality and the economy. The FAE-MYPE program targets small and micro agricultural producers and will be used by banks as well as credit cooperatives.

Under Reactiva, banks were awarded state guarantees in auctions that ensured the lowest rate for the end user for a 36-month loan with a 12-month grace period of no capital repayment. The government provides a guarantee to the lending bank for 80%-98% of the loan on a pro rata basis, depending on the size of the credit.Lending under the Reactiva Perú state-guarantee for corporations and SMEs now accounts for around 16.5% of total loans, according to Central Bank data. The program ended on 30 November 2020 which was the last date when state guarantees could be applied for.

Problem loans in Peru were 3.4% at year-end 2020, 75 basis points higher than year-end 2019 before the pandemic. However, government aid such as the Reactiva program is key to mitigate an expected deterioration in credit quality. The four largest banks in the market – Banco de Crédito del Perú (Baa1/Baa1 stable, baa21), Banco BBVA Perú S.A.(Baa1 stable, baa2), Banco Internacional del Perú – Interbank (Baa1/Baa1 stable, baa2) and Scotiabank Perú (A3 stable, baa3) – hold around 90% of total loans to midsize companies and almost 100% of total loans to SMEs and are the greatest beneficiaries of the Reactiva program.

However, the additional grace period will reduce Peruvian banks’ interest income as capital on restructured loans need not be paid, which will compress their net interest margins. We estimate that the average rate on Reactiva loans with a 24-month maturity is 1.6%, well below average rates on other loans. In 2020, bank net interest margins fell by 100 basis points as provisioning expenses rose 120%; net income to tangible assets fell to 0.4%, from the 2.1% 2016-19 average. With the ability to restructure loans and allow borrowers to pay only interest, the new measures will allow banks to keep their loan-loss provision expenses in check, which will aid their net income.

Under the new measures, loans of up to PEN90,000 can be restructured without any requirement, loans between PEN90,001 and PEN750,000 can be restructured if the borrower’s sales fell by 10% in the fourth quarter of 2020 versus fourth-quarter 2019 and for loans between PEN750,001 and PEN5 million, borrowers must show that fourth-quarter sales fell by 20% versus 2019.

Credit Outlook: 15 March 2021. Pg. 17
Moodys