Telefonica Europe#s Proposed Hybrid Securities Rated #BB+# And Assessed As Having Intermediate Equity Content

Stocks and Financial Services Press Releases Tuesday March 13, 2018 17:25
PARIS--14 Mar--S&P Global Ratings

PARIS (S&P Global Ratings) March 13, 2018--S&P Global Ratings said today that it had assigned its 'BB+' long-term issue rating to the proposed hybrid notes to be issued by Telefonica Europe B.V., the Dutch finance subsidiary of Spain-based telecommunications group Telefonica S.A., which will guarantee the proposed notes.

We understand the group intends to use the notes' proceeds to replace an existing EUR1,125 million hybrid with a first call date in September 2018, which the group intends to call, and utilize the rest of the notes' proceeds to fund an expected repurchase of other existing hybrids. We understand that, after this replacement and other liability management transactions, the group intends to maintain the total amount of hybrids outstanding at its current level, corresponding to a ratio of outstanding hybrids to adjusted capitalization below 12% in our updated estimates. This is well below the 15% limit for us to view hybrid leverage as having intermediate equity content.

At the same time, we have reassessed the EUR1,125 million September 2018 first call hybrid as having minimal equity content, given the intent to call the instrument. We will also reassess, among other existing hybrids issued by Telefonica Europe, from intermediate to minimal equity content an amount corresponding to the portion of the proposed new hybrid that is in excess of the EUR1,125 million. This is because we understand that the group intends to execute liability management tenders among other existing hybrids issued by Telefonica Europe, or alternatively exercise any call of existing hybrids, and utilize this excess portion as a replacement. Therefore, the overall amount of hybrids that we assess as having intermediate equity content will be unchanged.

We classify the proposed hybrids as having intermediate equity content until the first reset date, because they meet our criteria in terms of their subordination, permanence, and optional deferability during this period. Consequently, when we calculate Telefonica S.A.'s adjusted credit ratios, we will treat 50% of the principal outstanding and accrued interest under the proposed hybrids as equity rather than debt, and 50% of the related payments on these securities as equivalent to a common dividend.

The two-notch difference between our 'BB+' issue rating on the proposed hybrid notes and our 'BBB' issuer credit rating (ICR) on Telefonica S.A. signifies that we have made the following downward adjustments from the ICR:

  • One notch for the proposed notes' subordination, because our long-term ICR on Telefonica S.A. is investment grade; and
  • An additional notch for payment flexibility due to the optional deferability of interest.

The notching of the proposed securities points to our view that there is a relatively low likelihood that Telefonica Europe will defer interest payments. Should our view change, we may significantly increase the number of downward notches that we apply to the issue rating. We may lower the issue rating before we lower the ICR.

KEY FACTORS IN OUR ASSESSMENT OF THE INSTRUMENT'S PERMANENCE

Although the proposed securities are perpetual, Telefonica Europe can redeem them as of the first call date, which falls more than five years after issuance, and every year thereafter. If any of these events occur, the company intends to replace the proposed instruments, although it is not obliged to do so. In our view, this statement of intent mitigates the issuer's ability to repurchase the notes.

The interest to be paid on the proposed securities will increase by 25 basis points (bps) not earlier than 10 years after the issue date, and by a further 75bps 20 years after the first reset date. We view the cumulative 100bps as a moderate step-up, which provides Telefonica Europe with an incentive to redeem the instruments after about 25 years.

Consequently, we will no longer recognize the proposed instrument as having intermediate equity content after the first reset date, because the remaining period until its economic maturity would, by then, be less than 20 years.

However, we classify the instrument's equity content as intermediate until its first reset date, as long as we think that the loss of the beneficial intermediate equity content treatment will not cause the issuer to call the instrument at that point.

KEY FACTORS IN OUR ASSESSMENT OF THE INSTRUMENT'S SUBORDINATION

The proposed securities will be deeply subordinated obligations of Telefonica Europe, and will have the same seniority as the hybrids issued in 2013, 2014, 2016, and 2017. As such, they will be subordinated to senior debt instruments, and only senior to common and preferred shares; we understand that the group does not intend to issue any such preferred shares.

KEY FACTORS IN OUR ASSESSMENT OF THE INSTRUMENT'S DEFERABILITY

In our view, Telefonica Europe's option to defer payment of interest on the proposed securities is discretionary. It may therefore choose not to pay accrued interest on an interest payment date because it has no obligation to do so. However, any outstanding deferred interest payment would have to be settled in cash if an equity dividend or interest on equal-ranking securities is paid, or if common shares or equal-ranking securities are repurchased.

That said, this condition remains acceptable under our rating methodology because, once the issuer has settled the deferred amount, it can choose to defer payment on the next interest payment date.
The issuer retains the option to defer coupons throughout the instrument's life. The deferred interest on the proposed securities is cash cumulative and compounding.

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